In banking, there is a common term called “reserve ratios” or “reserve requirements”.
For simplification, all this means is that government imposed regulations on private banks says that they are required to keep a certain amount of “money” (it isn’t really money…they call it “capital instruments” – something that is “as good as money”) back in the vault for every dollar they loan out. For example, if the reserve ratio is 10%, it means that the bank would keep 10 cents in the vault for every dollar they loan out.
We have been conditioned via government education not to think of this at all or at least rationalize this as a good idea. There can be many examples cited in history where depositor’s confidence in their bank was shaken, and they all lined up all at the same time to withdraw their money – a run on the bank. These were ugly scenes as you can imagine. Panicking people screaming, yelling, and fighting with bank staff – and each other – to be in line first before the bank ran out of cash.
To placate the populace, government:
- Mandated regulatory compliance on bank operations.
- Enacted a Central Bank as a lender of the last resort – or a donor of the first resort depending if a bailout is required.
- Setup a depositor’s insurance fund that would refund deposits in the event of the bank becoming insolvent. This of course would ultimately be paid by the taxpayer in the event a bank defaulted – essentially a subsidy to the bank owners, but hey, who cares?
In Canada, the reserve ratio was phased out in the Bank of Canada Act in 1992. Today, if you look at the Act, you will see the following stanza:
457. [Repealed, 1999, c. 31, s. 14]
It took some digging to find out what was contained in that section, but here it is:
457. (1) Subject to this section, a bank that was in existence immediately prior to the day this section comes into force shall maintain a primary reserve in the form of
(a) coins with a face value of two dollars or less that are current under the Currency Act;
(b) Bank of Canada notes; or
(c) deposits in Canadian currency with the Bank of Canada.(2) Subject to subsection (4), the primary reserve referred to in subsection (1) shall not be less on average during any prescribed period than an amount equal to the average of the monthly levels of required primary reserves calculated for the month in which this section comes into force and for the preceding 11 months, as determined under section 208 of the Bank Act, being chapter B-1 of the Revised Statutes of Canada, 1985.
(3) Where a bank to which this section applies has been, on the day this section comes into force, in existence for less than 12 months, the primary reserve referred to in subsection (1) shall not be less on average during any prescribed period than an amount equal to the average of the monthly levels of required primary reserves calculated for the month in which this section comes into force and for the preceding months it has been in existence, as determined under section 208 of the Bank Act, being chapter B-1 of the Revised Statutes of Canada, 1985.
(4) On the first day of the first month following the month this section comes into force, the primary reserve referred to in subsection (2) shall be reduced by 3 per cent, and thereafter on the first day of the first month of each of the next three succeeding six month periods, the primary reserve as modified by this subsection shall be reduced by 3 per cent, and on the first day of the twenty-fifth month following the month in which this section comes into force, the primary reserve referred to in subsection (1) shall be nil.
…
What I cannot determine is when the above was actually PASSED into law. All I seem to find is other sites stating it was sometime around the early 1990s. I’ll keep looking. If anyone knows and has proof, drop me a line and I’ll update this post.
Update: It seems that the above text was quietly passed into law in December of 1991, via Bill C-19. I need to find a reputable source for this.
What it says is that when this act is passed into law, the bank reserve requirement will fall over a 25 month period until the Bank Act of Canada no longer requires the bank to keep ANY reserves.
What i did find was Bill C-84. This bill was sponsored by the Minister of Justice and was described as:
An Act to correct certain anomalies, inconsistencies and errors and to deal with other matters of a non-controversial and uncomplicated nature in the Statutes of Canada and to repeal certain Acts that have ceased to have effect
This a housecleaning bill. Section 457 is one of them. If you have a “time bombed” clause like section 457 and it has expired, why keep it in the Act? In other words, it is a lot nicer saying:
457. [Repealed, 1999, c. 31, s. 14]
than:
457. “We changed this requirement. Banks don’t have to have ANY money in the vault to back their loans. We, the government of Canada, authorize them to mint as much checkbook money out of thin air as the market will bear. We will stay out of the banks business as they must know what they are doing. However, if they screw up, we will make sure the citizen bails them out via inflation and extortion…ooops, we meant taxation. Well, we would do that anyway. Good luck with that!”
This is why if you look at the Bank Act today, you will see no mention of any reserve requirements at all.
Ugh.
23 comments
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April 18, 2008 at 10:00 pm
GWilly
Gilligan – how do you think Canadas “reserve ratios” compares with international central bank ratios?
Here in the UK it was just broadcast that we hold 50% reserves in the high st banks
our central bank has just swapped 100 Bllion US Dollars in uk gov bonds (see #1 below) for equivalent mortgage loans, it acts as your statement says?
