UBC Theses and Dissertations

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UBC Theses and Dissertations

Banking clearing gains and losses 1966

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B A N K I N G C L E A R I N G G A I N S A N D L O S S E S b y D O N A L D G R A N T M c C O N A C H I E B . S . A . , U n i v e r s i t y of B r i t i s h C o l u m b i a , 1963 A T H E S I S I N C O M M E R C E S U B M I T T E D T O T H E F A C U L T Y O F G R A D U A T E S T U D I E S W e a c c e p t t h i s t h e s i s a s c o n f o r m i n g to the r e q u i r e d s t a n d a r d T H E U N I V E R S I T Y O F B R I T I S H C O L U M B I A A p r i l , 1966 In p r e s e n t i n g t h i s t h e s i s i n p a r t i a l f u l f i l m e n t of the requirements f o r an advanced degree at the U n i v e r s i t y of • B r i t i s h Columbia, I agree that the L i b r a r y s h a l l make i t f r e e l y a v a i l a b l e f o r reference and study, I f u r t h e r agree that per- m i s s i o n f o r extensive copying of t h i s t h e s i s f o r s c h o l a r l y purposes may be granted by the Head of my Department or by h i s r e p r e s e n t a t i v e s . I t i s understood t h a t . c o p y i n g or p u b l i - c a t i o n of t h i s t h e s i s f o r f i n a n c i a l gain s h a l l not be allowed without my w r i t t e n permission* Department of COMMERCE The U n i v e r s i t y of B r i t i s h Columbia., Vancouver 8 ? Canada Date APRIL 1966. i A B S T R A C T T h i s t h e s i s i s c o n c e r n e d w i t h a d i s c u s s i o n of b a n k i n g c l e a r i n g g a i n s a n d l o s s e s . B a c k g r o u n d m a t e r i a l c o v e r s the h i s t o r y of d e p o s i t b a n k i n g in g e n e r a l a n d in C a n a d a , a d i s - c u s s i o n of d e p o s i t e x p a n s i o n f o r a o n e a n d a m u l t i - b a n k s y s t e m , a n d the c l e a r i n g s y s t e m in u s e t o d a y by the C a n a d i a n C h a r t e r e d B a n k s . T h e b a c k g r o u n d m a t e r i a l c o n t i n u e s w i t h a d i s c u s s i o n of the r e s e r v e r a t e in C a n a d a , the r a t e s of the d e p o s i t l i ab i l i t y of the C a n a d i a n C h a r t e r e d B a n k s a n d the m e t h o d u s e d to d e t e r m i n e the r e q u i r e d p r i m a r y r e s e r v e e a c h b a n k m u s t m a i n - ta in w i t h the B a n k of C a n a d a . In r e s p e c t to the c l e a r i n g g a i n o r l o s s f i g u r e f o r a n y b a n k , e x a m p l e s a r e g i v e n to s h o w h o w the net c l e a r i n g g a i n o r l o s s f o r a n y b a n k in the s h o r t r u n c a n b e i n f l u e n c e d b y the s p e n d i n g h a b i t s of the b a n k s ' c u s t o m e r s , the m o n e y m a r k e t t r a n s a c t i o n s of the b a n k a n d i ts c u s t o m e r s , the a c t i o n of the B a n k of C a n a d a a n d the r a t e of i n v e s t m e n t g r o w t h f o r a n y o n e b a n k r e l a t i v e to o t h e r b a n k s . In the l o n g r u n c u s t o m e r s l o y a l t y i s d e e m e d to b e the s o l e f a c t o r h a v i n g ef fect u p o n the net c l e a r - i n g g a i n a n d l o s s f i g u r e s f o r a n y o n e b a n k . i i T h e c o n c l u s i o n s t a t e s the f o l l o w i n g t w o h y p o t h e s e s . 1 . In the s h o r t r u n , c l e a r i n g g a i n s a n d l o s s e s f o r a n y o n e b a n k a r e a f u n c t i o n of : the s p e n d i n g h a b i t s of the bank 's c u s t o m e r s ; the m o n e y m a r k e t t r a n s a c t i o n s of the b a n k a n d i t s c u s t o m e r s ; the a c t i o n of the B a n k of C a n a d a ; a n d , the r e l a t i v e r a t e of i n v e s t m e n t g r o w t h . 2 . In the l o n g r u n c l e a r i n g g a i n s a n d l o s s e s a r e a f a c t o r of the c u s t o m e r s l o y a l t y e n j o y e d b y e a c h b a n k . A n A p p e n d i x e x p l a i n s w h y t h e s e h y p o t h e s e s w e r e not t e s t e d a n d l i s t s the i n f o r m a t i o n that w o u l d b e n e e d e d to test t h e m . J . N . B r a y . i i i T A B L E O F C O N T E N T S I I N T R O D U C T I O N 1 II A S H O R T H I S T O R Y O F D E P O S I T B A N K I N G 7 In G e n e r a l 7 In C a n a d a 1 1 III B A N K I N G : D E P O S I T E X P A N S I O N A N D T H E C L E A R I N G S Y S T E M IN C A N A D A 15 D e p o s i t E x p a n s i o n : A O n e B a n k E x a m p l e 15 D e p o s i t E x p a n s i o n : A M u l t i - B a n k E x a m p l e 20 P r i m a r y a n d D e r i v e d D e p o s i t s < 23 T h e Inter B a n k C l e a r i n g S y s t e m 27 T h e L o c a l I n t e r - B a n k C l e a r i n g S y s t e m 31 T h e I n t e r n a l B a n k C l e a r i n g S y s t e m 34 A r e C l e a r i n g G a i n s G o o d o r B a d ? 