Most money in M1 is not cash but bank deposits. To see how banks handle them, economists use a simple balance sheet called a T-account.
Key idea
A bank's assets (what it owns: reserves, loans, securities) equal its liabilities (what it owes: mainly customers' deposits) plus owners' equity. Reserves split into required reserves (reserve ratio × deposits) and excess reserves (everything above that).
Why it works
When you deposit \$100, the bank owes you \$100 on demand: to the bank, your deposit is a liability. The \$100 of cash it now holds is an asset, a reserve. Both sides rise by \$100, so the T-account still balances. Whatever the bank does next (lend, buy a bond), it only swaps one asset for another or changes both sides together; that is why assets always equal liabilities plus equity. Equity is the cushion that belongs to the bank's owners.
Worked examples
Worked example: Required and excess reserves
A bank has \$50,000 of deposits and \$8,000 of reserves. The reserve requirement is 10%.
- Required reserves $= 0.10 \times 50{,}000 = 5{,}000$.
- Excess reserves $= 8{,}000 - 5{,}000 = 3{,}000$ dollars, which the bank could lend.
Answer: Required \$5,000; excess \$3,000
Worked example: Owners’ equity
A bank has reserves of \$6,000, loans of \$30,000 and securities of \$12,000, with deposits of \$44,000. Find equity.
- Assets $= 6{,}000 + 30{,}000 + 12{,}000 = 48{,}000$.
- Equity $= 48{,}000 - 44{,}000 = 4{,}000$ dollars.
Answer: \$4,000
A note on today's rules: the Federal Reserve set reserve requirements to zero in March 2020, so U.S. banks now have no required reserves. Problems here use a made-up ratio to show how the textbook model works; banks still hold reserves to make payments and to meet other regulations.
Common mistake
Listing deposits as a bank's assets. To the bank, a deposit is money it owes the depositor: a liability. The matching asset is the cash or reserves it holds. Check: both sides of a T-account must change by the same total.