The Bank Balance Sheet and Why It Reads Upside Down

A bank's balance sheet has deposits and borrowings on the liability side, advances and investments on the asset side, and a thin slice of net worth underneath. It reads upside down against a manufacturer's because the money a bank owes is the product it sells and the loans it made are the assets it holds, so the customer sits on both sides at once.

Every requirement, minimum and buffer named below is set by an authority that revises it, so four rows further down carry the authority and the address to read the current figure from. All the filled-in figures belong to one invented bank in one stated year, and every proportion is divided out from those figures.

Every balance sheet ever written says the same short thing. What is held equals what is owed plus what belongs to the owners, and the two sides meet because they are two views of one pile. What changes between a scooter factory and a bank is not the rule but what fills each side of it.

Consider a tailoring shop on a busy lane. Its assets are things that could be photographed: two machines, a rack of cloth, a cash box, and the money three regular customers still have to pay. Its liabilities are how those things were paid for: a loan against the machines, and a bill from the cloth wholesaler that has not been settled yet. A bank has almost nothing that could be photographed. Both of its sides are promises rather than objects, and the promises are its business rather than the way it financed one. The swap of objects for promises drives everything that follows, and it is why the intermediationStanding in the middle between people with spare money and people who need money, taking a claim from one side and giving a claim to the other. takes the shape of a balance sheet rather than a description.

Where should the reading of a bank's balance sheet start?

How a Bank Balance Sheet Works, read from the funding side downwards

Start on the side that says what the bank owes, and read down it. Reading downwards is not a stylistic preference. The funding side is the order the money actually arrives in: somebody hands the bank money first, and only then is there anything to lend or to hold. Reading the asset side first leads straight to Rs 1,44,000 crore of advances and to how the lending decision was made. The lending decision is a real question and the wrong one to ask second.

The funding side comes in three named parts, in size order. Deposits are the largest and they are also the thing the bank sells to the public. Then comes everything else the bank owes: money raised from people who are not depositors. Then, at the very bottom, net worth. Nobody lent the bank any of it. Net worth is the part left over once every other claim has been counted, and it is the reason the sheet ever balances.

Everything that follows hangs off that order. Money in, then money deployed, then whatever remains for the owners. Read in that direction, a bank stops looking like a strange company and starts looking like exactly what it is: a place where other people's money is gathered on stated terms and put somewhere else on different terms.

What are a bank's liabilities, and who holds the claim?

Every liability on a bank's balance sheet is a claim somebody else holds on the bank. Not a debt in the vague sense of an obligation hanging in the air, but a specific claim, held by a specific party, with terms attached. There are three kinds of holder and they are worth keeping apart.

A deposit is a claim held by a household or a firm, and it is repayable at parRupee for rupee, with no discount and no haggling. Rs 1,000/- paid in is a claim of Rs 1,000/-, whatever the bank did with the money afterwards.. Most of a deposit is repayable on demand, meaning whenever the holder asks. A borrowing is a claim held by another institution or an investor, repayable on terms that were written down when the money was raised. And net worth is the claim held by the owners. The owners are paid after every other claim has been paid, so their claim is the first one to shrink when something goes wrong.

Every one of those liabilities is somebody else's asset, one for one, with no rounding and no leakage in between. The pairing is not a metaphor about the system fitting together, it is an accounting fact that can be tested on a single household's money. A passbook says Rs 50,000/-. On the depositor's side that Rs 50,000/- is an asset, the largest one many households hold. On the bank's side the identical Rs 50,000/- is a liability, sitting inside its deposit line. One rupee, written twice, with opposite signs, and the pair nets to nothing. A claim whose second entry cannot be found means one of the two parties has been misread.

What are a bank's assets, and who owes what to whom?

Now turn the same question around. Every asset on a bank's balance sheet is a claim the bank holds on somebody else. An advance is a claim on a borrower, who has agreed to hand back money on a schedule. An investment is a claim on whoever issued the security the bank bought. A balance at the central bank is a claim on the central bank, sitting in an account the bank keeps there.

So a bank's balance sheet is claims on both sides, and the only thing that differs between the two columns is which way each promise points. Claims on both sides are what make a bank unlike a tailoring shop, a scooter factory or a wedding caterer. Suvarna Commercial Bank Limited holds Rs 2,40,000 crore of assets and almost none of it could be put in a photograph. The premises and the equipment are in there, inside a block of Rs 36,000 crore that this record does not break down any further, along with cash and the balance kept at the central bank. Everything else is a promise from somebody, written down.

