Bank Transactions and Balance Sheets: Explained

How do bank transactions affect balance sheets?

What happens when Singleton Bank lends $9 million to an auto supply company? What are the impacts on both banks involved in the transaction?

Understanding Bank Transactions and Balance Sheets

When Singleton Bank lends $9 million to an auto supply company, it records the loan as an asset on its balance sheet. The recipient's bank, First National, sees an increase in deposits and reserves by the same amount, with a 10% reserve requirement leaving the remainder available for lending.

Bank transactions, such as loans, have significant impacts on the balance sheets of both the lending and receiving banks. Let's delve into how these transactions unfold in the banking system.

When Singleton Bank extends a $9 million loan to Hank's Auto Supply, it categorizes this loan as an asset on its balance sheet. This asset is expected to generate income for Singleton Bank in the form of interest payments from the borrower.

Upon receiving the loan, Hank deposits the $9 million into his account at First National bank. This deposit causes an increase in both deposits and reserves at First National. However, due to regulatory requirements, First National must maintain a certain percentage of these new deposits as reserves, known as the reserve requirement.

In this case, with a 10% reserve requirement, $900,000 of the $9 million deposit must be held as reserves, leaving $8.1 million available for lending by First National. This mechanism is part of the fractional-reserve banking system, which allows banks to expand the money supply by issuing new loans based on a portion of the deposited funds.

Both banks update their balance sheets accordingly to reflect these changes. Singleton Bank acknowledges the new loan asset and its associated income potential, while First National notes the increase in deposits, reserves, and liabilities due to the new deposit.