Business in the Canadian Context
ADMS1010 – Summer 2012 – Troy Young
Lecture 9 – The Bank of Canada – July 5 2012
History of Banking
- Banks have been around for thousands of years.
- Such activities such as providing loans, taking deposits and changing money
have been done at banks since ancient Greece.
- The modern system of banking can be traced to Italy in the middle Ages.
International trade could not have occurred without the banks.
- Knights Orders like the Templars and the Hospitalise acted as bankers to finance
the Crusades. Money could be deposited at one of their castles and a note was
given to be redeemed at another, eliminating the need to carry money with you.
- Further developed in the Netherlands when goldsmiths would take in gold coins
and issue notes based on the value of the coins.
- People could also issue notes to others allowing them to be paid from their
reserves. This was the birth of the cheque.
- Because these notes were not all redeemed at the same time (and returned to
the goldsmiths to receive the coins deposited with them), they would then in turn
loan out the coins they had on reserve to make interest off of loans.
- Fractional Reserve Banking was born.
- Any deposit you make at a bank is in a sense a loan to that bank that is
repayable on demand.
- This is why you earn interest on your bank accounts.
- The bank then takes the money you have deposited and loans it out to others.
- Bank profits are realized on the difference in interest they pay to you for
depositing your money with them and the amount of interest they charge
someone to borrow money from the bank.
- The problem with Fractional Reserve Banking is that if people lose faith in the
bank and try to redeem their notes all at once, the bank is unable to pay.
- This is because the actual wealth the bank controls is not stored in one physical
location, but is dispersed throughout the various borrowers.
- If everyone tries to get their money out at once, this situation is called a bank run.
- In order to protect from this type of occurrence, governments began to create
What is a Central Bank?
- A central bank is a government created public institution that:
o Issues currency
o Regulates money supply
o Controls interest rates
o Has supervisory powers over the banking industry
Imposes reserve requirements
Acts as a lender-of-last-resort to mitigate things like bank runs - Is usually separate from government to protect it from political interference
- Money has a long history as a means of exchange. The value of money was
formerly tied to the value of the metal it was made out of (i.e. copper, silver or
- Paper notes eventually replaced coinage as the main source of money, mainly
because the weight of coins made them cumbersome for usage when large
amounts of money were required.
- Currently, the central bank holds assets (foreign exchange, gold or other
- Based on the value of these assets, and on the sale of bonds to the public,
currency notes are issued.
- Money supply is the total amount of money available in the economy.
- Money supply data is recorded at the central bank.
- This can be modified by purchasing financial assets or lending money to financial
- Commercial banks then increase this through fractional reserve banking.
Fractional Reserve Banking
- Banks maintain a portion (fraction) of their total customer’s deposits at the central
bank in the form of a reserve.
- The central bank requires that banks keep a minimum amount in reserve, to
cover the normal demand for withdrawals.
- The central bank oversees the activities of the commercial banks, provides
deposit insurance to consumers and acts as a lender of last resort to commercial
banks to bail them out in a time of crisis.
The Bank of Canada
- Canada followed the British banking system, with a limited number of larger
banks with multiple branches.
- In the US independent local banks was the norm.
- With our relatively small population spread out in rural centres, the British model
made more sense:
o Branch banks required less capital than a full independent bank.
- The branch banking system lead for a very stable banking system since the
branches spread the risk around the country.
- There was little need for a lender of last resort:
o In the US, with its small banks they would often find themselves with
seasonal cash flow problems and a central bank (the United States
Federal Reserve) was a necessity.
The US Federal Reserve System
- The US Federal Reserve System (The Fed)was set up in 1913. - The Fed was set up in part due to a financial crisis in 1907 (called the Panic of