Public funding of failing banks in the European Union (LBF vol. 19) 2020/2.3.1:2.3.1 The balance sheet of a bank

Public funding of failing banks in the European Union (LBF vol. 19) 2020/2.3.1

2.3.1 The balance sheet of a bank

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As a result of the great diversity of banking models, there is no one-size-fits-all-approach to describe the balance sheet of a bank. Table 1 shows a hypothetical example of the balance sheet of a universal bank. The universal banking model currently still is the predominant banking model within the EU.1

Table 1: Hypothetical example of universal bank balance sheet2

Balance sheet

Assets

Equity and liabilities

Cash and balances at central banks

Equity

Residential mortgages

Share capital

Loans and receivables – customers

Share premium

Loans and receivables – banks

Reserves

Securities financing

Capital securities

Derivatives

Financial investments

Liabilities

(e.g. in interest-earning securities)

Client deposits

Other assets

Bank deposits

Long term & subordinated debt

Short-term debt

Securities financing

Derivatives

Other liabilities

The equity and liabilities side of the balance sheet always has to be equal to the assets side of the balance sheet. This means that the sum of all equity and liabilities always has to be equal to the sum of all assets.

The assets side and the equity and liabilities side of the balance sheet of a bank together reflect the funding profile of a bank.

In a Recommendation dated 20 December 2012,3 the ESRB set out the liabilities breakdown of Eurozone banks on the basis of a comparison be tween the funding structure of the balance sheets of Eurozone banks as of the end of 2005 with that as of the end of 2011.

Figure 1: Liabilities breakdown of Eurozone banks

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Source: ESRB Recommendation on funding of credit institutions 2012

It can be derived from this chart that the largest share of liabilities of a bank is normally made up of client deposits, followed by intra-monetary financial institutions (MFIs) deposits4 and long term securities. On average, shares and other equity only make up a small percentage of total liabilities. This percentage even further decreased during the GFC.

The largest share of assets of a bank is normally made up of loans to customers.5 These customers can e.g. be retail customers or corporate customers. The loans can take many different forms. They can be residential mortgages, consumer loans or corporate loans, security backed or not, with a fixed or variable interest, long term or short term, etc. Other assets on the balance sheet of a bank are, for example, loans to other MFIs, derivatives contracts or securities held as investment.

Historically, the focus of regulators and supervisors has been on the liabilities side of the balance sheet of banks. For example, the ratio of total deposits to total liabilities is used as a measure of how stable a bank’s funding is. In addition, the regulatory capital requirements, but also the MREL as introduced under the resolution framework, address the composition of the liabilities side of the balance sheet. In order to provide a more comprehensive picture of a bank’s funding profile, increasing attention is however paid to the assets side of the balance sheet – e.g. through the application of the leverage ratio and the asset quality review by the ECB.

Addressing asset quality issues is one of the key priorities for the ECB in its banking supervision.6 In 2014 and 2015, the ECB conducted asset quality reviews and stress tests. As a result, it became clear that a number of banks in participating Member States experience high levels of non-performing loans (NPLs). This was the reason for the Commission to publish a package to address NPLs, as further discussed in section 2.6.2.

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