Taylor Scott
Banks are unique institutions that primarily deal with money and provide money-related services. Their assets are comprised of three main categories: cash and cash equivalents, earning assets, and non-earning assets. Cash and cash equivalents refer to the funds deposited in a central bank, while earning assets include loans, credits, and securities such as stocks and bonds. Non-earning assets are the infrastructure that enables the bank to function, including buildings and technology. Banks also have liabilities, which include customer deposits and debt. The balance sheet of a bank is a summary of its assets and liabilities, with equity representing the bank's own resources, such as shareholder capital and retained earnings. Understanding a bank's balance sheet is crucial to grasping its financial health and stability.
| Characteristics | Values |
|---|---|
| Cash and cash equivalents | Funds deposited in the central bank that can be immediately converted into cash |
| Earning assets | Total of all the credit and loans granted; securities portfolio such as stocks, public or private debt, derivatives |
| Non-earning assets | Infrastructure for the bank to function, including buildings, branches, IT systems, and furniture |
| Equity | The bank's own resources, including shareholders' contributed capital and retained earnings |
| Loans | Money loaned to borrowers |
| Securities | Investments or government securities |
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What You'll Learn
Cash and cash equivalents
Cash includes currency and demand deposits, such as checking, savings accounts, and money market accounts. Money market accounts (MMAs) and certificates of deposit (CDs) are bank accounts that pay interest. MMAs can be accessed at any time, whereas CDs have a specified amount of time during which withdrawals are not supposed to be made, usually between three months and 10 years.
Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and are subject to insignificant changes in value. They are often a more efficient use of capital compared to keeping cash in a basic bank account, as they offer the same accessibility and tend to pay more interest. Common types of cash equivalents include government bonds, money market funds, and commercial paper.
Regulatory agencies may require financial institutions to maintain specific cash and cash equivalents to guarantee that they have adequate funds to satisfy their customer commitments. Exchange rate variations can also influence a company's reported cash balances, liquidity, and ability to satisfy short-term financial demands.
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Earning assets
For banks, earning assets include any assets that directly generate income, such as interest-generating investments or income-generating rentals. This can also include other forms of assets that directly contribute to income, such as machinery or computers, or anything directly involved in producing goods and services to be sold.
The yield on earning assets is a financial solvency ratio that compares a financial institution's interest income to its earning assets. A high yield on earning assets is an indicator that a bank is bringing in a large amount of income from its loans and investments. This is often the result of good policies, such as appropriately priced loans and well-managed investments. A high yield also indicates that a bank can meet its short-term debt obligations and is not at risk of default or insolvency.
To calculate the earning assets to total assets ratio, bank analysts divide the average earning assets by the average total assets. This ratio indicates how effectively a bank is generating earnings with its underutilized assets.
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Non-earning assets
A bank's assets are typically divided into three categories: cash and cash equivalents, earning assets, and non-earning assets. Non-earning assets are those that are necessary for the bank to function but do not directly generate income. This includes the physical infrastructure of the bank, such as its buildings, branches, IT systems, and furniture. These assets are essential for the bank to carry out its operations and provide services to its customers.
NPAs are loans or advances that are past due, typically for 90 days or more, and are no longer generating income for the bank. These assets can arise from business failures, poor credit assessments, or borrowers defaulting on their loans. NPAs impact the bank's profitability and financial health, reducing their ability to lend and potentially threatening their operations. To manage NPAs, banks may seize and sell assets pledged as collateral or write off the loan as a bad debt, resulting in a total loss for the lender.
The management of NPAs is crucial for banks to maintain financial stability and meet regulatory requirements. Banks set aside provisions, allocating funds from their earnings to cover potential losses associated with NPAs. Additionally, banks are required to make their NPA numbers public, providing transparency into their financial health. High NPA ratios can lead to tighter regulations and a loss of market trust, further impacting the bank's operations and profitability. Therefore, non-earning assets, while not directly generating income, are essential for the bank's functioning, while NPAs, or non-performing earning assets, can create significant challenges for the bank and the broader economy.
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Equity
In the context of a bank, equity can refer to the shareholders' stake in the bank, which is identified on the bank's balance sheet. The calculation of equity is the bank's total assets minus its total liabilities. This value is sometimes referred to as total equity or shareholders' equity.
In the case of a bank account with a prior balance, there may be some ambiguity about whether to classify it as an asset or equity. If the balance came from personal money injected into the business, it could be recorded as Owner's Equity or a Loan to the Company. If the balance came from a business loan, it would be classified as a liability.
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Investments and securities
Investment securities are a category of securities or tradable financial assets that banks hold in their portfolios. They are one of the two main sources of revenue for banks, the other being loans. Investment securities can be found on the balance sheet assets of many banks and are carried at amortized book value.
Investment securities held by banks as collateral can take the form of equity (ownership stakes) in corporations or debt securities. Equity stakes can be in the form of preferred or common shares. Debt securities can take the common forms of secured or unsecured corporate debentures. (Secured corporate debentures can be backed by company assets, such as a mortgage or company equipment). In this case, secured debt (also called investment-grade) would be preferred. Treasury bonds or Treasury bills and municipal bonds (state, county, municipal issues) are also options for a bank’s investment securities portfolio.
Other types of investment securities can include money-market securities for quick conversion to cash. These generally take the form of commercial paper (unsecured, short-term corporate debt that matures in 270 days or less), repurchase agreements, negotiable certificates of deposit (CDs), bankers' acceptances, and/or federal funds.
Securities are the traditional method used by commercial enterprises to raise new capital. They may offer an attractive alternative to bank loans, depending on their pricing and market demand for particular characteristics. A disadvantage of bank loans as a source of financing is that the bank may seek a measure of protection against default by the borrower via extensive financial covenants.
Through securities, capital is provided by investors who purchase the securities upon their initial issuance. In a similar way, a government may issue securities when it chooses to increase government debt. Securities are traditionally divided into debt securities and equities. Debt securities may be called debentures, bonds, deposits, notes, or commercial paper depending on their maturity, collateral, and other characteristics.
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Frequently asked questions
A bank's assets are the loans it makes to borrowers. They include cash, investments or securities, and loans and advances made to customers, primarily corporations.
A bank's assets can be divided into three types:
- Cash and cash equivalents
- Earning assets
- Non-earning assets
Earning assets are the total of all the credit and loans granted. They also include a bank's securities portfolio, such as stocks, public or private debt, and derivatives.
Non-earning assets include all the necessary infrastructure for a bank to function, such as buildings, branches, IT systems, and furniture.
