The Canadian Financial System
Why Money is Important
The most critical issues in Canada today are:
Economic Growth
Creation of Jobs
Both depend on the ready availability of money within the economy.
What is Money?
Money is defined as anything that people generally accept as payment for goods and services.
Historically, various items such as salt, feathers, fur pelts, stones, rare shells, tea, and horses have functioned as money.
Barter
Definition of Barter: Barter is the direct trading of goods or services for other goods and services without using money.
Advantages of Barter: Some individuals have recently used online platforms to facilitate barter.
Problems with Traditional Barter: Traditional barter systems encounter challenges, such as the transportability of goods (e.g., carrying eggs or milk). Therefore, a monetary system is more efficient since money is portable, divisible, durable, and stable.
Characteristics of a Good Money System
Portability: Coins are easy to carry.
Divisibility: Different-sized coins allow consumers to make exact transactions.
Stability: Stable value ensures that everyone agrees on the same value of money.
Durability: Coins can last for millennia, even under adverse conditions (e.g., underwater).
Uniqueness: Difficult to replicate or counterfeit due to elaborate designs and minting processes.
Electronic Money
Definition of Electronic Money (e-money): A newer form of money used for online transactions.
Online payment services include PayPal, Google Wallet, and banking apps.
Digital Currency: Refers to electronic money that does not exist in physical form (bills or coins).
Cryptocurrencies: A subcategory of digital currency created using cryptographic algorithms.
Cryptocurrency
Cryptocurrency- subcategory of digital currency, they do not exist in physical form, which means they operate in electronic formats.
Pros:
Quick transactions and lower fees, compared to traditional banking.
Financial Inclusion means that they can provide financial services to unbanked populations.
Lets you verify transactions without compromising personal information.
Decentralization- distributing the power away from a central authority.
Cons:
The Canadian Financial System
The Bank of Canada
The Bank of Canada promotes the economic and financial welfare of the nation by:
Conducting monetary policy to foster confidence in the currency's value.
Supplying secure and widely accepted banknotes.
Promoting the safety and efficiency of Canada’s financial system.
Providing effective funds-management services.
Communicating objectives transparently and being accountable for actions.
Regulating the Financial System
The financial industry in Canada is tightly regulated, recognized as one of the country’s most regulated sectors.
Federal and Provincial Regulations:
Banks: Federally regulated.
Securities dealers, credit unions, and caisses populaires: Regulated at the provincial level.
Insurance, trust, loan companies, and cooperatives: May be regulated at either level depending on their registration jurisdiction.
Key Regulatory Bodies
Office of the Superintendent of Financial Institutions (OSFI): An independent agency aiming to bolster public confidence in the Canadian financial system, regulating over 400 federally regulated financial institutions.
Financial Consumer Agency of Canada (FCAC): Oversees financial institutions to protect financial consumers and enhance Canadians' financial literacy.
Canada Deposit Insurance Corporation (CDIC): A federal entity providing deposit insurance to ensure stability within the financial system, covering eligible deposits at member institutions (e.g., banks).
Components of the Canadian Financial System
The financial services industry comprises:
Traditional Banks (Commercial Banks): Profit-seeking banks accepting deposits and providing loans to individuals and businesses. They serve two customer types: depositors and borrowers.
Credit Unions and Trust Companies: Non-profit member-owned cooperatives providing banking services, including caisses populaires prevalent in Quebec.
Non-Banks: Financial entities not accepting deposits but offering various services such as life insurance, pension funds, and brokerage firms.
Function of Commercial Banks
They accept deposits through chequing and savings accounts and use these funds to extend loans, making a profit through efficient fund utilization.
Pension Funds
Pension funds represent money set aside by businesses or unions to support future retirement benefits for their members.
Using Technology to Improve Efficiency
Electronic Funds Transfer (EFT): Involves sending transaction messages from one computer to another.
Debit Cards: Function like cheques, directly withdrawing funds from a chequing account.