4 2 I V T H E B A N K I N G S Y S T E M O F C A N A D A 4 4 D e p o s i t E x p a n s i o n A n d T h e R e s e r v e R a t e 44 D e p o s i t L i a b i l i t i e s 46 M e t h o d O f D e t e r m i n i n g R e q u i r e d C h a r t e r e d B a n k D e p o s i t s Wi th T h e B a n k O f C a n a d a 47 V S H O R T R U N F A C T O R S A F F E C T I N G C L E A R I N G G A I N S A N D L O S S E S 50 i v C H A P T E R P A G E S p e n d i n g H a b i t s O f B a n k C u s t o m e r s 50 M o n e y M a r k e t T r a n s a c t i o n s 56 T h e B a n k O f C a n a d a 61 A F r u s t r a t i n g D i v e r s i o n 65 T h e R a t e O f I nves tment G r o w t h 70 V I L O N G R U N F A C T O R S A F F E C T I N G C L E A R I N G G A I N S A N D L O S S E S 76 C u s t o m e r L o y a l t y 76 VI I C O N C L U S I O N 86 B I B L I O G R A P H Y 88 A P P E N D I X " A " 91 V L I S T O F F I G U R E S F I G U R E P A G E 1 . D E P O S I T E X P A N S I O N : O N E B A N K E X A M P L E 17 1 - A 17 1 - B 17 1 - C 17 2 . D E P O S I T E X P A N S I O N : M U L T I - B A N K E X A M P L E 21 2 - A 21 2 - B 21 2 - C 21 3 . C L E A R I N G S A N D C L E A R I N G G A I N S A N D L O S S E S 29 3 - A A T y p i c a l C l e a n i n g H o u s e S t a t e m e n t 29 3 - B C a l c u l a t i o n O f N e t C i e a r i n g G a i n ( L o s s ) 29 4 . I N T E R N A L B A N K C L E A R I N G S Y S T E M E N T R I E S 37 4 - A 37 4 - B 37 4 - C 37 v i . F I G U R E P A G E 5 . " C l e a r i n g " A C H E Q U E D R A W N O N A B R A N C H O F T H E S A M E B A N K 40 5 - A 40 5 - B 40 6 . T H E E N T R I E S F O R C L E A R I N G A C H E Q U E 41 7 . C A L C U L A T I O N O F A V E R A G E D E P O S I T L I A B I L I T I E S 49 7 - A 49 7 - B 49 8 . E X A M P L E O F C L E A R I N G L O S S 52 9 . M O N E Y M A R K E T T R A N S A C T I O N S A N D C L E A R I N G G A I N S A N D L O S S E S 58 9 - A 58 9 - B 58 9 - C 59 1 0 . E X A M P L E O F C L E A R I N G G A I N S A N D L O S S E S F R O M I N V E S T M E N T E X P A N S I O N 7 2 1 0 - A 7 2 1 0 - B 7 3 1 0 - C 7 4 VII . F I G U R E P A G E 1 1 . C U S T O M E R L O Y A L T Y A N D C L E A R I N G G A I N S A N D L O S S E S 77 1 1 - A 77 1 1 - B 77 1 .1 -C 78 1 2 . C A N A D I A N D O L L A R D E P O S I T S O F C A N A D I A N C H A R T E R E D B A N K S I N S E L E C T E D Y E A R S 83 1 3 . P E R C E N T A G E O F C A N A D I A N D O L L A R D E P O S I T S O F C A N A D I A N C H A R T E R E D B A N K S I N S E L E C T E D Y E A R S 84 v i i i A C K N O W L E D G E M E N T I w i s h to a c k n o w l e d g e the h e l p , s u p p o r t a n d u n d e r s t a n d i n g of M r . J . N . B r a y , of the F a c u l t y of C o m m e r c e , U n i v e r s i t y of B r i t i s h C o l u m b i a , w i thou t w h o s e h e l p t h i s t a s k w o u l d not b e c o m p l e t e d , I a m a l s o d e e p l y i n d e b t e d to the B a n k of M o n t r e a l , a n d in p a r t i c u l a r the G e n e r a l M a n a g e r f o r B r i t i s h C o l u m b i a , a n d h i s staff f o r t h e i r h e l p in the p r e p a r a t i o n of t h i s t h e s i s . C H A R T E R 1 I N T R O D U C T I O N T h e p r o b l e m i n v o l v e d in t h i s s t u d y i s to attempt to f ind a n d i s o l a t e the m a n y c a u s e s of c l e a r i n g g a i n s a n d l o s s e s to i n d i v i d u a l b a n k s . T h e p u r p o s e of t h i s s t u d y i s to e x p l a i n w h y c l e a r i n g g a i n s a n d l o s s e s o c c u r , a n d to s h o w h o w the a c t i o n s of the m a n a g e m e n t of a s i n g l e b a n k c a n ef fect t h o s e c l e a r i n g g a i n o r l o s s f i g u r e s . T h e s u b j e c t i s of p r i m a r y i m p o r t a n c e in C a n a d a , a s the c l e a r i n g g a i n s a n d l o s s e s i n c u r r e d by C a n a d i a n C h a r t e r e d B a n k s a r e i m m e d i a t e l y a d d e d o r t a k e n f r o m the s t a t u t o r y r e s - e r v e r e q u i r e m e n t s that m u s t b e m a i n t a i n e d w i t h the c e n t r a l b a n k i n g a u t h o r i t y - T h e B a n k of C a n a d a . A s t h e s e r e s e r v e s m u s t b e m a i n t a i n e d by l a w , a n y f a c t o r a f f e c t i n g t h e m s h o u l d b e fu l ly e x p l o r e d . T h e d a i l y c l e a r i n g g a i n a n d l o s s f i g u r e s a r e the m o s t i m p o r t a n t f a c t o r a f f e c t i n g t h e s e s t a t u t o r y r e s e r v e a c c o u n t s . F r o m the s t a n d p o i n t of a p r o f i t m a x i m i z i n g c o m m e r c i a l b a n k i n g i n s t i t u t i o n , t h e s e r e q u i r e d r e s e r v e s m u s t b e k e p t to a m i n i m u m , a s they a r e n o n - r e v e n u e p r o d u c i n g a s s e t s . K n o w i n g w h a t f a c t o r s h a v e i n f l u e n c e o n t h e s e r e s e r v e s a n d w h a t c a u s e s 2 . t h e s e r e s e r v e s to r i s e a n d f a l l , w i l l b e t t e r e q u i p m a n a g e m e n t of C a n a d i a n C h a r t e r e d B a n k s to h a n d l e the f l u c t u a t i o n s in t h e i r r e s e r v e a c c o u n t s . M u c h t i m e a n d e n e r g y of the C a n a d i a