I hope “ultimately be paid by the taxpayer ” is not so accurate ;-(
What kinda shape does this likely leave us in after the current Crunch
nice post Gilligan 🙂 thx
#1 to put this amount in perspective of the UK economy, Each year Our georgeous ladies spend around 14 Billion Dollars on Bodycare products, this amount is also equiv to 6 mths of uk mortgage loans made
Please Double check these perspectives – as always dyofr
July 31, 2008 at 11:18 am
Wayne
The Canadian book ‘Bank Heist’ is a good history of the Canadian banking system. However, the edition I have is a little older when I think there was about 1% as a reserve requirement. Interesting to know they scrapped it alogether.
I must see movie on the world’s money system going back to pre-Christian times is the Money Masters. You can watch the whole thing on the net or buy the DVD.
Did you know that Caesar was assassinated by the ‘money changers’ to keep control of the money supply when Caesar was planning to introduce ‘real’ money? You can learn much about this history on that 2 DVD series.
Wayne
October 21, 2008 at 10:03 am
database
Great.
P.S. I think you will find a reputable source at amazon marketplace. Because there is no use for outdated statute books/codes/civil law books (As a German, I don’t know the correct word), you will get them very cheap. You just have to look for the year or the edition you are searching for.
December 4, 2008 at 1:26 am
PK
Very good facts collection!
Even I was searching about the same while looking for Canadian Monetary Policy Measures, and Monetary Aggregates. On Bank of Canada website only one measure is mentioned, i.e, Overnight Rate of Interest. I was wondering how only one measure is sufficient to operate a nation’s Monetary Policy.
Then I searched for Reserve Requirements. I could see only one line “Over the 1992–94 period, however, reserve requirements on bank accounts were phased out.” in the article ‘Analyzing the Monetary Aggregates’ on
http://www.bankofcanada.ca/en/review/2001/
macleane.pdf
You can see the article. But I got more information from your write-up than from elsewhere. Thanks very much!
February 12, 2010 at 8:47 am
Ronaldo
Great article, I was looking for this very thing, THANKS for making it so easy for me to find the answer. An educated MOFIA is in our presents today and wears a pin stripe suit and Amani shoes.
Anyone for robbery?
March 17, 2010 at 2:57 pm
Dave
great article. Thanks
March 26, 2010 at 6:39 am
Brett W
First off, to find the actual bill (C-19 c.46 1991 Bank Act) go to the Canada Gazette’s website:
http://gazetteducanada.gc.ca
It’s published in three parts:
Part I – contains Administrative Notices from the GoC and Proposed Regulations;
Part II – contains Official Regulations; and
Part III – contains Acts of Parliament which have receive Royal Assent for the quarter preceding the publishing date.
Both Part’s I & II are weekly publications (published every Saturday), Part III is generally published quarterly (sometimes more frequently).
The issue you’re interested in is Canada Gazette Part III, Vol. 14, No 7, as it relates to Bill C-19 Chapter 46 (c.46) 1991 Bank Act – which was a complete revamp of the entire Bank Act.
All Canada Gazette’s from 1998 onward have been published online as high-quality pdfs.
Gazette’s published before 1998 are currently being scanned to pdf – their quality varies as the quality of the original document scanned varies (the older they are, the poorer the quality they get).
Most city libraries and universities across the land act as Depository Libraries for the Gazette and should have either paper of microfiche copies available for copying/printing.
To get pre 1998 scans of the Gazette online go to:
http://www.collectionscanada.gc.ca/databases/canada-gazette/index-e.html
and click on “find an issue” on the left menu .. should be straight forward from there
(you can also get there from the Gazettes website following the links under Archives | 1841-1997 | then to the Library and Archives Canada website – which is the link just given above).
I’m kinda backtracking on what you’ve written – very much along the lines of my own thoughts and research at the moment.
Cheers
March 31, 2010 at 9:55 am
Morris
I went in to make a withdrawal from my RBC of a not insubstantial amount and was told I couldn’t. They tried to make me take out small amounts. Finally after many phone calls and Emails to their head office I got PERMISSION to take my cash,. However I was told I must show up on the specified date as they didn’t want such a large amount in the bank.
thank you for this info. Have you considered sending this info to The Fifth Estate or similar program.
March 31, 2010 at 10:09 am
gilliganscorner
No I have not considered sending it to the mainstream media.
Do you think they would say, “OMFG! We have to get word out to the public!”.
Nope.
May 27, 2010 at 10:24 am
Rick
Have you considered the Tier 1 capital ratios of the Canadian banks as an alternative to the capital reserve requirement as an indicator of the banks ability to repay depositors? TD bank shows a Tier 1 capital rato of 11.3% on the 2009 annual report.
July 4, 2010 at 12:28 pm
ronaldo
About 20 years ago Russia introduced the equivalent of of the “Treasury Bill” after the rulers of Russia discovered that you can control your people easier by “Debt” than by the KGB. Today Russian people are enslaved just the same as Canadians are through “Debt”.
