Money Myths

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Most people believe that when banks make loans they take money from people’s savings or other assets and lend to borrowers. Which make banks more or less intermediaries moving money from one source to another, and then they charge interest to cover costs and earn a profit.

However in reality once a loan officer at the bank is satisfied that the borrower will pay the loan amount back plus interest. The bank simply types this money into existence and is allowed to charge interest on it. This money doesn’t come from anywhere; it is brand new digital money that can be converted to cash if the borrower wishes. Money needs to come from somewhere and commercial banks have been given that privilege by parliament. In fact approximately 97.5% of all money in Canada is created in this way, the other 2.5% is created as hard currency. The bank notes are printed by Ottawa-based private sector security printer Canadian Bank Note Company, Ltd.; the coins are produced by the Royal Canadian Mint.

 In Canada when the topic of money creation is addressed in macroeconomic textbooks it is both inaccurate and outdated. The most commonly accepted method of money creation by economists is the money multiplier model. In the money multiplier model a bank must hold a certain percentage of reserves relative to the amount of money a commercial bank can create. However in Canada reserve requirements were phased out between June 1992 and June 1994 as a result of the 1991 Bank Act. It is up to the banks discretion how much cash they keep on hand for their daily business requirements and no specified reserves are required. If fact currently commercial banks do not even have a header for reserves on their balance sheets.

Many of us develop a concept of modern banking directly from childhood when we obtain our first piggy bank. Similar to a piggy bank we assume that when we put our money in a bank it is safe for later use. However in modern banking when you deposit your cash or cheque into your savings account two things happen. One it becomes property of the bank with a promise to pay you an equivalent amount upon your demand (demand deposits). In addition, to help understand how modern banking works the amount that you deposit into your bank account is entered as a liability on the banks balance sheet. 

Your money is only safe through the guarantees provided by the CDIC(Canadian Deposit Insurance Corporation). Since 1967 when the CDIC was first commissioned there have been 43 institutional failures (see appendix C of "From Next Best To World Class"). However if there is a systemic failure in the banking system like the one that occurred in 2007 and 2008 you could face severe losses. During the financial crisis of 2007/2008 while government officials were bragging about how sound our banking system was, at the same time Canadian Banks were bailed out to the tune of 114 billion dollars between 2008 and 2010, the government was careful in calling it “liquidity support” rather than a bailout. In a report released in 2012(The Big Banks’ Big Secret) by the Canadian Centre for Policy Alternatives it shows that Canadian Banks were funded from 3 different sources the Bank of Canada, Canadian Mortgage and Housing Corporation, and the U.S. Federal Reserve.