Transcript Banking Industry in Canada

CHAPTER 18
Understanding Money
and Banking
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
Learning Objectives
Define money and identify the different forms it takes in
the nation’s money supply.
Describe the different kinds of financial institutions that
make up the Canadian financial system and explain the
services they offer.
Explain how banks create money and identify the means
by which they are regulated.
Explain the functions of the Bank of Canada and
describe the tools it uses to control the money supply.
Identify ways in which the banking industry is changing.
Understand some of the activities in international
banking and finance
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
18-2
Money
Any object generally accepted by people as
payment for goods and services
Characteristics:
Portable: lightweight and easy to handle
Divisible: easily broken down to match the value of
goods
Durable: must not spoil or easily wear out
Stable: must be stable enough to hold its value over
time, apart from minor fluctuations
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© 2005 Pearson Education Canada Inc.
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Functions of Money
Medium of exchange
a single medium of exchange for goods and
services instead of barter
Store of value
can be used for future purchases
Unit of account
allows measurement of the relative value of
goods and services
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The Money Supply
Buyers and sellers must agree on the value
of money
The value of money is dependent on its
supply
as supply increases, value decreases
as supply decreases, value increases
Consists of both M-1 and M-2 forms of
money
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© 2005 Pearson Education Canada Inc.
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M-1 Money Supply
The most liquid forms of money
currency: paper money and coins issued by the
Canadian government
demand deposits: money in chequing accounts,
which can be transferred to others by cheque
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M-2 Money Supply
Everything in the M-1 Money supply plus
Savings deposits: savings account holdings
Time deposits: deposit requiring prior notice
before withdrawal of funds
Money market mutual fund investments
Measures the store of monetary value that is
available for making financial transactions
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Credit Cards
Not included in M-1 or M-2 Money
Supplies
Major source of consumer spending
Are a substitute for money, but they are not
money
Are privately issued and very profitable due
to annual fees, merchants fees & interest
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Financial Institutions
Traditionally consisted of four financial pillars
Chartered banks
Alternate banks (trust companies, credit unions, caisses
populaires)
Life insurance companies and specialized lending and
saving intermediaries
Investment dealers
Changes due to deregulation of the banking
industry
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© 2005 Pearson Education Canada Inc.
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Pillar #1:
Chartered Banks
Privately owned, profit-oriented, financial intermediary
Largest and most important of financial institutions
Each bank has many branches
Schedule A Banks
must be Canadian-owned with no more than 10% of voting
shares controlled by a single interest (90% of all bank assets)
Schedule B Banks
may be foreign-owned and need not meet the 10% limit
(foreign-owned bank deposits cannot exceed 8% of the total
domestic assets of all banks)
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
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Services Offered by Banks
Pension services
Trust services
International
services
Financial advice
Buy/sell securities
Electronic
technologies
Bank deposits
Bank loans
Bank accounts
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© 2005 Pearson Education Canada Inc.
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Bank Deposits
Accept deposits from some
customers to obtain money to
lend to others
chequing accounts
term deposits (money that
remains with the bank for a
period of time with interest paid
to the depositor)
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© 2005 Pearson Education Canada Inc.
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Bank Loans
Major source of shortterm financing for
business
Banks prefer to
finance inventories or
accounts receivable
rather than provide
long-term loans to
many businesses
Secured loan
backed by collateral
(e.g.: inventory)
Unsecured loan
not backed by
property
Prime rate of interest
lowest rate charged to
best customers
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© 2005 Pearson Education Canada Inc.
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Banks as Creators of Money
R e s e rve
Bank
N e w D e p o s it
R e q u ire m e n t
New Loan
1
$ 1 0 0 .0 0
$ 1 0 .0 0
$ 9 0 .0 0
2
$ 9 0 .0 0
$ 9 .0 0
$ 8 1 .0 0
3
$ 8 1 .0 0
$ 8 .1 0
$ 7 2 .9 0
4
$ 7 2 .9 0
$ 7 .2 9
$ 6 5 .6 1
5
$ 6 5 .6 1
$ 6 .5 6
$ 5 9 .0 5
6
$ 5 9 .0 5
$ 5 .9 1
$ 5 3 .1 4
7
$ 5 3 .1 4
$ 5 .3 1
$ 4 7 .8 3
8
$ 4 7 .8 3
$ 4 .3 1
$ 3 8 .7 4
9
$ 4 3 .0 5
$ 4 .3 1
$ 3 8 .7 4
$ 6 1 2 .5 8
$ 6 1 .2 6
$ 5 5 1 .3 2
$ 1 ,0 0 0 .0 0
$ 1 0 0 .0 0
$ 9 0 0 .0 0
T o ta ls fo r
th e firs t
n in e b a n k s
E x p a n s io n
lim it fo r
e n tire
b a n k in g
s ys te m
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© 2005 Pearson Education Canada Inc.
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Other Changes in Banking
Deregulation is causing banks to shift from
their historical role as intermediaries
between borrowers and depositors
Diversification into other financial products
Investment banking
Commercial paper
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The Impact of E-Technologies
Debit cards
Plastic money that immediately adjusts the consumers
account balance and pays the merchant
Point of Sale terminals
Electronic device used to facilitate debit card use
Smart Cards
A credit card sized computer that can be programmed
with “electronic money”
Ecash
Money that moves among consumers and businesses
via digital electronic transmission
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The Bank of Canada
The central bank of Canada
Managed by a Board of Governors
Regulates operations of the chartered banks
Manages the economy by manipulating the
money supply to expand or restrict the
economy
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© 2005 Pearson Education Canada Inc.