This was more significant than the Russian Revolution but went through unnoticed by alll.
They “ENSLAVED” an entire population without even firing one shot. Just as bad as the “SUCKER” lazy Canadians that allow this to exist in Canada. The reserve requirements were extinguished in Canada in 1992, 457. Repealed, 1999, c. 31, s.14.
457. (1).
Don’t you believe Canadian Government claim to no bank bailout, bailout was about 257 BILLION. exist
July 13, 2010 at 12:09 pm
Markus Buchart
Brett W.’s instructions were very good. The Canada Gazette you were seeking has now been posted at:
http://www.collectionscanada.gc.ca/databases/canada-gazette/001060-119.02-e.php?image_id_nbr=664836&f=p&PHPSESSID=7li9penjthhnct68goljgtfqk4
Go to page 1109 (or search for “Bank Act” in the find window). Then you’ll find the Bank Act amendments you were looking for.
On a quick skim, I don’t think that there is a provision explicitly abolishing the former reserve ratio requirement. Section 604 of the Act repeals the previous Bank Act. As the 1991 Act completely replaces the predecessor Act, its silence on the matter of a reserve ratio effectively abolishes the former requirement.
I agree with the Austrian School of Economics that fractional banking, that is where the reserve ratio is less than 100 per cent, is inherently unstable, inevitably leads to periodic fniancial crises, and underlies the business cycle. The best book on the subject is Murray Rothbard, What has Government done to our money? (1964).
Interesting post.
Markus Buchart
Winnipeg, Manitoba
July 13, 2010 at 3:47 pm
gilliganscorner
The verbage w.r.t section 457 is actually on pages 1364-1365 of that PDF doc (careful folks! It’s 95MB).
(4) On the first day of the first month
following the month this section conies into
force, the primary reserve referred to in subsection
(2) shail be reduced by 3 per cent,
and thereafter on the first day of the first
month of each of the next three succeeding
six month periods, the primary reserve as
modified by this subsection shall be reduced
by 3 per cent, and on the first day of the
twenty-fifth month following the month in
which this section comes into force, the primary
reserve referred to in subsection (1)
shall be nii .
Good find.
March 24, 2011 at 1:27 pm
Chris Jordan
Can you find anything regarding the date this section was enacted in Parliament so I can find who actually supported it?
An election coming up it would be great to know which members and or parties supported this as this is the root cause of the problem in Canada’s monetary system today!
October 14, 2010 at 6:26 pm
Marc
If you take a look at the web sit of the bank of canada, at that page:
http://www.bankofcanada.ca/en/backgrounders/bg-m2.html
you’ll see this:
SOME PEOPLE ASK WHY the Bank of Canada can’t directly increase or decrease the money supply at will, since it regulates the supply of paper currency in circulation.
The answer is that the bank notes issued by the Bank represent only a small portion of all the money circulating in the economy at any one time. The bulk of the money supply consists of deposits that the public holds at financial institutions. The amount of money in circulation can be measured in a number of ways. Some of these different measures, which are called monetary aggregates, are described below.
…
Commercial banks and other financial institutions provide most of the assets used as money through loans made to individuals and businesses. In that sense, financial institutions create, or can create money.
The Bank of Canada manages the rate of money growth indirectly through its influence on short-term interest rates, or through the reserves provided to large deposit-taking institutions. When short-term interest rates change, they tend to carry other interest rates – such as mortgage rates and other lending rates from commercial banks – along with them. When interest rates rise, consumers and businesses tend to hold less money, to borrow less, and to pay back existing loans. The result is a slowing in the growth of M1+ and in the other broader monetary aggregates.
I think it’s realy obvious that private bank create money,
the central bank just try to control them
April 24, 2011 at 3:55 pm
Ken
Brilliant post (and great comments). Thanks so much.
August 18, 2011 at 11:18 pm
tom
thank you all, for your postings. i just watched “oh canada our bought and sold out land” and i could not find #457 either? i appreciate all your work!
August 30, 2011 at 3:29 pm
Adam Soltys
Hi,
After reading through your article and some of these comments I was curious to learn how Canadian banks could get away without having any minimum reserve requirements imposed on them.
Well, it turns out that even though they don’t have a fixed reserve ratio, they are required to keep “adequate capital and liquidity”. It’s not just left to the banks themselves to decide what’s adequate means, either; there’s actually a government agency called the Superintendent of Financial Institutions for that very purpose:
http://www.osfi-bsif.gc.ca/
http://laws-lois.justice.gc.ca/eng/acts/O-2.7/page-2.html#h-3
They put out a guideline that defines the capital requirements for the banks:
http://www.osfi-bsif.gc.ca/app/DocRepository/1/eng/guidelines/capital/guidelines/CAR_A_11_e.pdf
And even though it’s just a guideline, the Superintendent does have the power to enforce the banks to follow it, according to the Bank Act:
PART X
ADEQUACY OF CAPITAL AND LIQUIDITY
Adequacy of capital and liquidity
485. (1) A bank shall, in relation to its operations, maintain
(a) adequate capital, and
(b) adequate and appropriate forms of liquidity,
and shall comply with any regulations in relation thereto.