Bank Assets vs Bank Liabilities, the two sides set beside each other

Set the two columns next to each other and the symmetry does the teaching. On the left, what Suvarna Commercial Bank Limited holds: advances of Rs 1,44,000 crore, investments of Rs 60,000 crore, and Rs 36,000 crore of everything else. On the right, who holds a claim on it: depositors with Rs 1,92,000 crore, then Rs 24,000 crore owed to somebody the record does not name, then the owners with Rs 24,000 crore. Same total, opposite directions, and the customer of the bank turns up in both columns rather than one.

What happens when one line on the sheet is missing?

A line the statement never printed is produced by subtraction. The identity that both sides must be equal is not a description of the statement, it is a tool for producing that missing line. The tool is the part most readers never use. A balance sheet is treated as something to read off, when it is also a small machine: three of four numbers produce the fourth.

The machine at work. Suvarna Commercial Bank Limited holds total assets of Rs 2,40,000 crore. Deposits account for Rs 1,92,000 crore of the funding and net worth accounts for Rs 24,000 crore. Deposits and net worth together add to Rs 2,16,000 crore. Taken from Rs 2,40,000 crore, Rs 24,000 crore is unaccounted for. The bank owes that much to somebody, on terms this record never states. No split for that line, and no description of what sits inside it, appears anywhere in the record.

What does the whole sheet look like once both sides are built?

Here is the finished thing, built line by line rather than copied down. Read the funding column first, then the deploying column, then check that the two totals match. The totals do match, and they have to.

The proportions follow, one division each, and few of them have to be told. Deposits over total assets is Rs 1,92,000 crore over Rs 2,40,000 crore, or 80.0 per cent of the sheet funded by the public. Advances over deposits is Rs 1,44,000 crore over Rs 1,92,000 crore, or 75.0 per cent. Advances over total assets is 60.0 per cent and investments over total assets is 25.0 per cent, so advances and investments together, at Rs 2,04,000 crore, are the earning assetsThe part of what a bank holds that pays it interest. Cash, premises and equipment sit outside it and pay nothing. of the bank. Everything else it holds is the remaining 15.0 per cent.

The arithmetic and its limit travel together, so the limit belongs beside the arithmetic rather than at the end. The record holds one year of one made up bank. There is no earlier year to compare it against, no second bank standing next to it, and no failure or cycle anywhere in it. The arithmetic reconciles to the rupee and reaches no further than itself: it will not turn into a rate for any other period, it is not evidence about what any way of running a bank achieves, and it is not typical of anything at all. Both of those sentences are true at once, and a reader who takes only the first has taken the more dangerous half.

Why does a bank's balance sheet read upside down against a company's?

Because of where the customer shows up, and that is the whole of it. Forget the layout of the statement for a moment and follow one person through both businesses instead.

Take a furniture workshop. Its customer appears on the asset side and nowhere else, as an amount still owed for a dining table delivered last month. The workshop's liabilities have nothing to do with its customers: they are a term loan and a bill from the timber supplier, and both exist because the workshop had to pay for the things it works with. For a manufacturer, the liability side is how the business was paid for and the customer sits on the other side entirely.

Now take Suvarna Commercial Bank Limited. Its customer appears twice. Taking that money is a service the bank sold, so a depositor sits inside the Rs 1,92,000 crore on the funding side. Lending is the other service, so a borrower sits inside the Rs 1,44,000 crore of advances on the deploying side. Depositor and borrower can be the same person on the same afternoon, and that is what makes a bank's liabilities its business rather than its financing. A schoolteacher with a salary account and a housing loan at the same branch is on both sides of that sheet at once, and nothing about that is unusual.

Why is what a company calls debt a bank's raw material?

Most of what anybody absorbs about company finances runs the other way, and instinct has to be turned around. A manufacturer works to carry less debt. Each rupee of it costs interest, none of it does anything on its own, and a year that ends with less of it is usually a better year than one that ends with more.

