In order to indicate clearly the way various transactions give rise to items in the statement, the business conducted in the first few days of a new bank will serve as a basis for analysis. To simplify the explanation of this subject, a record will be made only of those accounts in the statement which are affected by each transaction. A plus or minus sign will be used to indicate an increase or decrease in the amount of each item. Lastly, a completed statement showing the result of these changes will be presented.

In a small city, the X National Bank is organized under a charter which authorizes the issue of one thousand shares of capital stock with a par value of $100 each. In order to comply immediately with the national bank regulations requiring a bank to accumulate a surplus of at least 20 per cent before dividends can be paid, the shares are sold at a price of $120, thus realizing the sum of $120,000. As a result, the initial statement reads as follows:

Assets

Cash............. $120,000

The directors then buy a building for $20,000 and spend $5,000 for equipment, all of which they purchase with cash.

These two transactions affect the statement of the bank each in a different way. In the first case both asset and liability sheets of the ledger were increased by the same amount. The second transaction affected only the asset accounts, of which one was decreased and two others increased, so that the net total of the assets always remained the same.

In order to become a member of the Federal Reserve system the X National Bank must purchase stock in the district Reserve bank to an amount equaling 6 per cent of the former's capital and surplus. Up to the present member banks have been required to pay actually 3 per cent of this sum. The X Bank therefore buys Federal Reserve bank stock to the amount of $3,600 and pays for it in cash.

The bank begins operations with a group of new depositors opening checking accounts and leaving $10,000 in cash. Thus the bank's assets in cash will be increased and the liability side of the ledger will show a new item in the form of demand deposits. In this case the total assets and liabilities are correspondingly increased, while the two previous sets of transactions left them unchanged.

Assets

Cash............. +$10,000

Liabilities

Demand deposits... +$10,000

One customer, with $1,000 for which he has no immediate use, leaves it with the bank, on the understanding that the bank may require thirty days' notice of withdrawal, and so a time instead of a demand deposit is created.

Assets

Cash............. +$1,000

Liabilities

Time deposits...... +$1,000

A number of other customers start new accounts by depositing $10,000 in checks drawn against their balances with other banks in the community. Assuming that these institutions are members of the local clearing house, the X Bank will secure payment of the checks on the following day. Meantime the amount of these instruments will be added to the accounts of the depositors.

Assets

Exchanges for the clearing house___ +$10,000

Liabilities

Demand deposits... +$10,000

Several customers seek demand loans from the bank and offer the stock of certain local corporations as security. This stock is held by the bank merely as collateral, and does not appear in the statement, as the asset which the bank holds is not the stock itself, but the note reflecting the sum due it from the borrowers. The bank agrees to lend $20,000 to its customers, who do not desire cash, but credit to their deposit accounts.

Assets

Loans............ +$20,000

Liabilities

Demand deposits... +$20,000

Thus it is seen that a bank's deposits may be increased in three ways: (1) cash left by customers, (2) checks and cash items drawn on other institutions, (3) loans granted by the bank itself.

The discounting of a note may have a similar effect upon a customer's balance. For example, a depositor who is a local manufacturer requests the bank to discount his own sixty-day note of $10,000 in order that he may buy raw material. The note is taken by the bank at the rate of 6 per cent. With the discount, the charge to the borrower is deducted in advance, and not, as in the case of a loan, at maturity. In this transaction the discount amounts to $100, and so the borrower receives not the full face amount of the note, but only the proceeds, $9,900. This sum is added to the amount of deposits, while the $100 is carried as discount collected but not earned. As the customer is indebted to the bank for the full amount of the note, it is so entered under the item of discounts.

Assets

Discounts......... +$10,000

As the institution under consideration is a national bank, it is permitted to issue notes for circulation, provided it deposits with the Treasury of the United States at Washington an equal amount of government bonds and in addition contributes 5 per cent to the Redemption Fund maintained with the Treasurer. The directors first authorize the purchase of $20,000 worth of United States 2-per-cent bonds bearing the circulation privilege and, let us assume, selling at a par value of $100, for which cash is paid.

At the same time the bank sends to the Treasurer $400 as the required deposit of 5 per cent in the Redemption Fund.

Having observed all regulations, the bank now issues its notes to the amount of $20,000. These instruments are placed in circulation by giving them to customers who have received credit from the bank. It can thus grant loans by increasing the deposit accounts of its customers or by giving them its circulating notes.