Regulations and guidelines
(2) The Governor in Council may make regulations and the Superintendent may make guidelines respecting the maintenance by banks of adequate capital and adequate and appropriate forms of liquidity.
Directives
(3) Notwithstanding that a bank is complying with regulations or guidelines made under subsection (2), the Superintendent may, by order, direct the bank
(a) to increase its capital; or
(b) to provide additional liquidity in such forms and amounts as the Superintendent may require.
Compliance
(4) A bank shall comply with an order made under subsection (3) within such time as the Superintendent specifies therein.
Notice of value
(5) Where an appraisal of any asset held by a bank or any of its subsidiaries has been made by the Superintendent and the value determined by the Superintendent to be the appropriate value of the asset varies materially from the value placed by the bank or subsidiary on the asset, the Superintendent shall send to the bank, the auditor or auditors of the bank and the audit committee of the bank a written notice of the appropriate value of the asset as determined by the Superintendent.
————-
“Superintendent” means the Superintendent of Financial Institutions appointed pursuant to the Office of the Superintendent of Financial Institutions Act;
I hope this helps to clear things up a bit.
October 8, 2011 at 3:32 am
halfacanuck
I realize I’m a bit late to the party here, but I thought you might be interested in the recent Federal Reserve research paper “Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?”:
http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf
According to this study there is no correlation between growth in reserves and growth in loans issued, therefore banks are not constrained by their reserves when lending, therefore the US is not operating under a fractional reserve banking system, therefore the textbook “money multiplier” is not a correct description of how things work in the real world. It is the same in Canada, which is why the reserve requirement there has been eliminated in favor of ensuring adequacy of capital.
AFAIK the only function of reserves is to facilitate inter-bank lending and check clearing and such (though banks can, I believe, use excess reserves as collateral for borrowing, but I haven’t properly checked that out yet so don’t take my word for it). Banks will lend as much as possible given their actual constraints, which is to say capital, borrower creditworthiness, regulation, etc. Central banks these days (try to) control *demand for* loans via interest-rate adjustments rather than *supply of* loans via reserve requirements.
I’m not sure what you’d call our current system, but “fractional reserve” is no longer an accurate label, IMO.
November 27, 2011 at 1:08 am
Brad S
Here is a paper on the bank of canada’s website from 1997 detailing a strategy for having no reserve requirements appropriately named
Implementation of Monetary Policy in a
Regime with Zero Reserve Requirements
http://www.bankofcanada.ca/wp-content/uploads/2010/05/wp97-8.pdf
November 27, 2011 at 1:24 am
Brad S
The above noted paper has an appendix section which details the legislation and how it was implemented from the B of C’s point of view
December 16, 2011 at 7:43 pm
Cara
I love this page. I found out about fractional reserve banking a few years ago thanks to Robert Kiyosaki and I couldn’t believe that society doesn’t understand the importance of it.
I’ve been searching for specific information regarding Canada’s banking policies on FRB and was surprised it is so difficult to find. But then again, I shouldn’t be surprised.
I’m taking an introductory corporate finance course right now and am surprised that the text book doesn’t once mention this.
I’m going to be reading all this information for months!
Thanks!
February 7, 2012 at 12:17 am
Saltspringer
Interesting article, thanks for posting it.
I’ve been doing some reading on this subject, and yes, it does seem that Canada’s private banks have no set reserve requirements, but are required to maintain ‘adequate’ reserves by the Office of the Superintendent of Financial Institutions, the OSFI.
What is adequate? At the moment (February 2012) the OSFI is requiring that they hold 10% in reserves (it’s actually a bit more complicated, but that’s the total amount). Out of curiosity, I called up the CIBC to see what they were holding and was directed to their annual report where they are required to disclose this information on a quarterly basis. Near the end of 2011, they were holding reserves of about 18%.
But the bigger question for me is, what is the portion of those reserves that are Government of Canada treasury bills and bonds? From what I can tell, at least for the CIBC (the only private bank I’ve studied so far), these bills and bonds make up only a very small part of the assets they hold against which they lend – but if anybody else has information to the contrary, I’d appreciate hearing about it.
If these bills and bonds are indeed a very small part of their assets, it would seem to me to make very little difference to the banks if they could no longer lend the Government of Canada, though of course I’m sure they appreciate the easy money.
All of this still begs the question: why is our government not borrowing interest-free from the Bank of Canada?