n C h a r t e r e d B a n k s i s d e v o t e d to the f o r e c a s t i n g a n d h a n d l i n g of c l e a r i n g g a i n s a n d l o s s e s , i n s o f a r a s they do ef fect the r e s e r v e a c c o u n t s w i t h the B a n k of C a n a d a . H o w e v e r , a s yet l i tt le i s r e a l l y k n o w n about w h a t c a u s e s t h e s e c l e a r i n g g a i n s a n d l o s s e s , a n d h o w the p o l i c - i e s of the i n d i v i d u a l b a n k s , the b a n k ' s c u s t o m e r s , a n d the B a n k of C a n a d a , c a n p o s s i b l y ef fect the s i z e , m a g n i t u d e a n d m o d e of t h e s e c l e a r i n g g a i n a n d l o s s f i g u r e s . It i s h o p e d that t h i s s t u d y w i l l i n c r e a s e the e x i s t i n g k n o w l e d g e o n t h i s s u b j e c t . A n o t h e r i m p o r t a n t a s p e c t of t h i s s t u d y i s to attempt to fi l l in w h a t the a u t h o r c o n s i d e r s to b e a v o i d in the t h e o r y of b a n k i n g . In the l i t e r a t u r e s u r v e y e d , w h i c h w a s s u b s t a n t i a l a n d h i g h l y i n d i c a t i v e of that p u b l i s h e d o n t h i s s u b j e c t , the a u t h o r f ound o n l y o n e m o r e than p a s s i n g r e f e r e n c e a s to h o w c l e a r i n g g a i n s a n d l o s s e s o r i g i n a t e a n d a s to h o w the a c t i o n s of the i n d i v i d u a l b a n k s m a n a g e m e n t , the b a n k ' s c u s t o m e r s , o r the c e n t r a l b a n k i n g a u t h o r i t y , c o u l d ef fect the c l e a r i n g g a i n o r l o s s f i g u r e s . In C h a p t e r 11 , w e w i l l b e g i n w i t h a s h o r t h i s t o r y of the 3 . e v o l u t i o n of d e p o s i t b a n k i n g ; f i r s t in g e n e r a l a n d then s p e c i f i c - a l l y a s it a r o s e in C a n a d a . T h i s w i l l g i v e the r e a d e r s o m e h i s t o r i c a l b a s e f r o m w h i c h to b e g i n the s t u d y of b a n k c l e a r i n g s . T h i s w i l l b e f o l l o w e d by a c h a p t e r o n d e p o s i t e x p a n s i o n a n d the c l e a r i n g s y s t e m in u s e in C a n a d a . In i t ia l ly w e w i l l s e t up a o n e b a n k c a s e to s h o w h o w the b a n k s o r the b a n k i n g s y s - tem c a n " c r e a t e m o n e y " b y the p r o c e s s of d e p o s i t e x p a n s i o n . F r o m the s i n g l e b a n k e x a m p l e , w e w i l l then m o v e into a m u l t i - b a n k e x a m p l e , w h e r e the ef fect of d e p o s i t e x p a n s i o n o n s e v e r a l b a n k s c a n b e s h o w n . W e w i l l then m o v e to a d i s c u s s i o n of the t w o b a s i c t y p e s of d e p o s i t s a n d the d i f f e r e n c e b e t w e e n t h e m . C h a p t e r 111 w i l l c o n t i n u e w i t h a n i n t r o d u c t i o n to the c l e a r i n g s y s t e m that e x i s t s in C a n a d a at the p r e s e n t t i m e . T h e i n t e r - b a n k c l e a r i n g s y s t e m w i l l b e d i s c u s s e d , f o l l o w e d by a d i s - c u s s i o n of the l o c a l i n t e r - b a n k c l e a r i n g s y s t e m , a n d f i n a l l y , the i n t e r n a l b a n k c l e a r i n g s y s t e m w i l l b e d i s c u s s e d . T h i s c h a p t e r w i l l c o n c l u d e w i t h a n at tempt to s h o w that c l e a r i n g g a i n s a n d / o r l o s s e s c a n e i t h e r b e " g o o d " o r " b a d " to a n y b a n k , d e p e n d i n g o n the s t a t e of that b a n k at the t ime of the g a i n o r l o s s . T h e b r e a k f r o m e x a m p l e s to p r a c t i c e w i l l b e m a d e in C h a p t e r I V , w h e r e the r e s e r v e r a t e a n d the d e p o s i t e x p a n s i o n p o s s i b l e in C a n a d a w i l l b e d i s c u s s e d . H e r e a l s o , the m e t h o d of d e t e r m i n i n g the c h a r t e r e d b a n k s d e p o s i t s w i t h the B a n k of C a n a d a w i l l b e d i s c u s s e d . T h e h e a r t of t h i s s t u d y i s c o n t a i n e d in C h a p t e r s V a n d V I , w h e r e the f a c t o r s a f f e c t i n g c l e a r i n g g a i n s a n d l o s s e s w i l l b e d i s c u s s e d . In C h a p t e r V , the s h o r t - r u n f a c t o r s a f f e c t i n g c l e a r - i n g g a i n s a n d l o s s e s w i l l b e d i s c u s s e d , a n d in C h a p t e r V I , the l o n g - r u n f a c t o r s w i l l b e d i s c u s s e d . C h a p t e r VI I w i l l c o n c l u d e t h i s s t u d y a n d g i v e in s u m m a - t ion f o r m the p o i n t s r a i s e d a n d c o n c l u s i o n s r e a c h e d . T h i s s t u d y i s l i m i t e d in that it s h o w s w h a t s h o u l d h a p p e n r a t h e r than w h a t d o e s h a p p e n . H o w e v e r , t h i s i s not a fault of the t h e o r y i t s e l f , but i s a r e s u l t of the u t t e r l a c k of a n y t y p e of b r e a k d o w n of C a n a d i a n c l e a r i n g g a i n a n d l o s s f i g u r e s , by the c h a r t e r e d b a n k s , the C a n a d i a n B a n k e r s A s s o c i a t i o n , o r the B a n k of C a n a d a . A p p e n d i x " A " e x h i b i t s the a t t e m p t s to t r a c k d o w n a n y b r e a k d o w n of the c l e a r i n g f i g u r e s , a n d the fut i le r e s u l t s of t h i s l a b o u r . B e f o r e b e g i n n i n g , it i s p e r h a p s w i s e to d e f i n e a f e w t e r m s a n d e s t a b l i s h s e v e r a l g r o u n d r u l e s w h i c h a r e e s s e n t i a l to a n u n d e r s t a n d i n g of w h a t f o l l o w s . I N V E S T M E N T S : T h e t e r m " i n v e s t m e n t s " w i l l b e u s e d t h r o u g h o u t t h i s s t u d y to d e s c r i b e w h a t a b a n k g e t s w h e n it g i v e s a l o a n o r p u r c h a s e s a s e c u r i t y f o r i ts o w n p o r t f o l i o . W h e n a b a n k e x t e n d s a l o a n , in ef fect w h a t it d o e s i s p u r - c h a s e a n a s s e t - the note - w h i c h of c o u r s e i s a l i a b i l i t y of the ent i ty r e c e i v i n g the p r o c e e d s of the n o t e . S i m i l a r l y , w h e n a b a n k p u r c h a s e s a s e c u r i t y f o r i t s o w n p o r t f o l i o , it p u r c h a s e s a n a s s e t - the b o n d , s t o c k o r d e b e n t u r e - w h i c h i s a l s o a l i a b i l i t y of the ent i ty i s s u i n g that s e c u r i t y . T h u s f r o m the b a n k ' s v i e w , the g i v i n g of a l o a n a n d the p u r c h a s i n g of a s e c u r i t y a r e both i n v e s t m e n t s in r e v e n u e p r o d u c i n g a s s e t s . T h e r e f o r e , u n l e s s o t h e r w i s e d e f i n e d , the t e r m " i n v e s t m e n t s " w h e n u s e d in t h i s s t u d y w i l l b e a p p l i e d to both the g i v i n g of a l o a n a n d the p u r c h a s i n g of a s e c u r i t y f o r the b a n k ' s p o r t f o l i o . T H E D E P O S I T O F I N V E S T E D F U N D S : A n u n d e r l y i n g a s s u m p t i o n t h r o u g h o u t t h i s p a p e r w i l l b e that the p r o c e e d s of a l l i n v e s t m e n t s ( a s p r e v i o u s l y d e f i n e d ) w i l l i n i t i a l l y b e c r e d i t e d to a d e p o s i t a c c o u n t w i t h s o m e b a n k . T h i s i s not a n u n r e a l i s t i c a s s u m p t i o n , a s g e n e r a l l y w h e n a b a n k e x t e n d s a l o a n to a c u s t o m e r , the p r o c e e d s a r e i n i t i a l l y c r e d i t e d to the c u s t o m e r ' s d e p o s i t a c c o u n t . 6 . In o r d e r f o r the a b o v e a r g u m e n t to b e v a l i d , it m u s t a l s o b e a s s u m e d that the c u r r e n c y r a t i o , ( the p e r c e n t a g e c a s h i s of the total " m o n e y s u p p l y " ) m u s t a l s o b e c o n s t a n t . T h i s r a t i o h a s p r o v e n to b e r e l a t i v e l y c o n s t a n t o v e r l o n g p e r i o d s of t ime by S t e p h e n M c D o n a l d , in h i s a r t i c l e " T h e In te rna l D r a i n a n d B a n k C r e d i t E x p a n s i o n " , a n d it w i l l b e a s s u m e d to b e c o n s t a n t f o r t h i s s t u d y . (1 ) (1 ) M c D o n a l d , S . J _ . , T h e I n te rna l D r a i n a n d B a n k C r e d i t E x p a n s i o n ; J o u r n a l of F i n a n c e ; V o l u m e 8, N o . 4 , D e c e m b e r , 1 9 6 3 , p a g e 4 0 7 . C H A P T E R II A S H O R T H I S T O R Y O F D E P O S I T B A N K I N G In G e n e r a l . It i s the g e n e r a l c o n s e n s u s that b a n k s o r i g i n a t e d f o r the s o l e p u r p o s e of a c c e p t i n g d e p o s i t s . H o w e v e r , t h i s m i s - c o n c e p t i o n w a s r e c o g n i z e d b y e a r l y s c h o l a r s in the s u b j e c t of m o n e y a n d b a n k i n g a n d i s r e c o g n i z e d a m o n g the c o m m e r c i a l b a n k e r s of t o d a y . T h e t e r m " b a n k i n g " o r i g i n a t e d in I ta ly , w h e r e the o r i g i n a l f unc t ion of the b a n k s w a s to f i n a n c e the g o v e r n m e n t s of the c i t i e s in w h i c h t h e s e b a n k s w e r e f o r m e d . It w a s o n l y a f t e r t h e s e p r i v a t e f i n a n c e c o m p a n i e s w e r e l o n g e s t a b l i s h e d that t h e y b e g a n to p a r t i c i p a t e in w h a t w e n o w k n o w a s the b u s i n e s s of b a n k i n g . T h e g r e a t b a n k s of n o r t h e r n E u r o p e , o r i g i n a t e d not by t h e i r l e n d i n g f u n c t i o n , a s d i d the b a n k s of I ta ly , but by t h e i r c o n v e n i e n c e f u n c t i o n s ; a s i s n o t e d by A d a m S m i t h . " T h e c u r r e n c y of a g r e a t s t a t e , s u c h a s F r a n c e o r E n g l a n d , g e n e r a l l y c o n s i s t s a l m o s t e n t i r e l y of i t s o w n c o i n . S h o u l d t h i s c u r r e n c y , t h e r e f o r e , b e at a n y t i m e w o r n , c l i p p e d , o r o t h e r w i s e d e - g r a d e d b e l o w i t s s t a n d a r d v a l u e , the s t a t e b y a r e f o r m a t i o n of i t s c o i n c a