So year over year, if the bank is well run, the capital gets bigger and Banker Bobby gets richer. But now the jargon gets completely confusing and backwards because most of us aren't used to thinking like a bank: The 90 bucks that Alex deposited in Banker Bobby's bank, also has a name, and it's called liabilities." To Alex of course, it's not liability, it's a deposit, it's his savings, but to Banker Bobby it's a liability. Why? Because he owes Alex that 90 bucks, he's liable to Alex for that money. Alex can withdraw it at any time and Banker Bobby needs to pay Alex interest on it. To Banker Bobby, it's like a loan Alex gave him.
So now let's gently introduce another piece of jargon... That 100 bucks that Banker Bobby gave to Caitlin? That's called an "asset." Caitlin has to pay Banker Bobby some money every month and within 3 years has to pay the entire 100 bucks back, plus 6% interest every year on the amount of the loan that remains outstanding, i.e. on the amount of the loan she hasn't yet paid back, which is referred to as "the principal."
So, when Banker Bobby thinks of Caitlin's dollhouse mortgage, he thinks of it like an investment. He gave Caitlin 100 bucks up front, and she's supposed to pay him back 6% on the principal each year for 3 years, or for however long the dollhouse mortgage is agreed to last. That is Banker Bobby's asset, because Caitlin is legally and financially obliged to pay him that nice return. And if he wants to, he, Banker Bobby, can sell that asset to someone else, who then has the legal right to collect those agreed upon payments from Caitlin, for the life of the loan. This is known as selling a debt instrument or just selling debt, or selling a mortgage.
The point to be understood here is that every bank balance sheet looks this way. On the left side you have assets, and on the right side you have liabilities plus capital. And they always balance out. And this is true from this very simple hypothetical children's bank in a world with one depositor and one dollhouse, right up to the largest and most complicated bank that has ever existed, Citibank whose balance sheet we will now take a look at.
First it says what they have in the way of assets. Instead of 100 dollars in assets, they have 1.95 trillion dollars in assets.
On the other side of the balance sheet, liabilities, 1.8 trillion and capital of 150 billion. Notice that these two sums equal 1.95 trillion. Once again, it all adds up. Assets equal liabilities plus capital. Both sides of the balance sheet are in balance.
So, here's where things get interesting. And here's why we had to make sure you understood bank balance sheets first.
Caitlin comes to Banker Bob and says, "I can't pay my mortgage. I lost my job. So that money I owe you, it's not coming."
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