This video breaks down a bank's balance sheet even further by walking through assets, liabilities, equity, required reserves, and excess reserves.
Practice this yourself on Khan Academy right now:https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/ap-financial-sector/banking-and-the-expansion-of-the-money-supply-ap/e/fractional-reserve-banking
Watch the next lesson: https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/ap-financial-sector/banking-and-the-expansion-of-the-money-supply-ap/v/money-creation-in-a-fractional-reserve-system-ap-macroeconomics-khan-academy
Missed the previous lesson? Watch here: https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/ap-financial-sector/definition-measurement-and-functions-of-money-ap/v/commodity-money-vs-fiat-money
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This is a good simplified explanation, but I think it's important for anyone wanting a more in-depth understanding to know that reserves do not have to come first in our system. All banks are connected through the Federal Reserve, which is first and foremost a clearing house for interbank transfers, but also serves to facilitate interbank loans. That is the "Federal Reserve Rate" that is talked about so often; the rate at which banks loan each other money. The "Target Rate" is what the Federal Reserve board has voted and decided to make the rate that they want the system to have.
If a bank does not have the reserves to meet the requirement, they take a loan from another bank, overnight, to satisfy the requirements. The most important ramifications of this is that deposits do NOT have to come first, and a bank can make loans in excess of what its deposits would support, and make up the difference with overnight loans. In the US system, loans come first, and it is literally the creation of money (and an equal liability.)
If the entire banking system does not have the reserves to satisfy requirements, then banks can get loans directly from the federal reserve through the "discount window" that is traditionally more expensive (in the cost of interest payments, usually 0.5% more than the target rate) than other banks, and even more expensive than the interest rate paid for deposits.
Another interesting chart is this, https://fred.stlouisfed.org/series/EXCSRESNS from the federal reserve that shows that we have an unprecedented amount of reserves over the last decade, and no bank is going to the discount window for overnight loans because there is just so much excess money in the system currently. The Federal target rate does not currently have much power behind it, because banks don't HAVE to comply with it, and can loan to each other at whatever rate they want; and that's only when banks HAVE to take loans, which the vast majority are not needing right now.
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