A bank’s balance sheet

In March 2023, customers of Silicon Valley Bank asked to withdraw about $42 billion in a single day. The money was not sitting in a vault. It had been lent and invested. The bank was closed the next morning.

Your savings account is an asset to you: money you own. To the bank it is the opposite, a debt it must repay when you ask. Your mortgage is a debt to you, but to the bank it is an asset: a stream of payments it expects to receive. To read a bank's balance sheet, flip your point of view.

Here is Example Bank plc, a made-up UK bank with £500bn of assets. The same five building blocks appear in almost every bank's accounts, under slightly different names.

Loans are the heart of the business: mortgages, credit cards, loans to firms. They are shown net of an allowance for expected lossesAn amount set aside against loans for losses the bank expects. Loans are shown net of it on the balance sheet., so the figure is what the bank expects to collect, not what it lent. Securities are mostly government and other high-quality bondsTradable financial assets such as government and corporate bonds.. They earn interest and can be sold or pledged quickly for cash. Next to them sits cash and central bank reservesMoney a bank holds in its own account at the central bank. Banks use it to settle payments with each other., the most liquid asset of all.

Customer deposits are the cheapest and usually the largest source of funding. Many can be withdrawn on demand. Wholesale funding is money borrowed in bulk from professional lenders: deposits from other banks, repoA short-term loan secured on bonds: the borrower sells bonds and agrees to buy them back later at a set price., and bonds the bank issues, including covered bondsA bank bond backed by a ring-fenced pool of loans, usually mortgages.. It is more expensive and can vanish fast when lenders get nervous. Subordinated debtDebt that is repaid only after deposits and senior debt if the bank fails. sits just above equity in the queue for repayment. Equity is what belongs to shareholders: the money they paid in plus profits kept over the years.

Names vary. A US bank shows “loans and leases” and “stockholders' equity”; an IFRS bank shows “loans and advances to customers” and “total equity”. Under IFRS 9 and US GAAP alike, some securities are carried at market value and others at cost adjusted over time, so a fall in bond prices does not always show up straight away in equity.

The accounting equation from L1.8.01 still holds. For a bank, write it with the bank's own building blocks:

Two consequences follow directly from it:

• A loss on any asset, with liabilities unchanged, comes straight out of equity: $\Delta E = \Delta A$ when $\Delta L = 0$.
• Repaying a depositor from cash moves both sides by the same amount, so equity does not change. Only a forced sale below book value creates a loss.

Hover over or tap each line to see what it is and the risk behind it. Then push a shock through the bank. Try 2% of loans going bad: what share of equity disappears? Then try a deposit run of 20%, and then 50%.

Losses are charged to equity before any tax relief. In a run, the bank pays from cash first and then sells investment securities at a 10% discount to their book value.

Depositors at Example Bank plc lose confidence and withdraw 20% of customer deposits. Follow the money. Try each step before you reveal it.

Almost every line of a bank's balance sheet has a rule attached. Thin equity is why regulators set minimum capital ratios under the Basel framework (L1.8.06). Short-term funding is why they set liquidity rules: the Liquidity Coverage Ratio and the Net Stable Funding Ratio, met in later levels. Deposit insurance, such as the FDIC's cover of up to $250,000 per depositor, per insured bank, for each account ownership category in the United States, aims to make runs less likely. The loss allowance on loans follows IFRS 9 or, in the US, CECL.

• Flip your viewpoint: deposits are the bank's liabilities, loans are its assets.
• The five building blocks: loans and securities (assets), deposits and wholesale funding (liabilities), and equity.
• Banks fund most assets with borrowing. Equity is often well under 10% of assets, so small losses matter.
• A loss on assets comes straight out of equity. A run drains cash first and only hurts equity when assets are sold below book value.
• Banks lend long and borrow short. That earns money and creates the risk of a run.

Central bank reserves

Money a bank holds in its own account at the central bank. Banks use it to settle payments with each other.

Securities

Tradable financial assets such as government and corporate bonds.

Loss allowance

An amount set aside against loans for losses the bank expects. Loans are shown net of it on the balance sheet.

Customer deposits

Money customers have placed with the bank in current and savings accounts. The bank owes it back.

Wholesale funding

Money a bank borrows from other banks, companies and investors in large amounts, rather than from ordinary savers.

Repo

A short-term loan secured on bonds: the borrower sells bonds and agrees to buy them back later at a set price.

Covered bond

A bank bond backed by a ring-fenced pool of loans, usually mortgages.

Subordinated debt

Debt that is repaid only after deposits and senior debt if the bank fails.

Maturity transformation

Funding long-term loans with short-term deposits. Banks earn from it, and it exposes them to runs.

Bank run

Many depositors withdrawing at once because they fear the bank will fail.