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Bank balance sheets and fractional reserve banking | APⓇ Macroeconomics | Khan Academy - YouTube
Channel: Khan Academy
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in this video we're going to talk about
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balance sheets and in particular balance
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sheets for
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banks and a fractional reserve lending
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system now it's not just banks that have
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balance sheets all corporations have a
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balance sheet you can even have your own
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individual balance sheet that is a
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snapshot of what do you have a value and
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what do you owe to other people now the
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things that you have a value if we're
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talking about a bank the things that the
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bank has of value those are called
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assets
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and that could be cash that the bank has
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in its vaults it might be property that
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the bank owns
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and the things that the bank owes to
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other people
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are liabilities
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why uh
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and this might be money that the bank
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owes to someone else some future lobby
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obligation
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now there's this other notion of equity
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and when we're talking about a
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corporation like a bank equity is what's
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left over if you take your assets and
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you subtract your liabilities equity is
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you could view it as the net worth how
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much net value is owned by the
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shareholders and to make this tangible
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you can look at an analogy to your
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everyday life
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if you're thinking about your own
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personal balance sheet let's say the
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only asset you owned was a car that was
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worth ten thousand dollars
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ten thousand dollar car so that is your
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asset
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and let's say that you only have one
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liability you had to borrow eight
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thousand dollars in order to buy that
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ten thousand dollar car
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so this is something that you owe to
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other folks so that is your liability
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what would be your equity here what
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would be your net worth well if you own
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something worth ten thousand dollars if
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all of your assets are ten thousand but
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you owe eight thousand
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what you have left over that's going to
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be two thousand dollars
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and so this would be your equity in
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everyday language is often times the net
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worth and so assets minus liabilities is
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equal to equity or if you add
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liabilities to both sides of that you
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could say that assets
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are equal to
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liabilities plus
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plus
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equity
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and so when you see many balance sheets
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it's typical to see it in two columns on
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the left hand side you have assets and
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on the right-hand side you have
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liabilities plus equity and these two
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things should add up to the same amount
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so whatever assets are liabilities plus
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equity should add up to that same amount
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so now let's use this framework to start
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ourselves a bank and so let's say we
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immediately go and buy a building and
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some equipment worth a million dollars
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just to even have a place to run the
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bank and so we immediately have assets
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of building
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building
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plus equipment
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plus equipment of
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one million dollars
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now i just said whatever our total
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assets are that would be our liabilities
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plus our equity
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so in this situation what are our
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liabilities so far remember the balance
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sheet gives us a snapshot at any moment
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in time
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well so far i don't owe anything to
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anyone i'll just assume that i had that
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million dollars i didn't have to borrow
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from anyone to to get that million so i
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have zero dollars in liabilities and so
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what would the equity be pause the video
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and think about that
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well liabilities plus equity needs to be
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one million dollars if liabilities is
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zero then our equity is one million
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dollars so if i'm the owner of the bank
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this tells me that the value of what i
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own is one million dollars
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but as we know banks don't exist just to
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be a building they take deposits from
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people and then they make loans to
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people so let's say someone's walking
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down the street and they see our bank
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and say hey that looks like a good place
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to deposit their money it looks like a
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safe place maybe they'll get some
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interest on it and so they come and they
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give a million dollar cash deposit they
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have a suitcase with a million dollars
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of cash in it so how would that be
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reflected on this balance sheet
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well it would actually get categorized
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as reserves
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reserves you can view as the federal
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reserve notes the cash that it has on
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hand it could be money that's in its
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vaults it could be an account that it
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has with the central bank although that
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gets a little bit more sophisticated but
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you should just you can visualize it as
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its cash one way to simplify it and so
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in this situation your reserves are now
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going to be one million dollars where
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did that come from it came from that
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suitcase of cash that that person gave
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now what happens on the right hand side
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of this balance sheet they didn't just
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give us the money at some future point
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in time they might withdraw some or all
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of that money our liabilities now so we
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now have a demand deposit let me write
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it this way
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demand deposit
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for
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one million dollars and this is a good
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time to pause this video and really
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understand this because this is
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essential for understanding banks is
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that yes we got that cash but it's
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offset by a liability because at some
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point in the future we have to give that
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million dollars back to that person who
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made that deposit and they can come on
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demand
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now you might be saying all right this
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is all nice but how am i as a bank going
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to make money and the main way that
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banks make money is by making loans but
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how do they loan out the money if all of
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this is on demand deposit well in a
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fractional reserve system you don't have
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to keep all of your demand deposits on
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hand as reserves you can actually lend
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out a good chunk of it and it's dictated
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by what the required reserve ratios are
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so let's say in the country we're in or
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the jurisdiction we're in the required
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reserve ratio so required
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required
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reserve
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ratio
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is 10
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of demand deposits
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that means that we can look whatever our
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demand deposits are we have to keep ten
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percent of that in reserves and then the
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excess reserves we can loan out and so i
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can now group my reserves and instead of
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saying a million dollars of just total
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reserves i could sub categorize it as
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required reserves
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required
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reserves
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and excess reserves
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now what do you think are going to be
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the required and excess reserves in this
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scenario pause this video and figure it
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out well required in excess are going to
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add up to my total million dollars of
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reserves the required reserves are 10 of
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the my demand deposits so i have to keep
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10 of this million dollars which is 100
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000
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and then the rest is excess reserves of
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900 000
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and so this model is based on the idea
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that statistically especially if these
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demand deposits are coming from many
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different people it's unlikely that more
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than 10 percent will be will be
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withdrawn at any moment in time and we
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can talk about runs on banks where this
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tends to break down and so banks will
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then lend out this other 90 of the
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demand deposits or up to 90 of the
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demand deposits and they lend them out
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to people they think are likely to pay
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back the money with interest and that
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interest is how banks make the money and
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so this bank could say hey i have 900
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000 of excess reserves which i which i
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can use to make loans to other people
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and so let's say a bunch of people come
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by and they have some good ideas and we
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think that they're going to pay us back
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so what we do is we can take those
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excess reserves up to 900 000 of them
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and instead of having it as excess
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reserves we can put them out as loans so
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we can make loans of 900
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000. now one thing that might be
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counterintuitive to some of you is say
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wait i'm used to a loan being something
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like a liability here we just said we
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owed people money and so that was an
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obligation to other people why is it an
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asset here
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well it depends if you are the lender or
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the person borrowing the money here as
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the bank we are the lender the loan is
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an asset because someone is going to pay
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us money back in the future this has
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value if we owed money to someone else
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well then that would be a liability
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and so now notice here the whole time
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that we were doing this the assets were
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equal to the liabilities plus equity
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assets right now are two million dollars
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one million plus one hundred thousand
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plus nine hundred thousand and our
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liabilities plus equity are two million
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dollars one million in liabilities one
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million in equity
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