n e f f e c t u a l l y r e - e s t a b l i s h 8 . i ts c u r r e n c y ; but the c u r r e n c y of a s m a l l s t a t e , s u c h a s G e n o a o r H a m b u r g , c a n s e l d o m c o n - s i s t a l t o g e t h e r o n i ts o w n c o i n , but m u s t b e m a d e up in a g r e a t m e a s u r e of the c o i n s of a l l the n e i g h b o u r i n g s t a t e s w i t h w h i c h i ts i n h a b - i t an ts h a v e c o n t i n u a l i n t e r c o u r s e . S u c h a s t a t e , t h e r e f o r e , b y r e f o r m i n g i t s c o i n , w i l l not a l w a y s b e a b l e to r e f o r m i ts c u r r e n c y . If f o r e i g n b i l l s of e x c h a n g e a r e p a i d in t h i s c u r r e n c y , the u n - c e r t a i n v a l u e of a n y s u m of w h a t i s in i t s o w n n a t u r e s o u n c e r t a i n , m u s t r e n d e r the e x c h a n g e a l w a y s v e r y m u c h a g a i n s t s u c h a s t a t e , i t s c u r r e n c y b e i n g , in a l l f o r e i g n s t a t e s , n e c e s s a r i l y v a l u e d b e l o w w h a t it i s w o r t h . " "In o r d e r to r e m e d y the i n c o n v e n i e n c e to w h i c h t h i s d i s a d v a n t a g e o u s e x c h a n g e m u s t h a v e s u b - j e c t e d t h e i r e m e r g e n c e , s u c h s m a l l s t a t e s , w h e n they b e g a n to a t tend to the i n t e r e s t of the t r a d e , h a d f r e q u e n t l y e n a c t e d , that f o r e i g n b i l l s of e x - c h a n g e of a c e r t a i n v a l u e s h o u l d b e p a i d , not in a c o m m o n c u r r e n c y , but by a n o r d e r u p o n , o r by a t r a n s f e r i n , the b o o k s of a c e r t a i n b a n k , . . . , t h i s b a n k a l w a y s b e i n g o b l i g e d to p a y , in g o o d a n d t r u e m o n e y , e x a c t l y a c c o r d i n g to the s t a n d a r d of the s t a t e . " (2 ) T h u s the b a n k s of n o r t h e r E u r o p e f i r s t b e g a n to p e r f o r m the f u n c t i o n of a c c e p t i n g d e p o s i t s f o r the t r a n s f e r of f u n d s f r o m o n e m e r c h a n t to a n o t h e r , b y o r d e r . S u b s e q u e n t to t h i s , b a n k s b e c a m e the m a i n m e t h o d b y w h i c h m o n e y c o u l d b e t r a n s m i t t e d f r o m p a r t y to p a r t y a n d p l a c e to p l a c e , a n d e x t e n s i v e u s e w a s (2 ) S m i t h , A d a m ; W e a l t h of N a t i o n s , B o o k 4 , C h a p t e r 3 , a s r e p o r t e d b y W a l t e r B a g e h o t , L o m b a r d S t r e e t , T e g a n , P a u l , T r e n c h , T r u b n o r & C o . L t d . ; L o n d o n , 1 8 9 6 , P a g e 81 a n d 8 2 . 9 m a d e of t h i s s e r v i c e by the m e r c h a n t s of the d a y . In c o n t r a s t to the o r i g i n of d e p o s i t s in the n o r t h e r n E u r o p e a n b a n k s , the b a n k s of S c o t l a n d in i t i a ted t h e i r d e p o s i t s in a n o t h e r m a n n e r . O r i g i n a l l y , t h e s e S c o t t i s h b a n k s d e r i v e d t h e i r f u n d s f o r l e n d i n g s o l e l y f r o m the c i r c u l a t i o n of b a n k n o t e s . In s u c h a s y s t e m , the w i l l i n g n e s s to h o l d the note i s s u e s of t h e s e b a n k s w a s a p r i m e f a c t o r in the s u c c e s s o r f a i l u r e of a n y p a r t i c u l a r b a n k . A s the w i l l i n g n e s s to h o l d c u r r e n c y i n - c r e a s e d , the f u n d s a v a i l a b l e to the b a n k s f o r l e n d i n g p u r p o s e s a l s o i n c r e a s e d . D u r i n g t h i s t i m e , l i t t le at tent ion w a s p a i d to the d e p o s i t s i d e of the b a n k i n g b u s i n e s s , a n d it w a s not unt i l a s u b s t a n t i a l t i m e a f t e r t h e s e b a n k s w e r e f o r m e d that they a c c e p t e d d e p o s i t s f o r o t h e r than r e m i t t a n c e o r r e p a y m e n t of l o a n p u r p o s e s . T h e e m e r g e n c e of n o t e s in c i r c u l a t i o n p r i o r to d e p o s i t s s e e m s l o g i c a l e n o u g h in that " t h e p a p e r c i r c u l a r i s b e g u n by the b a n k e r , a n d r e q u i r e s no e f for t o n the p a r t of the p u b l i c ; o n the c o n t r a r y , it n e e d s a n e f for t of the p u b l i c to b e r i d of n o t e s o n c e i s s u e d ; but d e p o s i t b a n k i n g c a n n o t b e b e g u n by the b a n k e r a n d r e q u i r e s a s p o n t a n e o u s a n d c o n s i s t e n t e f fo r t in the c o m m u n i t y , a n d t h e r e f o r e p a p e r i s s u e i s the n a t u r a l p r e l u d e to d e p o s i t b a n k i n g . (3 ) (3 ) B a g e h o t , W a l t e r , o p . c i t . P a g e 8 9 . 