The core activity of a bank is financial intermediation. This function entails using resources from customers (liabilities) to offer financing to the same or other bank customers (assets). Therefore, it is essential to be able to understand a bank’s balance sheet and each line linked directly to customers.
In the article entitled “What is a bank's balance sheet?” we offer a broad overview of the structure of a financial institution’s balance sheet. We make reference to the items that make up the assets (cash and cash equivalents, earning assets and non-earning assets), liabilities and equity.
Considering that a bank’s core activity is financial intermediation (i.e. attracting money from savers and lending it to those that request it), when analyzing a financial institution’s balance sheet, it is essential to compare the resources managed by the company from customers and the loans made to those or other customers. This is what is known as the bank’s volume of business.
In this article, we will take a quick look at the contents of each one of those items
Customer loans and advances are the total amount of loans made to customers that have not been amortized. When speaking about the figure at gross level, we need to take into account that it includes non-performing loans - i.e. loans that have been in default for more than 90 days since maturity - and loan loss provisions (which cover the estimate losses linked to NPLs and customer prepayments). The net figure is calculated detracting these loan-loss provisions from the gross loan figure.
Normally, the loan investment heading is broken into three items:
- loans to public administrations (in a Spanish bank this would include loans made to city councils, autonomous communities and the State itself)
- secured loans, where the borrower pledges a property or specific right (most commonly the mortgage) as collateral to guarantee repayment
- and other loans to the private sector, which include loans to finance families (for example, consumer loans) and those granted to productive activities or companies. Regarding banks with a relevant international presence, it is worth distinguishing between loans granted to residents in the country in which the country is domiciled and those made to non-residents.
Regarding customer resources, it is essential to distinguish between customer deposits and off-balance sheet resources (basically investment funds, pensions and customer portfolios).
Customer deposits are funds received by the bank corresponding to what is strictly understood as its core activity. This item includes current accounts and savings accounts (commonly referred to as demand deposits), which are assimilated to cash, as it is the depositor who decides when to cancel them, and the time deposits, whose maturity date is fixed.
Off-balance sheet resources are funds received by banks which are not related to their core activity, but which are contracted by customers. They cannot be used to grant loans, but today they are essential in the financial structure of an institution. The banking business cannot be understood without this type of product complementing the traditional deposits. The most common off-balance sheet resources are the investment funds (collective investment vehicles that handle a group of pooled funds from different investors to invest them in different financial instruments) and the pension plans (private savings plans aimed at perceiving retirement and invalidity pensions or death grants). Normally, these resources are managed through companies without a legal status, which are integrated within the structure of the financial company.