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Monetary Policy Actions of the Bank
of Canada
Expansionary Policy
Restrictive Policy
Tools
(stimulate business
activity and increase the
money supply)
(slow down business activity
and decrease the money
supply)
Open
Market
Operations
Buy government securities:
Sell government securities:
(increases bank reserves
(decreases bank reserves
enabling banks to make loans
to businesses and
consumers)
limiting the banks' abilities
to make loans to businesses
and consumers)
Lower the bank rate:
Raise the bank rate:
(increase the willingness of
(decrease the willingness of
Bank Rate
banks to borrow, more loans can
be made to businesses and
consumers)
banks to borrow, fewer loans can
be made to businesses and
consumers)
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© 2005 Pearson Education Canada Inc.
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Pillar #2: Alternate Banks
Trust companies
safeguard funds and estates entrusted to it
serves as a trustee, transfer agent, & registrar for corporations
Credit unions (caisses populaires)
cooperative savings and lending institution formed by a
group of individuals with common interests
offer savings accounts, loans, mortgages to members
invest its own funds in corporate & government securities
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© 2005 Pearson Education Canada Inc.
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Pillar #3: Specialized Lending and
Savings Intermediaries
Life insurance firms
Factoring companies
Financial corporations
Venture capital or
development firms
Pension funds
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© 2005 Pearson Education Canada Inc.
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Life Insurance Firms
Life Insurance companies
mutual or stock company that shares risks with
policy holders for payment of premiums
some money from premiums is lent back out
substantial investments in real estate, mortgages
and government bonds
largest financial intermediaries in Canada next
to the chartered banks
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© 2005 Pearson Education Canada Inc.
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Factoring Companies
Buy uncollected accounts receivable from a firm
for less than its face value
Attempts to collect the face value of the receivables
from customers
The difference between the amount collected and the
cost of the receivables is the firm’s profit
Allows firms with old, or uncollectible, accounts
receivable to redeem at least part of their value
rather than writing them off completely
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
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Financial Corporations
Sales finance company
finances instalment purchases made by
individuals or businesses
loans are secured by the item being financed
(e.g.: computer)
Consumer finance company
makes personal loans to consumers
collateral may or may not be required
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
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Venture Capital or Development
Firms
Provide funds for new or expanding firms
that have great potential
Obtains funds from individual investors,
financial intermediaries, retained earnings
While accepting increased risk with new
ventures, VC firms seek to earn higher than
normal returns
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
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Pension Funds
Accumulate cash that will be paid out to
subscribers in the future in the form of
pension income
Money is invested until it is needed
Investments include stocks and bonds,
mortgages
$
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© 2005 Pearson Education Canada Inc.
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Pillar #4: Investment Dealers
Stock brokers or underwriters
Distribute new stock and bond issues
(underwriting)
Facilitate trading of stock and bond on
exchanges (brokerage)
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© 2005 Pearson Education Canada Inc.
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?
Other Sources of Funds
Government financial institutions and granting
agencies
Business Development Bank of Canada (BDC)
Canada Mortgage and Housing Corporation (CMHC)
Export Development Corporation
Canada and its provinces borrow from
international sources of funds, including other nations
The Canadian Capital Market (international funds)
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© 2005 Pearson Education Canada Inc.
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Exchange Rates and Trade
Exchange rates influence the willingness of
Canadians to invest abroad and buy
imported items (or vice versa)
A trade surplus occurs when Canada is
exporting more products than it is importing
(likely to occur when the dollar is undervalued)
A trade deficit occurs when Canada is
importing more products than it is exporting
(likely to occur when the dollar is overvalued)
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
18-28
The Law of One Price
a basic commodity should be priced equally across all
countries
(if prices differ it is assumed to be due to over or under valuation
of the local currency)
The
Big
Mac
Index
Country
Big Mac Price
(Local Dollar)
Big Mac
Price Equiv.
(US Dollars)
Over/Under
Valuation
$2.71
$2.71
--
Denmark
27.75 krone
4.10
+51%
Switzerland
6.30 Francs
4.50
+69%
Britain
1.99 pounds
3.14
+16%
Japan
262 yen
2.19
-19%
United States
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© 2005 Pearson Education Canada Inc.
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International Payments Process
Local banks convert payments to the currency
required by foreign trade associates
Local banks then send payment, in foreign currency,
to the foreign trade partner
The foreign trade partner deposits the payment in
his/her own foreign-based bank
When equal values of money are moving back and
forth between nations, no real funds need to be
transferred between nations because the payments are
in balance
Banks also trade currencies
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
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International Bank Structure
International banking is governed by a network of
loose agreements between individual countries or
groups of countries.
The World Bank and the International Monetary
Fund assist by financing international trade
IMF
150 nations who combined resources to promote stable
exchange rates, provide temporary short-term loans,
encourage cooperation on international monetary
issues, and develop a system for international payments
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
18-31