Bus 201 ch 14

Learning Objectives

  • Define Money

    • Identify different forms it takes in Canada’s financial institutions.

  • Understanding Financial System

    • Understand the kinds of financial institutions that make up the Canadian financial system.

    • Explain the services offered by these institutions.

  • Bank of Canada Functions

    • Explain the functions of the Bank of Canada.

    • Describe the tools it uses to control the money supply.

  • Role of Specialized Banks and Intermediaries

    • Explain the role of alternate banks, specialized lending and savings intermediaries, and investment dealers in the Canadian financial system.

  • International Banking

    • Understand the concepts and activities in international banking and finance.

What Is Money? (LO 14-1)

  • Definition

    • Money is any object generally accepted as payment for goods and services.

  • Characteristics of Money

    • 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 retain value over time with minor fluctuations.

Functions of Money

  • Medium of Exchange

    • Used to trade goods and services (alternative to barter).

  • Store of Value

    • Can be used for future purchases.

  • Unit of Account

    • Allows measurement of the relative value of goods and services.

The Spendable Money Supply

  • Valuation Dependence

    • The value of money is contingent on its supply (i.e., money in circulation).

    • High Money Supply: The value of money drops.

    • Low Money Supply: The value of money increases.

  • Definitions of Money Supply

    • Narrow Definition (M-1): The most liquid forms of money.

    • Wider Definition (M-2): Broader categories of money that include M-1.

M-1 Money Supply (LO 14-1)

  • Components

    • Currency: Paper money and coins issued by the Canadian government.

    • Demand Deposits: Chequing account money, which can be transferred to others.

    • Cheque: An order that instructs the bank to pay a given sum to a specified person or firm.

M-2 Money Supply (LO 14-1)

  • Components

    • Everything in M-1 plus:

    • Time Deposits: Deposits requiring prior notice before withdrawal.

    • Money Market Mutual Funds: Pooled assets from many investors, invested in short-term, low-risk financial securities.

    • Savings Deposits: Holdings in savings accounts.

Credit Cards

  • Classification

    • Not Included: Credit cards are not included in M-1 or M-2.

    • Nature: Not money; they are a medium of exchange but a money substitute. Their use is temporary.

    • Costs: Associated with interest fees and merchants' fees, which generate profit for issuers (e.g., annual fees).

The Canadian Financial System (LO 14-2)

  • Traditional Structure

    • Comprised four financial pillars:

    • Chartered Banks

    • Alternate Banks

    • Specialized Lending and Savings Intermediaries

    • Investment Dealers

    • Regulatory Changes: The distinctions are becoming blurred due to changes in financial industry regulations.

Chartered Banks (LO 14-2)

  • Ownership and Nature

    • Privately owned, profit-oriented financial institutions in Canada.

  • Types of Chartered Banks

    • Schedule I Banks: Domestic banks that can accept deposits.

    • Schedule II Banks: Foreign banks operating in Canada.

Services Offered by Banks (LO 14-2)

  • Range of Services

    • Pension Services

    • Trust Services

    • International Services

    • Financial Advice

    • Electronic Funds Transfer

    • Bank Loans

Bank Loans (LO 14-2)

  • Financing Type

    • Major source of short-term financing.

    • Preference for long-term loans to finance inventories over accounts receivable.

  • Loan Types

    • Secured Loan: Backed by collateral.

    • Unsecured Loan: Not backed by collateral.

  • Interest Rates

    • Prime Rate of Interest: The best rate offered to customers.

Banks as Creators of Money (LO 14-2)

  • Mechanism

    • Banks expand the money supply by taking in deposits and making loans; they do not mint bills and coins.

Adaptations in the Banking Sector (LO 14-2)

  • Diversification: Expansion into other financial products.

  • International Banking: Increasing changes in consumer demands.

  • Regulatory Landscape: Effects of deregulation prompting shifts in roles.

The Bank of Canada (LO 14-3)

  • Central Bank Role

    • Managed by a board of governors; regulates chartered banks.

    • Manages the money supply through:

    • Buying/Selling Securities

    • Changing the Bank Rate: The rate at which chartered banks can borrow from the Bank of Canada.

Alternate Banks (LO 14-4)

  • Types

    • Trust Companies: Safeguard funds and estates.

    • Credit Unions: Cooperative savings and lending institutions formed by individuals with common interests.

Intermediaries: Specialized Lending and Savings (LO 14-4)

Life Insurance Companies (LO 14-4)

  • Functionality

    • Accept premiums while sharing risks with policyholders; returns money from premiums through loans.

    • Investments: Substantial investments in mortgages, government bonds, and real estate.

Factoring Companies (LO 14-4)

  • Business Model

    • Buy uncollected accounts receivable for less than face value and collect at face value.

    • Value Creation: Allows firms with old or uncollectible accounts receivable to redeem at least part of their value.

Financial Corporations (LO 14-4)

  • Types of Institutions

    • Sales Finance Company: Finances instalment purchases secured by the item.

    • Consumer Finance Company: Offers personal loans, collateral may or may not be required.

Venture Capital Firms (LO 14-4)

  • Objective

    • Finance firms with great potential for growth; accept increased risk for potential higher-than-normal returns.

Pension Funds (LO 14-4)

  • Accumulation

    • Cash accumulated for future payouts to subscribers, typically invested in stocks, bonds, and mortgages.

Investment Dealers (LO 14-4)

  • Role

    • Stockbrokers or underwriters; primary distributors of new stock and bond issues.

Other Sources of Funds (LO 14-4)

  • Entities

    • Business Development Bank of Canada (BDC)

    • Export Development Corporation (EDC)

    • Canada Mortgage and Housing Corporation (CMHC)