Chapter 33: The Banking System and the Money Supply
The Canadian Banking System
- The Canadian Banking System consists of a central bank and a
number of chartered banks. Which consists of the following
financial institutions:
o The Bank of Canada
o Chartered banks
o Near banks
o Other financial institutions
- Near Banks are financial institutions other than chartered banks
that accept deposits from the public. Which include credit unions,
trust companies, and mortgage loan companies.
The Origins of Modern Banking
- Modern banking can be traced to the seventeenth century, when
goldsmiths accepted gold deposits and issued paper receipts.
- Goldsmith’s receipts became money once they were generally
accepted.
The Commercial (Chartered) Banks
- A commercial (chartered) bank is a financial institution chartered
by the government.
- In Canada, commercial banks are also called Chartered Banks
because prior to 1980, a bank could be established by a special
charter granted by parliament.
Structure of Canadian Banking
- The Canadian banking system is a branch banking system, which
is a sharp contrast to the unit banking system typical of the U.S.
- A Unit Banking system has many independent banks.
- The Bank Act governs the operation of commercial banks in
Canada.
- Schedule A banks are Canadian-owned which Schedule B Banks
are foreign.
The Business of Commercial Banks
- Commercial banks must strike a balance between profitability
and liquidity.
- Commercial banks earn income by making profitable loans and
investments.
Balance Sheets of Chartered Banks
- A Balance Sheet is a statement of assets, liabilities and owner’s
equity.
- An Asset is owned, a Liability is owed, and Capital (owner’s
Equity) is the difference between total assets and total liabilities.
Main Sources of Funds
- Consumers’ deposits provide the main source of funds for
commercial banks.
Personal Savings Deposits
- At the end of Sept. 1995, total personal savings was $291.4
billion or 69% of total Canadian dollar deposits.
Non-personal Term and Notice Deposits
- These deposits amounted to $90.5 billion or about 22% of total
Canadian dollar deposits.
Government of Canada
- Another source of funds for chartered banks is the federal
government, they hold deposits at the banks. Government of
Canada deposits at chartered banks amounted to $7.1 billion.
Capital and Debentures (Subordinated debt)
- Debentures are bonds secured by the credit-worthiness of the
borrower.
Main Uses of Funds
- The major use of bank funds is loans extended to customers.
Cash Reserves and Highly Liquid Assets
- The Bank Act is a federal legislation that governs the chartered
banks.
- The Canadian system is called a Fractional Reserve Banking
System that allows the bank to be obliged to hold only a fraction
of the total amount deposited with them.
- Legal Reserve Requirements have now been phased out.
- The reserve ration is the ratio of reserves to deposits.
- Each person’s deposit at Canadian chartered bank is insured
against loss by the Canada Deposit Insurance Corporation
(CDIC) up to a maximum of $60 000.
- Chartered banks keep a certain amount of there assets in the
form of cash (Primary reserves) and other liquid assets called
Secondary Reserves which consist of currency, day-to-day loans,
treasury bills, and call and short loans.
Government of Canada Bonds
- Government of Canada bonds are liquid assets that earn interest
income for their holders. Chartered banks held a total of $45.1
billion worth of Government of Canada bonds.
Loans in Canadian Dollars
- General loans by chartered banks amounted to $215.3 billion,
about 52% of total loans in Canada. In addition chartered banks
extend loans to the provinces and the municipalities.
Canadian Securities
- Banks use their funds to purchase Canadian securities issued by
provincial and municipal governments and by corporations. The
total value pf these securities was $36.3 billion, 72% of which
was corporate securities.
Foreign Operations
- Canadian chartered banks are quite active on the international
banking scene.
The Expansion of the Money Supply by the Commercial Banks
- To see how changes in the money supply result from the
operation of the banking system, let us make the following
simplifying assumptions.
o Commercial banks desire to keep a cash reserve of 10%
o All deposits are demand deposits.
o The banks invest their funds in loans only.
o They are successful in extending as much in loans as they
possibly can.
- Banks increase the money supply b creating deposits when they
extend loans.
- The money multiplier is the reciprocal of the reserve ratio.
- Money Multiplier = 1/ Reserve ratio
The Near Banks
Caisses Popularies and Credit Unions
- Caisses populaires and credit unions operate under provincial
legislation. The local credit unions and caisses populaires in each
province belong to a central credit union operating in the
province.
Sources and Uses of Funds
- Credit unions and caisses populaires’ funds are used mainly for
mortgage lending and cash loans.
- Credit unions’ and caisses populaires’ funds obtain most of their
funds from customer’s deposits.
Trust and Mortgage Loan Companies
Main Sources and Uses of Funds
- Term deposits constitute the main source of funds for trust and
mortgage loan companies.
- Most of the funds trust and mortgage loan companies are used
for mortgage lending.