We're going to have a look at the cash and cash equivalence balance, which will typically be the very first line of a bank's balance sheet.

Here we have an example of a real bank's balance sheet, and right at the very top we have a line item headed up cash and cash equivalent.

It's very deliberately right at the top of the asset section of the balance sheet.

As cash and cash equivalence are the most liquid assets that a bank owns under US.

GAP assets are presented typically in order of decreasing liquidity.

The level of cash a bank holds is driven by regulatory requirements, including the liquidity coverage ratio and the net stable funding ratio.

So what's captured in cash and due from banks, and what are the criteria for inclusion in this balance? The definitions for us, GAP and IRS are broadly similar here To be included within cash and crash equivalents, items need to be highly liquid financial assets.

Further to this, they also need to satisfy two additional criteria.

They need to be readily convertible into a known amount of cash and have an insignificant risk of change in value from the amount recorded at inception.

So let's take these ideas and turn.

What do we mean by highly liquid? Well, the financial assets must have a strong secondary market to facilitate quick buy and sell transactions, and the market must be able to provide investors with accurate price quotes.

Further to this, an investment normally meets the definition of a cash equivalent if it has a maturity of three months or less from the date of acquisition.

Let's think about an example here.

A financial asset, say a bond with a maturity of three years at the point of acquisition, will clearly not be classified as cash equivalent when it is acquired.

However, as it progresses through its life, its maturity will fall, and at some point its maturity will hit that three month threshold.

So what do we do? Well, we don't reclassify it as a cash equivalent.

We do absolutely nothing here.

We make the decision on the criteria at the point when we acquire the financial asset and then we leave it alone.

For an asset to meet the cash categorization, it needs to have less than three months to maturity from the date of acquisition.

Now, let's think about the other two criteria as an example.

Let's compare and contrast an investment in bonds and an investment in equity.

We know that on maturity, a bond will redeem at par a known value.

We also know that if that bond is redeeming in the very near future, then the risk of changes in value become lower as its value tends towards par over time.

However, that's not to say that changes in value are insignificant for all bonds.

Lower credit quality corporate bonds, even near to maturity may still be at risk of significant changes in value. So these Are unlikely to be considered a cash equivalent.

By way of contrast, three month treasury bills are highly likely to meet these criteria.

Compare this to equities.

There is no redemption date and no known future value.

Also, equities are subject to significant changes in value.

This means that an investment in equities would not meet the criteria of a cash equivalent whilst an investment in bonds could meet the definition of a cash equivalent subject to its satisfying the criteria we've just outlined.