Final answer:
A bank's balance sheet is a financial statement listing its assets and liabilities, showing the financial position at a given time. It serves as a key tool for understanding a bank's net worth or capital, and banks must manage their balance sheets to mitigate financial risks.
Step-by-step explanation:
A balance sheet is a fundamental financial statement used in accounting that lists an entity's assets and liabilities. Assets represent items of value owned by the entity that can be used to produce income or can be converted into cash, such as cash in vaults or loans issued to customers. Liabilities are obligations the entity owes to others, including deposits made by customers which the bank is required to repay. The difference between assets and liabilities is known as the net worth or bank capital. This financial statement reflects the financial position of a bank at a specific point in time.
Banks serve as financial intermediaries in the financial capital market, operating between savers who supply capital and borrowers who demand loans. The balance sheet is sometimes called a T-account due to its two-column format creating a T-shape with a vertical line down the middle and a horizontal line under the headings 'Assets' and 'Liabilities'. The bank's net worth is calculated by subtracting liabilities from assets.
It is crucial for banks to manage their balance sheets effectively as they face risks such as negative net worth if asset values decline due to factors like loan defaults or interest rate fluctuations that lead to an asset-liability mismatch.