Bank capital and liquidity

Just a simple guide that covers really basic concepts of banking, but I still learned a tremendous amount and am perhaps sheepish now regarding how little I knew, even though I always like to consider myself an 'economist'. Reading this quarterly bulletin made me realise what capital vs reserves rlly are. Can't believe it took me this long to know this. To learn this, the crucial step is to start from the basic accounting equation, ALE: Assets = Liabilities + Equity Then, one must draw a stylised bank balance sheet, with 2 columns, assets on the left and L+ E on the right. The reason why I failed to learn the basic yet vital difference between capital and reserves was because in all the articles that I read before this, none of them drew the stylised bank balance sheet. Crucially, a bank does NOT 'hold' capital, or 'set aside' capital! Capital is not an asset. It is a source of funds, on the right side of the balance sheet. Capital requirements just mandate banks to fund themselves with more capital, rather than deposits, or worse, flighty debt e.g. short-term wholesale funding. I had learned from that bespectacled guy in Aaron Pek's group chat in 2022/ 2023 that the gist of the Basel standards was to mandate banks to fund themselves with more equity, because equity absorb losses. My intuition at the time was: we must align capitalism with capitalism. What I meant was that if we want to create a thriving, effective system of capitalism, then we must hold capitalists accountable for the businesses they own, and not impose double standards. So, let the capitalists bear losses, NOT the bank's depositors i.e. regular savers. Or worse, public authorities using taxpayer money. Furthermore, I already knew that letting losses hit a bank's DEPOSITS would certainly trigger a bank run. My intuition at the time was right. This bulletin just supplemented my understanding with the new knowledge gained that capital is essentially the bank's own funds. So it doesn't just include shareholders' equity, but the bank's retained earnings as well. Another great framework to think about was this bulletin's illustration of insolvency vs illiquidity, or 'balance sheet insolvency' vs 'cash-flow insolvency'. The latter requires a bank to hold sufficient liquid assets, which are: cash, Treasuries/ gilts, and central bank reserves. THIS (liquid assets) is what banks are required to 'hold', or 'set aside' - NOT capital! ASSETS are a use of funds. If a bank doesn't hold enough liquid assets, then it won't have enough assets to repay its creditors should a large number of depositors/ investors withdraw at the same time. Hence the central bank's reserve requirements. But since the GFC, we are now in an ample reserve regime whereby the Fed has lowered the reserve requirement to 0%. Zero reserve banking! Which leads me to: This excellent bulletin has given me a solid framework to understand a myriad of important, relevant topics, e.g. capital ratios, CET ratios, reserve requirements, COF, funding ratios, bank regulation, and even RORA, for I now conceptually understand the gist of RWAs. It all ties back to the 'Bank funding costs' bulletin I read a few months ago that allowed me to conceptually understand the building blocks of COF, which gave me the theoretical foundation to understand why HLB's COF is so high. Supplementing this with the 'House of Morgan' book that I'm currently reading made for a fantastic combo. Just some further questions left/ areas to go into: 1) Cochrane's criticism of the Basel framework, that requirements are really easy for banks to game. 2) Why exactly did the Fed completely remove reserve requirements? I know the logic is presumably that they want banks to make as much loans as possible to stimulate the economy, not being strapped by having to hold liquid assets on the asset side of the balance sheet. And how does the ample reserve regime work? They flooded banks with reserves, so now the banking system has like $3T of reserves as of April 2026. But they allow banks to hold no reserves - so they want banks to convert all those reserves into loans? 3) Look into the countercyclical nature of the Basel requirements. 4) Now, why exactly does a bank want to attract deposits? Presumably, bank can only use funds if it has funds (lol). I.e., it can only make more loans if it has more equity or more deposits. But don't banks create loans out of thin air? They do not lend out customer deposits - what I mean is that they don't need a customer to put in more deposit for them to take that money and lend it to someone else. The only mechanism that I can think of is this. When a customer deposits in the bank, the bank's liabilities grow. But the balance sheet must balance by definition. So the asset side grows correspondingly, with either cash or central bank reserves I presume. (Because every banking transaction has 2 opposite sides, although a customer deposit creates a liability, at the end of the day the customer is still placing cash in the bank which is an asset.) So, only then can the bank make more loans and convert that cash/ reserves into loans. If a bank has peanut deposits, then it cannot many loans. Another mechanism is that if a bank has few deposits, it means that the bank is funding itself with more equity or wholesale funding - both of which are much more expensive. So a bank must attract lots of cheap deposits to fund itself. More deposits means that the bank is levering itself up more which is great from a risk-taking perspective. 5) SC mentioned today that issuing a BG creates a liability on the bank's balance sheet. What is the nature of BGs for balance sheet accounting? Clearly, the bank has to set aside an expected payout for BGs, creating a liability. Also, presumably, the fees collected from BGs go into assets as cash. But aside from that, how does the balance sheet balance? When liabilities increase from BGs, how does the asset side increase correspondingly? I think figuring this one out will help me understand the 'desirability' of various trade products. E.g., we push for funded assets before the FYE to window-dress our balance sheet. But in normal times, non-funded assets are desirable as well for they earn good fee income.