Smart Cards: Electronic tools merging functions of credit cards and IDs.
The Canadian Financial System: Financial Markets
Financial markets encompass:
Markets for money, bonds, equities, derivatives, and foreign exchange.
Securities Markets
They assist businesses in acquiring long-term funding and provide investors a venue for trading securities.
Role of Investment Bankers
Specialists in the issuance and sale of new securities for corporations and organizations, who typically invest on behalf of others (institutional investors).
Stock Exchanges
Organizations where members facilitate the buying and selling of securities for companies and investors.
Securities Regulations
Companies must issue a prospectus, which is a summary of economic and financial information necessary for prospective investors before they can purchase securities. Approval from the respective securities commission is required.
How Investors Buy Securities
Stockbroker: A registered representative acting as a market intermediary, who handles buying and selling securities for clients.
Online Trading Services: Investors can also use these platforms to trade stocks and bonds without traditional brokers.
Robo-advisors: Automated online services analyzing investments, managing portfolios, and optimizing tax situations.
Choosing the Right Investment Strategy
Investment strategy requires considering the following criteria:
Investment Risk: The likelihood that an investment will decline in value.
Yield: The anticipated return on investment, usually over a set period (one year).
Duration: The commitment length of invested funds.
Liquidity: The ease of accessing invested funds when necessary.
Tax Consequences: Implications of investments on one’s tax situation.
Reducing Risk by Diversification
Diversification: Involves spreading investments across various asset classes to mitigate risk. For example, an investor could allocate 25% in higher-risk stocks and another 25% in conservative bonds.
Investing in Stocks
Market performance often hinges on how well a company meets its objectives, impacting potential capital gains., which is the difference in profit when selling a stock.
Investors in stocks gain ownership in a firm, leading to participation in potential growth through increasing share prices.
Stock Splits and Indexes
Stock Split: A corporate action where shareholders receive additional shares.
Stock Indexes: Measure performance trends of various stock markets.
Buying on Margin: This method entails borrowing part of the stock’s purchase cost from a brokerage; the margin reflects the investor's own contribution.
Investing in Bonds
Government bonds represent safe investments with guaranteed income, backed by government credit.
Investing in Mutual Funds and Exchange-Traded Funds (ETFs)
Mutual Funds: Pooled investments where a fund buys various securities and sells units of ownership to investors.
Characteristics include cost-sharing for small investors, diversification, and options between no-load and load, and open-end vs. closed-end funds.
ETFs: Collections of securities traded like individual stocks on public exchanges, blending aspects of mutual funds and stock trading.
The Canadian Financial System: Clearing and Settlement Systems
Financial Market Infrastructure (FMI): A system that enables the clearing, settling, or recording of payments and securities transactions among participating entities, commonly referred to as clearing and settlement systems.
Types of FMIs
Payment Systems: Facilitate fund transfers between parties.
Central Counterparties (CCPs): Act as an intermediary in financial agreements to ensure compliance and fulfill obligations, safeguarding parties involved in financial contracts.
Securities Settlement Systems: Ensure the secure transfer of securities and other financial assets.
Chapter Summary
What is Money?
Money serves as a universally accepted medium for the exchange of goods and services. Key characteristics include portability, divisibility, stability, durability, and uniqueness, with new forms such as electronic money and cryptocurrencies emerging.
Key Components of the Financial System
Incorporates traditional banks, credit unions, trust companies, and various non-bank entities like insurance companies and pension funds, all regulated by institutions like the Bank of Canada, OSFI, and CDIC.
Financial Markets
Comprise sectors for money, bonds, equities, and derivatives, with stock exchanges functioning as marketplaces for buying and selling securities.
Investment Strategies
Include diversification for risk management, investment options such as stocks (company ownership), bonds (low-risk income), and mutual funds/ETFs (pooled investments for enhanced diversification).
Clearing and Settlement Systems
Provide assurance for the secure transfer and documentation of payments and financial transactions.