1 0 . A s b u s i n e s s p r o g r e s s e d , m e r c h a n t s b e g a n to a c c u m - u la te l a r g e q u a n t i t i e s of t h e s e n o t e s a n d they found that h o a r d i n g t h e s e n o t e s w a s a r i s k y v e n t u r e , in that t h e s e n o t e s w e r e s u b j e c t to l o s s , theft o r d e s t r u c t i o n . T h i s r i s k t h e y w e r e not p r e p a r e d to a c c e p t . H o w e v e r , b y r e t u r n i n g t h e s e n o t e s to the i s s u i n g b a n k , they f ound t h e y c o u l d o b t a i n 1 a c r e d i t f o r t h e s e n o t e s o n the b o o k s of the s a i d b a n k . O n t h e s e c r e d i t s , o r d e p o s i t s , they c o u l d d r a w t h e i r b i l l s of e x c h a n g e in p a y i n g f o r the n e w m e r c h a n d i s e w h i c h w a s b e i n g p u r c h a s e d c o n t i n u a l l y , w i thou t the r i s k s that a c c o m p a n i e d the h o a r d i n g of the b a n k n o t e s t h e m s e l v e s . T h u s d e p o s i t b a n k i n g b e g a n , a n d c h e q u e s d r a w n o n t h e s e d e p o s i t s b e g a n to r e p l a c e the c u r r e n c y in c i r c u l a t i o n . W e c o n c l u d e t h e n , that a s y s t e m of note i s s u a n c e i s a p r i m a r y w a y of a r r i v i n g at a g r e a t s y s t e m of d e p o s i t b a n k i n g w h i c h i s s o n e c e s s a r y f o r the c o m m e r c i a l b a n k i n g b u s i n e s s t o - d a y . A s t h e s e d e p o s i t s r e p l a c e the n o t e s in c i r c u l a t i o n , the b a n k s ' s w i t c h f r o m note i s s u a n c e a s a s o u r c e of f u n d s f r o m w h i c h to l e n d , to f u n d s d e r i v e d f r o m d e p o s i t s p l a c e d w i t h the b a n k s ; a n d d e p o s i t b a n k i n g a s w e k n o w it t o d a y e m e r g e s . 1 1 . In C a n a d a . B a n k i n g a s w e n o w k n o w i t , d i d not c o m e into e x - i s t e n c e in C a n a d a unti l a f t e r the W a r of 1 8 1 2 . P r i o r to t h i s t i m e , m o s t e x c h a n g e w a s in the f o r m of c o i n s of the v a r i o u s c o u n t r i e s w h o h a d e x p l o r e d C a n a d a . D u r i n g t h i s t i m e , l i m i t e d s u p p l i e s of p a p e r m o n e y of q u e s t i o n a b l e w o r t h f r o m p u b l i c a n d p r i v a t e s o u r c e s w e r e c i r c u l a t i n g t h r o u g h the m e r - c h a n t s w i t h i n the c o l o n y . In p a r t i c u l a r , P r a n c e h a d c i r c u l a t e d v a s t a m o u n t s of p a p e r c u r r e n c y w h i c h l a t e r h a d b e c o m e w o r t h - l e s s . A s a r e s u l t , the s e t t l e r s of C a n a d a w e r e w a r y of p a p e r m o n e y a n d the p r a c t i c e of h o a r d i n g w h a t e v e r c o i n a g e w a s in c i r c u l a t i o n b e c a m e a p r o b l e m . B e c a u s e of the s c a r c i t y of c u r r e n c y , the b a c k b o n e of the f i r s t b u s i n e s s e s a n d the f i n a n c i n g of t h e s e b u s i n e s s e s in C a n a d a w a s b y the e x t e n s i o n of t r a d e c r e d i t . H o w e v e r , w h e n b u s i n e s s p r o g r e s s e d to the point w h e r e the f a r m e r w a s no l o n g e r s e l l i n g h i s p r o d u c e to the m e r c h a n t w h o s u p p l i e d h i m w i t h h i s n e e d s , a n e w m e d i u m of e x c h a n g e b e c a m e e s s e n t i a l , a n d c u r r e n c y i s s u a n c e b e g a n . T h e f i r s t i s s u e of a n y k i n d of c u r r e n c y in C a n a d a w a s the i s s u a n c e of a r m y b i l l s , in the a m o u n t of 2 5 0 , 0 0 0 c u r r e n c y . T h e s e b i l l s w e r e m a d e l e g a l t e n d e r in C a n a d a a n d w e r e a c c e p t a b l e a s p a y m e n t f o r a l l p u b l i c a n d p r i v a t e d e b t . 1 2 . In 1 8 1 7 , n i ne M o n t r e a l m e r c h a n t s a g r e e d to f o r m a b u s i n e s s f o r the f u n c t i o n of g e n e r a l b a n k i n g to b e k n o w n a s the B a n k of M o n t r e a l . A s a r e s u l t of t h i s a s s o c i a t i o n the B a n k of M o n t r e a l w a s f o u n d e d a s a n u n c h a r t e r e d b a n k o n N o v e m b e r 3 r d , 1 8 1 7 . T h e b r a n c h b a n k i n g s y s t e m w h i c h w e e n j o y in C a n a d a t o d a y w a s d e r i v e d f r o m the S c o t t i s h s y s t e m of b a n k i n g a l r e a d y d i s c u s s e d . H o w e v e r , t o d a y , " t h e b a n k s of C a n a d a h a v e d e v e l o p e d a l o n g l i n e s m a r k e d l y d i f f e r e n t f r o m t h o s e of E n g l i s h o r S c o t t i s h i n s t i t u t i o n s a n d e q u a l l y d i v e r g e n t f r o m the r o u t e f o l l o w e d b y the b a n k s in the U n i t e d S t a t e s . S o m e of the f i n a n c i a l e x p e r i e n c e s of G r e a t B r i t a i n a n d the U n i t e d S t a t e s h a v e b e e n f ru i t f u l l y u s e d b y C a n a d a , o t h e r s h a v e b e e n r e g a r d e d a s h o r r i d w a r n i n g s ; but the p r o c e s s of s e l e c t i o n a n d the s u b - s e q u e n t d e v e l o p m e n t b e a r a d i s t i n c t l y C a n a d i a n s t a m p . " ( 4 ) D e s p i t e the e v o l u t i o n of b a n k i n g in C a n a d a , a n A m e r i c a n , A l e x a n d e r H a m i l t o n , the F i r s t S e c r e t a r y of the T r e a s u r y , h a s b e e n r e c o g n i z e d a s the F a t h e r of the C a n a d i a n b a n k i n g s y s t e m . H a m i l t o n ' s i d e a l w a s to se t up a N a t i o n a l B a n k of N o r t h A m e r i c a , (4 ) J a m e s , F . C . , T h e E c o n o m i c s of M o n e y , C r e d i t a n d B a n k i n g , N e w Y o r k , 1 9 4 0 . 