CHAPTER 13 Banking and the Management of Financial Institutions 323 When it suffers the $10 million deposit outflow, its balance sheet becomes Assets Reserves Loans Securities Liabilities $ million $90 million $10 million Deposits Bank capital $90 million $10 million After $10 million has been withdrawn from deposits and hence reserves, the bank has a problem: its desired reserves are 10% of $90 million, or $9 million, but it has no reserves! To eliminate this shortfall, the bank has four basic options One is to acquire reserves to meet a deposit outflow by borrowing them from other banks in the overnight market or by borrowing from corporations.1 If the First Bank acquires the $9 million shortfall in reserves by borrowing it from other banks or corporations, its balance sheet becomes Assets Reserves Loans Securities Liabilities $ million $90 million $10 million Deposits Borrowings from other banks or corporations Bank capital $90 million $ million $10 million The cost of this activity is the interest rate on these loans, such as the overnight interest rate A second alternative is for the bank to sell some of its securities to help cover the deposit outflow For example, it might sell $9 million of its securities and deposit the proceeds with the Bank of Canada, resulting in the following balance sheet: Assets Reserves Loans Securities Liabilities $ million $90 million $ million Deposits Bank capital $90 million $10 million The bank incurs some brokerage and other transaction costs when it sells these securities The government of Canada securities that the bank holds are very liquid, so the transaction costs of selling them are quite modest However, the other securities the bank holds are less liquid, and the transaction costs can be appreciably higher One way that the First Bank can borrow from other banks and corporations is by selling negotiable certificates of deposit This method for obtaining funds is discussed in the section on liability management