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The assets of banks are categorized into two broad groups, with a few sub-groups as follows (we ignore "other assets"):

• Central bank money:

- Notes and coins.

- Deposits (required and excess reserves).

• Loans:

- Non-marketable debt (NMD):

- Loans to non-banks.

- Interbank loans.

- Marketable debt (MD), i.e. investments.

Central bank money

Central bank money is the banks' holding of bank notes and coin (which are the central bank's liabilities), and deposits with the central bank. The latter is comprised of two accounts in some countries (current or settlement account and reserve account) and just one in others (called settlement or reserve account). The amounts held on this account/s are (1) the statutory required reserves (RR) of the banks, which are determined as a proportion of bank deposits (or liabilities), and (2) excess reserves (which may be held from time to time). Usually, interest is not paid on this account/s, meaning that the banks keep the minimum required reserves in these accounts

Ignoring the RR for a moment, the central bank account/s of the banks are also the clearing accounts, i.e. the interbank clearing takes place via these accounts.

Central bank money is only about 2-5% of total assets, and yet these accounts are at the very centre of the banking system and monetary policy. The central bank operates via these accounts to keep the banks short of reserves (usually), and accommodates them at the KIR. The latter is the "foundation" rate in the interest rate structure.


Bank loans are also called advances and credit. This portion of the banks' balance sheets makes up the vast majority of their assets. As we have seen, the following are the categories:

• Non-marketable debt (NMD):

- Loans to non-banks.

- Interbank loans.

• Marketable debt (MD), i.e. investments.

The vast majority of bank loans are NMD, i.e. small loans, to non-banks, and there are many types, for example:

• Installment sale credit (old name: hire-purchase credit).

• Suppressive sales agreements.

• Leasing finance.

• Credit card debtors.

• Foreign currency loans.

• Mortgage loans.

• Overdraft loans

Of these NMD, the last two are in the majority.

Interbank loans are the counterpart of the interbank loans that appear on the liability side of the balance sheet.

Marketable debt (MD) refers to the holdings of the banks of investments such as treasury bills, bonds, promissory notes, bankers' acceptances and commercial paper. As noted, banks also hold shares (ordinary / common shares and redeemable preference shares,), but this is unusual. In most cases, MD makes up a small proportion of assets.

Figure 11 is presented as a summary of the assets ("uses" of funds) of banks (as well as the liabilities). This brings us to one of the unique features of banks: the ability to create new deposits (= money) by making new loans.

the business of banking: full picture

Figure 10: the business of banking: full picture

Liability and asset portfolio management

Asset and liability portfolio management is the essence of banking, and every bank has an active asset and liability committee (ALCO) that meets frequently. In a nutshell, banks endeavour to balance liabilities and assets in such a way that the maximum profit is generated, given an acceptable risk profile.

The ultimate balance of liabilities and assets sought by banks is to have assets that generate the highest floating interest rate possible, and no credit risk, and liabilities that carry the lowest floating rate possible. To the extent that there is a term and rate (fixed versus floating) mismatch, the ideal portfolio construct depends on the interest rate view of the bank. If there is certainty in respect of interest rate movements, then in a falling rate environment (ideally with a positively sloped yield curve) assets should have the longest term possible and liabilities should be as short as possible. Conversely, in a rising rate environment, assets should have a short-term maturity and liabilities a long maturity. But, term mismatches are risky.

The reality is vastly different. Other banks are competing for business, clients of the bank require deposits and investments and accommodation that differ from the bank's ideal portfolio construct, interest rate movements can be volatile and unpredictable (and subject to shocks), and there are many risks that banks face.

Banks are in the business of lending funds. Thus, they have a disposition to grow their asset "books" to the extent dictated by the capital requirement, and to generate profits that can be added to capital resources (retained funds) in order to grow the book even faster. In the past history of banking, locally and internationally, a number of banks have "gone for growth at all costs", and in many cases the cost has been failure. For this reason the focus of the regulatory authorities is on risk management.

It is easy for a bank to grow its asset book, but with this comes risk in many forms. Thus banks have to balance the search for business with strict risk management. This is discussed at some length later.

Money creation

Bank assets and liabilities are not static. They increase mainly as a result of money creation. Thus will be discussed in detail later; here we present a simple example. Keep in mind that broad money, M3, is made up of bank notes and coins (N&C) + bank deposits (BD) (held by the domestic non-bank private sector - NBPS):

M3 = N&C + BD.

Of these BD is the largest (+/- 95%). BD increase when banks make new loans = buy NMD and MD.



1 Equity and liabilities


Bank deposits

-10 + 10


0 Total |





Equity and liabilities



Bank loan (overdraft)








Equity and liabilities

Loan to Company B

+ 10

Deposit of Company A

+ 10





Company A is a producer of goods required by Company B. Company B requires finance of LCC 10 million in order to purchase the goods, and approaches Bank A for a loan. After a credit check, the bank grants Company B an overdraft facility.

Company B draws a cheque for LCC 10 million on its overdraft facility and presents the cheque to Company A and takes delivery of the goods. Company A is thrilled to the back teeth with the sale and deposits the cheque with bank A. The cheque is put through the interbank clearing system, and the balance sheets of the respective parties end up as shown in Balance Sheets 1-3.

It will be evident that the deposit of Company A amounts to an increase in M3 (bank deposits held by the NBPS), and that its source was the increase in the overdraft granted to Company B and utilised by it (the real source of course was the demand for loans (A = change):

AM3 = ABD = Abank loans.

Questions immediately arise: can banks really do this in the real world? Surely there must be a brake on the system?

The answer is yes, the banks do this every day; in fact the system is designed to allow this to happen. The brake on the system, i.e. the mechanism that prevents the increase in money creation escalating out of hand, is monetary policy.

Off-balance sheet activities


The off-balance sheet activities of banks may be split into two categories as follows:

• Off-balance-sheet activities that carry risk.

• Off-balance-sheet activities and services that carry no or little risk.

Off-balance-sheet activities that carry risk

The off-balance sheet activities of banks that carry risk are many and include the following:

• Indemnities.

• Guarantees.

• Irrevocable letters of credit.

• Underwriting.

• Effective net open position in foreign currencies.

• Portfolios managed by others on behalf of the bank.

• Securities / commodities broking.

Off-balance-sheet activities that carry no or little risk

The off-balance sheet activities of banks that carry little or no risk are multi-faceted and include:

• Corporate finance (mergers, acquisitions, company listings).

• Debt origination (companies and government).

• Project finance.

• Bookkeeping services.

• Economic advice to corporate and individual clients.

• Advice on importing and exporting.

• General investment advising.

• Trust and estate services.


ABSA Bank Limited, 1992. Banks. In Falkena, HB, et al (editors), Financial Institutions. Halfway House: Southern Book Publishers.

Bessis, W, 1999. Risk management in banking. New York: John Wiley and sons.

Faure, AP, 2005. The financial system. Cape Town: Quoin Institute (Pty) Limited.

Heffernan, S, 2000. Modern banking in theory and practice. New York: John Wiley and sons.

Mishkin, FS and Eakins, SG, 2000. Financial markets and institutions. Reading, Massachusetts: Addison Wesley Longman, Inc.

Rose, PS, 2000. Money and capital markets (international edition). New York: McGraw-Hill Higher Education.

Saunders, A, 2001. Financial markets and institutions (international edition). New York: McGraw-Hill Higher Education.

Santomero, AM and Babbel, DF, 2001. Financial markets, instruments and institutions (second edition). Boston: McGraw-Hill/Irwin.

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