When a bank accepts a deposit from one of its customers, to the bank the deposit account is classified as
a. an asset.
b. a liability.
c. neither an asset nor a liability.
d. an asset in some cases and a liability in other cases, depending on the type of loan.
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The only possible answer to this question is B. Money that is deposited in a bank is always a liability from the point of view of the bank. To understand this, think about what the bank must be prepared to do when money is deposited. Once money is deposited, the bank must be prepared to give the money back. The bank is required to give the money back to the depositor whenever the depositor wants it back. Because of this, the deposits in a bank are liabilities from the perspective of the bank.
Strictly speaking, none of the options is technically correct. A correct answer would be that deposits represent both a liability and an asset. Option (d), "an asset in some cases and a liability in other cases, depending on the type of loan," is the best answer among those offered, so is almost certainly the answer the professor or teacher is anticipating.
The reason deposits, and there are a number of different types depending upon the type of account (for example, checking, money market, etc.) are both a liability and an asset has to do with the relationship of banks to their customers. Banks provide a service but charge a fee for that service. When a customer deposits money into his or her account, that money is an asset that the bank can use to loan out to other customers. As loans involve the charging of interest--a fee the customer agrees to pay to the lender in exchange for the loan--the bank earns a profit on that loan, unless, of course, circumstances change that makes the loan unpayable or the value of the interest less than it was at the time of the loan agreement. In this sense, deposits are a definite asset.
Deposits are a liability in the sense that the banks incur a certain obligation towards the customers whose money it has accepted. Here, in particular, is where the distinction between checking and savings accounts comes into play. When money is deposited into a savings account, it accrues interest. The money deposited increases in value according to interest rates at the given time. So, the bank, in a reverse loan-arrangement of sorts, is paying the customer a premium for the privilege of having held the customer's money. Of course, savings interest rates have been anemic for many years, so that value has been minimal, but it does represent a liability nonetheless. Money deposited into checking accounts may or may not accrue interest, but it usually does not. In fact, the customer may, depending upon the arrangement, pay a fee for maintaining a checking account with a financial institution. The deposit, however, represents a liability to the bank because it is money owed back to the customer.
A. An Asset--when customers deposit money, the bank is able to bundle cash from many depositors to use as operating income for loan customers and administrative costs. This is why they pay savings account customers interest as an incentive for restricting their frequency of withdrawals.
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