Kimura
VIP Member
A more relevant example: let’s say a bank customer borrows $20,000 and he takes it all in cash. The bank records a new loan worth $20,000, and simultaneously records a decrease of $20,000 in its cash assets. We have a total net balance which is 0. There are also different methods to calculate the interest on the loan from an accounting perspective.
Most of the time the borrower will accept the loan into a bank account. The bank credits the borrower’s account for $20,000 which is a liability for the bank. The bank records the $20,000 loan as an asset, so we have a balance sheet of 0. In this first instance the balance sheet is 0 since the decrease in cash assets are offset by an increase in the loan assets. The second instance is also 0 since the increase in the bank’s assets are offset by an equal increase in the liabilities of the bank.
Even if our borrower accepts the loan amount as a checking account balance, as soon as he begins to make purchases, some reserves will invariably exit the bank. It’s entirely possible that the reserves will not leave the bank in the event all of his spending went to depositors at the same bank. If this were to occur, the outcome of the settlement/clearing of payments would be a decrease in the bank’s liability to our borrower and an increase in liabilities to payees so to speak. Most of the time, at least in my experience, most individuals or firms the borrower ends up making payments to are depositors at other banks. Any bank settlements of the aforementioned payments will need a settlement between our two banks which will result in a wire transfer from the FED for reserve funds from our borrower’s bank to the other bank.
Let’s look at the first instance so I can tie it into your example. The borrower takes the $20,000 in cash. He spends the $20,000 in cash which is taken out of our bank’s vault when the loan was approved. Any of the businesses that receive his cash will ultimately make cash deposits at their banks at some point along the line. That cash ends up back in the vault at some bank and back in the banking system. The same would occur if our borrower spent by debit card, wire transfer or check. The clearing system mechanism will result in reserves shifting from our borrower’s bank into the reserve accounts of other banks.
Most of the time the borrower will accept the loan into a bank account. The bank credits the borrower’s account for $20,000 which is a liability for the bank. The bank records the $20,000 loan as an asset, so we have a balance sheet of 0. In this first instance the balance sheet is 0 since the decrease in cash assets are offset by an increase in the loan assets. The second instance is also 0 since the increase in the bank’s assets are offset by an equal increase in the liabilities of the bank.
Even if our borrower accepts the loan amount as a checking account balance, as soon as he begins to make purchases, some reserves will invariably exit the bank. It’s entirely possible that the reserves will not leave the bank in the event all of his spending went to depositors at the same bank. If this were to occur, the outcome of the settlement/clearing of payments would be a decrease in the bank’s liability to our borrower and an increase in liabilities to payees so to speak. Most of the time, at least in my experience, most individuals or firms the borrower ends up making payments to are depositors at other banks. Any bank settlements of the aforementioned payments will need a settlement between our two banks which will result in a wire transfer from the FED for reserve funds from our borrower’s bank to the other bank.
Let’s look at the first instance so I can tie it into your example. The borrower takes the $20,000 in cash. He spends the $20,000 in cash which is taken out of our bank’s vault when the loan was approved. Any of the businesses that receive his cash will ultimately make cash deposits at their banks at some point along the line. That cash ends up back in the vault at some bank and back in the banking system. The same would occur if our borrower spent by debit card, wire transfer or check. The clearing system mechanism will result in reserves shifting from our borrower’s bank into the reserve accounts of other banks.
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