1 3 . f o r w h i c h h e d r e w up p l a n s that w e r e p r e s e n t e d to the C o n - g r e s s , a l o n g w i t h a r e p o r t s t a t i n g the d e s i r a b i l i t y of s u c h a n a t i o n a l b a n k . H o w e v e r , t h i s p l a n w a s not a c c e p t e d b y the C o n g r e s s of the U n i t e d S t a t e s n o r b y the C r o w n r e p r e s e n t a - t i v e s in C a n a d a , a n d the i d e a w a s d r o p p e d . C a n a d a ' s f i r s t b a n k , the B a n k of M o n t r e a l , w a s the f i r s t e s t a b l i s h m e n t of a p r i v a t e n a t u r e in C a n a d a to i s s u e n o t e s , a n d u p o n i t s e s t a b l i s h m e n t in 1 8 1 7 , it b e g a n to i s s u e i t s o w n c u r r e n c y n o t e s . T h u s , s i m i l a r to the e x p e r i e n c e of the n o r t h e r n E u r o p e a n b a n k s , the i s s u a n c e of n o t e s p r o c e e d e d , a n d to a c o n s i d e r a b l e e x t e n t , the a c c e p t a n c e of d e p o s i t s . S o o n a f t e r the o r g a n i z a t i o n of the B a n k of M o n t r e a l , it w a s r e c o g n i z e d that t h e r e w a s n e e d f o r s o m e type of s a v i n g s i n s t i t u t i o n , a n d the M o n t r e a l S a v i n g s B a n k w a s o p e n e d in la te 1 8 1 9 . A n e d i t o r i a l of the p e r i o d c o m m e n t s , " t h e o b j e c t of s u c h i ns t i tu t ion i s to o p e n to the l o w e r o r d e r s , a p l a c e of d e p o s i t f o r t h e i r s m a l l s a v i n g s , w i t h a l l o w a n c e f o r a r e a s o n a b l e m o n t h l y i n t e r e s t , a n d w i t h ful l l i b e r t y to w i t h d r a w t h e i r m o n e y at a n y t i m e e i t h e r in w h o l e o r in p a r t . . . . " (5 ) (5 ) M o n t r e a l H e r a l d , E d i t o r i a l , A u g u s t 2 4 t h , 1819 1 4 . " T h e M o n t r e a l S a v i n g s B a n k w a s e v e n t u a l l y t a k e n o v e r b y the B a n k of M o n t r e a l in 1 8 5 6 , at w h i c h t i m e the l a t t e r i ns t i tu t ion e s t a b l i s h e d i t s f i r s t s a v i n g s d e p a r t m e n t . " (6 ) A f t e r c o n s i d e r a b l e d i s c u s s i o n a m o n g the b a n k s a n d the G o v e r n m e n t of the t i m e , it w a s d e c i d e d in 1841 that the then c h a r t e r e d b a n k s no l o n g e r b e a l l o w e d to i s s u e n o t e s . A s t h e s e n o t e s w e r e c a l l e d i n , i n d i v i d u a l s w e r e g i v e n c r e d i t o n the b o o k s of the v a r i o u s b a n k s f o r the n o t e s r e t u r n e d , a n d the f i r s t d e p o s i t b a n k i n g a s w e k n o w it t o d a y w a s in i t i a ted in C a n a d a . T h u s , by the m i d d l e of the n ine teen th c e n t u r y , C a n a d a h a d a w e l l e s t a b l i s h e d d e p o s i t b a n k i n g s y s t e m . (6 ) M c l v o r , R . C . , C a n a d i a n M o n e t a r y , B a n k i n g a n d F i s c a l D e v e l o p m e n t ? M a c M i l l a n C o m p a n y of C a n a d a L i m i t e d , 1 9 5 8 , P a g e 3 4 . C H A P T E R III B A N K I N G : D E P O S I T E X P A N S I O N A N D T H E C L E A R I N G S Y S T E M I N C A N A D A D E P O S I T E X P A N S I O N : A O n e B a n k E x a m p l e In t h i s s e c t i o n it w i l l b e o u r in tent ion to e x p l a i n the t h e o r y of d e p o s i t e x p a n s i o n by the a c q u i s i t i o n of a s s e t s ; p r i - m a r i l y n o t e s . N o attempt at t h i s t i m e w i l l b e m a d e to r e l a t e the t h e o r y to a c t u a l h a p p e n i n g s in the r e a l w o r l d . "It i s not u n n a t u r a l to th ink of the d e p o s i t s of a b a n k a s b e i n g c r e a t e d b y the p u b l i c t h r o u g h the d e p o s i t of c a s h r e p r e s e n t i n g e i t h e r s a v i n g s o r a m o u n t s w h i c h a r e n o t , f o r the t i m e b e i n g , r e - q u i r e d to m e e t e x p e n d i t u r e s , but the b u l k of the d e p o s i t s a r i s e out of the a c t i o n s of the b a n k s t h e m s e l v e s , f o r by g r a n t i n g l o a n s , a l l o w i n g m o n e y to b e d r a w n o n o v e r d r a f t s , o r p u r c h a s i n g s e c u r - i t i e s , the b a n k c r e a t e s a c r e d i t o n i ts b o o k s w h i c h i s the e q u i v a l e n t of a d e p o s i t . " (7) It i s e s s e n t i a l to the u n d e r s t a n d i n g of the c o m m e r c i a l b a n k i n g s y s t e m , that the e x p a n s i o n of d e p o s i t s t h r o u g h the e x p a n s i o n (7 ) T h e R e p o r t of the C o m m i t t e e o n F i n a n c e a n d I n d u s t r y , L o n d o n , E n g l a n d , 1 9 3 1 , S e c t i o n 7 4 , P a g e 3 4 . 