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18/06/2020 02:33:03 PM

Assets and Off balance sheet items of Commercial bank

Assets: Uses of Funds

Let’s start with the assets side of the balance sheet – what bank do with the funds they raise. Assets of bank are what bank claims against other institutions or people. They are divided into four broad categories: cash, securities, loans, and all other assets.

Cash Items

Cash assets are of three types. The first and most important is reserves. Bank hold reserves because regulations require it and because prudent business practice dictates it. Reserves include cash in the bank’s vault (vault cash) and bank’s deposits at the Central Bank. The goal is setting requirements high enough to ensure sufficient liquidity of the Banking System without unnecessarily cutting into profits. It is held to meet customers’ withdrawal requests.

Cash items also include what are called cash items in process of collection. When you deposit your paycheck into your checking account, several days may pass before your bank can collect the funds from your employer’s bank. In the meantime, the uncollected funds are considered your bank’s asset, since the bank is expecting to receive them.

Finally, cash includes the balances of the accounts that banks hold at other banks. In the same way that individuals have checking accounts at the local bank, small banks have deposit accounts at large banks, and those accounts are classified as cash.

Securities

The second largest component of bank assets is marketable securities. While banks in some countries can hold stock, U.S banks cannot.

Bank’s bond holdings are split between U.S government bonds and agency securities bonds.

These are very liquid and are a good backup for the bank’s cash balances. They can be sold quickly if the bank needs cash. For this reason, securities are sometimes referred to as secondary reserves

Loans

This is how they earn their most profit, but loans also carry risk. We can divide loans into five broad categories: Business loans, called commercial and industrial (C&I) loans; real estate loans, including home and commercial mortgages as well as and home equity loans; consumer loans like auto loans and credit card loans; interbank loans; and other types, including loans for the purchase of other securities. These types of loans vary considerably in their liquidity. Some, like home mortgages and auto loans, usually can be securitized and resold. Others, like small business loans, may be nearly impossible to resell.

The primary difference among various depository institutions is in the composition of their loan portfolio. Commercial banks make loans primarily to businesses; savings and loans provide mortgages to individuals; credit unions specialize in consumer loans.

Off-Balance-Sheet activities

Bank performs services that help reduce transactions costs and information costs as well as to transfer risk and generate fees. Many of these activities do not appear as either assets or liabilities on the bank’s balance sheet, even though they may represent an important part of a bank’s profit.

For example, banks often provide trusted customers with lines of credit. The firm pays the bank a fee in return for the ability to borrow whenever necessary. When the agreement is signed, the bank receives the payment and the firm receives a loan commitment. Until the firm has drawn down the credit line, the transaction appears on the bank’s balance sheet. The bank is compensated for reducing both transactions and information costs.

Letters of credit are another important off-balance-sheet item for banks. These letters guarantee that a customer of the bank will be able to make a promised payment. For example, a U. S. importer of television sets may need to reassure a Chinese exporter that the firm will be able to pay for the imported goods when they arrive. This customer might request that the bank send a commercial L/C to the Chinese exporter guaranteeing payment for the goods on receipt. By issuing the letter of credit, the bank substitutes its own guarantee for the U.S. importer’s credit risk, enabling the transaction to go forward. In return for taking this risk, the bank receives a fee.

A related form of the letter of credit is called a standby letter of credit. It is issued to firms and governments that wish to borrow in the financial markets. Commercial paper, even when it is issued by a large, well-known firm, must be backed by a standby letter of credit that promises the bank will repay the lender should the issuer default. This is true for state and local governments as well: in most cases, they need a bank guarantee to issue debt