A bank gathers the equivalent line deliberately. Deposits are not how the bank paid for its business, they are the business, so a bank carrying fewer of them is a smaller bank rather than a safer one. Cutting Suvarna Commercial Bank Limited's deposits in half does not tidy up its finances; it halves the business the bank lives on and takes most of its advances with it.

The street version is exact rather than merely friendly. A shopkeeper wants a smaller loan. The loan is a weight on a shop that would run better without it. A wholesaler wants a fuller godown. The stock is what the wholesaler sells. Both statements are correct and they are about different businesses. Deposits are a bank's stock, and an empty godown has never been a sign of prudence.

How much of the sheet is the owners' money?

A tenth of it, and the answer can be said three different ways without becoming three different facts. Net worth is 10.0 per cent of total assets. Total assets are 10.0 times net worth. Deposits on their own are 8.0 times net worth. Rs 1,92,000 crore over Rs 24,000 crore is exactly eight. The three statements are one division read from three directions, and a reader who files them as three separate findings has begun double counting the same balance sheet.

Now take the consequence, and compute it rather than accept it. If the assets are worth Rs 2,40,000 crore and the owners' claim is Rs 24,000 crore, then a fall of Rs 24,000 crore in what the assets are worth is a fall of 10.0 per cent, and it is also the entire owners' claim. Every 1.0 per cent knocked off the asset side is Rs 2,400 crore, so it takes ten of those to reach the bottom of the slice. The whole calculation is one division, and it is why the thinnest strip on the sheet gets more attention than every fat line above it. The division is not a judgement about the bank. The division measures how much room there is.

Which raises the question every reader asks next. How much of that slice must a bank hold? Which instruments are allowed to count as it? How much extra has to be stacked on top in good years? All three belong to capital adequacyThe set of rules deciding how much of an institution's own money has to stand behind what it holds, and which kinds of money are allowed to count., they are the Reserve Bank of India's to set and to change, and the framework they grew out of was first written down internationally by the Bank for International Settlements. Each of those amounts is set by a rule that can move, so the form names the rows and prints beside each one the address the current answer is published at. A requirement recalled rather than read from the source stops being true on the morning the rule moves.

What does this balance sheet refuse to show?

Three things, and each of them is an absence worth naming rather than a gap to be filled.

The sheet shows no dates. Every line on the sheet carries a size and not one of them carries a schedule, so the statement never says when a deposit can be asked for or when an advance next repricesChanges the interest rate it carries, either because the rate was always floating or because the agreement comes up for renewal.. Rs 1,92,000 crore of deposits could in principle be asked for over years or over a fortnight, and the number would look identical either way.

The sheet shows no split of any line. The Rs 36,000 crore the bank holds beyond advances and investments is one figure covering cash, the balance at the central bank and the premises, and this record breaks it into nothing smaller. The Rs 24,000 crore the bank owes beyond its deposits and its net worth is the same story from the other side.

And it is a position at one instant rather than a year. Nothing on it is a flowAn amount measured over a stretch of time rather than at a moment, such as interest earned across a year. A balance is the opposite: a photograph taken at one instant., so it does not show what came in or went out to arrive at these balances. The balance sheet is a photograph, and a photograph of a busy junction shows where the vehicles are and nothing whatsoever about where they were going.

What this record does not carry

There is one year and one bank behind everything above. There is no quarterly series, no split of the advance book by segment or by sector, no maturity buckets, no restructured book, no written off book, no borrower detail, no branch or employee count, no split of the Rs 36,000 crore of assets that are neither advances nor investments, and no split of the interest bill between depositors and everybody else the bank owes. Where one of those is needed, the honest move is to say so and work with what exists. An invented line would look identical to a reported one, and no reader could tell them apart.

How does somebody actually read this sheet in practice?

What is worth keeping from a bank's balance sheet?

Four sentences, and the rest hangs off them.

1. Both sides are claims, pointing opposite ways. A bank holds promises other people made to it and owes promises it made to other people, and it holds almost nothing that could be photographed.
2. Read the funding side first and read it downwards. Deposits, then everything else owed, then the residual that belongs to the owners.
3. The identity is a tool, not a description. Three known lines produce the fourth by subtraction, and where the record stops, the gap is named.
4. The leverage is the consequence of taking deposits. Net worth at 10.0 per cent of assets, assets at 10.0 times net worth and deposits at 8.0 times net worth are one fact said three ways.