The key elements of banking
Bankers must avoid lending out via long-term loans a very high proportion of the money they attract without regard for the potential of depositors and other creditors to suddenly demand their money back.
That is, banks must prudentially retain reserves of cash (and other liquid assets) to satisfy creditors as the need arises. Yet holding too much cash leads to the loss of opportunities to lend that money (acquire assets) to earn higher interest. This liquidity management involves a delicate balance.Second, banks must protect themselves against the possibility of their assets falling below liabilities (what the bank owes depositors and other creditors of the bank). Such an eventuality would make a bank insolvent and unable to carry on. This might happen, for instance, if, say, 10% of the loans it has made to businesses go sour and are never repaid (as happened with HBOS following the financial crisis). If a bank was to play it ultra-safe it would always hold assets worth at least 20% more than its liabilities. This level of safety is being called for by some experts in the wake of the 2008 financial crisis, but very few banks come anywhere near that level; more typical levels are 3-5%.
This capital management is a much debated topic. The fundamentals are that a bank starts out with some money put in by its owners to pay for buildings, equipment, etc. Shareholders' funds, obtained by the selling of shares in the bank, have the advantage that the shareholders do not have the right to withdraw their money from the company - it is permanent capital (although they might sell their shares to other investors). As well as paying for the initial set-up, shareholders' capital provides a buffer acting as a safety margin against the event of a significant number of the loans granted to borrowers going wrong. The buffer is referred to as capital and loans made are assets of the bank. Deposits (and other loans to the bank) are liabilities:
Total assets = Total liabilities + Capital
In addition to capital being raised at the foundation of the business it can be augmented over the years through the bank making profits and deciding to keep those profits within the business rather than distributing them as dividends to shareholders - retained earnings. It can also be increased by selling more shares. Capital is also called net worth or equity capital.