Bank Balance Sheet & Income Statement Flashcards
What does a bank’s balance sheet show?
It lists the bank’s assets (what it owns) and liabilities (what it owes).
Where do assets and liabilities appear on a bank’s balance sheet?
Assets appear on the left, and liabilities (plus capital) appear on the right.
What is bank capital?
A cushion of funds that protects banks from insolvency due to asset devaluations.
What is the accounting equation for a bank’s balance sheet?
Assets = Liabilities + Capital
Why is capital important for banks?
It acts as a shock absorber for loan defaults, asset devaluations, and financial risks.
What are the most important types of bank assets?
Loans (commercial, industrial, real estate) and investments.
What are the most important types of bank liabilities?
Deposits (checkable and non-transaction), CDs, and borrowed funds.
What is the difference between checkable and non-transaction deposits?
Checkable deposits allow checks to be written, while non-transaction deposits do not.
What are certificates of deposit (CDs)?
Fixed-term deposits, often over $100,000, used as an investment alternative.
What is net interest income?
The difference between total interest income and total interest expense.
How do you calculate net income?
- Start with Net Interest Income
- Add Non-Interest Income
- Subtract Non-Interest Expenses
- Subtract Provisions for Loan & Lease Losses
- Subtract Taxes
- Adjust for Securities Gains/Losses & Extraordinary Items
How do you calculate Return on Assets (ROA)?
ROA = Net Income / Total Assets
How do you calculate Return on Equity (ROE)?
ROE = Net Income / Total Equity
What is the relationship between ROA and ROE?
ROE = ROA × Equity Multiplier (Total Assets / Total Equity)
What does Net Profit Margin measure?
How much profit a bank makes for every euro it generates in sales.
What does Net Interest Margin measure?
It evaluates how well a bank’s investments generate income relative to its interest expenses.
What is Total Shareholder Return (TSR)?
The sum of capital gains and dividends, divided by the initial stock price.
What is the Price-Earnings (P/E) ratio?
A measure of how overvalued or undervalued a firm is by comparing stock price to earnings per share.
What is the Price-to-Book ratio?
The ratio of the market value of stockholders’ equity to its book value.
What are the two main types of economic policies?
Fiscal policy and monetary policy.
Who conducts fiscal policy?
National governments.
What does fiscal policy involve?
Adjusting government revenue collection (taxes) and expenditures (spending).
Who conducts monetary policy?
Central banks.
What does monetary policy control?
The money supply and interest rates.
What is the primary goal of monetary policy?
To maintain price stability and financial stability.
What is money supply?
The total quantity of money available in an economy.
What is M1?
M1 = Demand deposits + Currency & Coins in circulation (most liquid measure).
What is M2?
M2 = M1 + Savings deposits + Small time deposits + Institutional money market mutual funds.
What is M3?
M3 = M2 + Large time deposits + Institutional money-market funds + Short-term repurchase agreements.
What are the three main tools of monetary policy?
- Official bank rate
- Open market operations
- Reserve requirements
What is the monetary base?
The sum of currency in circulation and reserve balances.
What is the official bank rate?
The interest rate set by the central bank, influencing all other interest rates in the economy.
What is the main goal of the Bank of England’s Monetary Policy Committee (MPC)?
To maintain an inflation target of 2%.
What happens when the central bank lowers interest rates?
Saving becomes less attractive, borrowing increases, and economic activity rises.
What happens when the central bank raises interest rates?
Saving becomes more attractive, borrowing decreases, and economic activity slows down.
What are open market operations?
The buying and selling of government securities by the central bank.
What happens when the central bank buys securities?
Reserves increase, leading to higher money supply and economic expansion.
What happens when the central bank sells securities?
Reserves decrease, leading to lower money supply and economic contraction.
What are reserve requirements?
The percentage of deposits that banks must hold in reserve, either as cash or deposits at the central bank.
How does a higher reserve requirement affect the economy?
It reduces the money supply by limiting the amount banks can lend.
How does a lower reserve requirement affect the economy?
It increases the money supply by allowing banks to lend more.
What is the money multiplier?
The inverse of the reserve requirement ratio (RRR), determining the potential increase in money supply.
What is the fractional reserve system?
A system where banks keep only a fraction of deposits in reserves and lend out the rest.
What is contractionary monetary policy?
A policy aimed at reducing money supply to control inflation.
What is expansionary monetary policy?
A policy aimed at increasing money supply to boost economic growth.
What is the difference between bank capital and bank reserves?
Bank capital absorbs financial losses, while reserves ensure liquidity.
What are bank reserves?
Cash or deposits held at the central bank, used to meet withdrawal demands.
Why do banks try to minimize excess reserves?
Because reserves do not earn interest when held as cash.
What happens if a bank has insufficient reserves?
It may be unable to meet customer withdrawals or regulatory requirements.
Why is capital important for banks?
It protects against loan defaults and asset devaluations.
Why do banks need to balance reserves and capital?
To ensure both liquidity for withdrawals and financial stability against losses.