1 6 . of l o a n s a n d s e c u r i t y p u r c h a s e s be c l e a r l y u n d e r s t o o d . T o e x h i b i t t h i s d e p o s i t e x p a n s i o n t h r o u g h the g r a n t i n g of l o a n s a n d the p u r c h a s e of s e c u r i t i e s , let u s t a k e a n u n r e a l - i s t i c l y s i m p l e m o d e l of a n i n d i v i d u a l b a n k , s t a r t i n g w i t h a n in i t ia l c a s h d e p o s i t of $ 1 0 0 . In t h i s m o d e l w e w i l l a s s u m e w e a r e the o n l y b a n k , a n d that a l l c u s t o m e r s h a v e d e p o s i t a c c o u n t s w i t h " O u r B a n k " . B a c h t r a n s a c t i o n b e t w e e n " O u r B a n k " a n d o u r c u s t o m e r s w i l l b e dea l t w i t h t h r o u g h t h e s e d e p o s i t a c c o u n t s . T h e o n l y b a s i c d a t a w e n e e d to d e v e l o p o u r m o d e l , i s the l e g a l r e s e r v e r e q u i r e m e n t , w h i c h f o r o u r p u r p o s e s w e w i l l a r b i t r a r i l y set at the r a t e of 10% of a g g r e g a t e d e p o s i t s . F o r t h i s s i m p l e e x a m p l e , let u s a l s o a s s u m e that the r e s e r v e m e n - t i o n e d m u s t b e in the f o r m of c a s h ; that i s l e g a l t e n d e r n o t e s . U p o n the r e c e i p t of o u r in i t ia l c a s h d e p o s i t of $ 1 0 0 , the b a l a n c e s h e e t of " O u r B a n k " w o u l d l o o k a s i s s h o w n in F i g u r e 1 - A o n the f o l l o w i n g p a g e . W e h a v e r e c e i v e d c a s h of $ 1 0 0 f r o m o u r c u s t o m e r , c r e a t i n g a d e p o s i t l i a b i l i t y of $ 1 0 0 in f a v o r of o u r c u s t o m e r . A s c a n be s e e n , at the m o m e n t w e h o l d a 100% c a s h r e s e r v e f o r o u r d e p o s i t l i a b i l i t i e s . T h a t i s , o u r c a s h h o l d i n g s a r e 100% of o u r d e p o s i t l i a b i l i t i e s . A s t h i s i s a b o v e the 10% w h i c h i s r e q u i r e d b y l a w in o u r e x a m p l e , w e w i l l at tempt to l e n d out f u n d s in o r d e r to g e n e r a t e r e v e n u e . 17 F I G U R E 1 D E P O S I T E X P A N S I O N : O N E B A N K E X A M P L E A s s e t s C a s h F I G U R E 1 - A " O u r B a n k " B a l a n c e S h e e t $ 1 0 0 $ 1 0 0 L i a b i l i t i e s D e p o s i t s $ 1 0 0 $ 1 0 0 A s s e t s C a s h L o a n s F I G U R E 1 - B " O u r B a n k " B a l a n c e S h e e t L i a b i l i t i e s $ 1 0 0 $ 4 0 0 $ 5 0 0 D e p o s i t s $ 5 0 0 $ 5 0 0 A s s e t s C a s h L o a n s F I G U R E 1 - C " O u r B a n k " B a l a n c e S h e e t $ 1 0 0 $ 7 0 0 . i a b i l i t i e s D e p o s i t s $ 1 0 0 0 S e c u r i t i e s $ 2 0 0 $ 1000 $ 1 0 0 0 1 8 . L_et u s a s s u m e w e n o w l e n d out $ 4 0 0 to a n e w c u s t o m e r to w h o s e a c c o u n t w e c r e d i t the p r o c e e d s of the l o a n , a n d o u r n e w b a l a n c e s h e e t a f t e r the g r a n t i n g of t h i s l o a n l o o k s a s s h o w n in F i g u r e 1 -E3 . F r o m F i g u r e 1 - B w e s e e n o w that o u r c a s h r e s e r v e s a m o u n t to 20% of o u r d e p o s i t l i a b i l i t i e s , s t i l l d o u b l e the l e g a l r e s t r a i n t p l a c e d o n u s by the m o n i t a r y a u t h o r i t i e s in t h i s e x - a m p l e . In o r d e r to e x p a n d o u r r e v e n u e f u r t h e r , w e w i l l se t out to p u r c h a s e m o r e r e v e n u e p r o d u c i n g a s s e t s . T h i s t i m e w e l o a n a f u r t h e r $ 3 0 0 a n d in a d d i t i o n p u r c h a s e $ 2 0 0 in b o n d s f r o m o n e of o u r c u s t o m e r s , in e a c h c a s e c r e d i t i n g the p r o - c e e d s f r o m t h e s e t r a n s a c t i o n s to o u r c u s t o m e r s ' d e p o s i t a c c o u n t s w i t h u s . S u b s e q u e n t to t h i s t r a n s a c t i o n , the b a l a n c e s h e e t of " O u r B a n k " l o o k s a s i s s h o w n in F i g u r e 1 - C . A s i s e v i d e n t f r o m F i g u r e 1 - C , o u r c a s h r e s e r v e s a r e n o w 10% of o u r d e p o s i t l i a b i l i t i e s , a n d f u r t h e r e x p a n s i o n of o u r l o a n s o r f u r t h e r p u r c h a s e s of s e c u r i t i e s w o u l d p l a c e u s in the p o s i t i o n of e x c e e d i n g the s t a t u t o r y 10% c a s h r e s e r v e r e - q u i r e m e n t p l a c e d o n u s by the m o n i t a r y a u t h o r i t i e s in th i s e x a m p l e . T h u s , unt i l w e c a n e i t h e r i n c r e a s e o u r h o l d i n g s of c a s h , o r the r e q u i r e d r e s e r v e i s r e d u c e d , w e c a n no l o n g e r e x p a n d o u r l o a n s o r i n c r e a s e o u r s e c u r i t y p u r c h a s e s . 1 9 . F r o m the a b o v e i l l u s t r a t i o n s w e c a n s e e that " O u r B a n k " h a s i n c r e a s e d i t s d e p o s i t s of i t s o w n v o l i t i o n , b y the g i v i n g of l o a n s a n d the p u r c h a s i n g of s e c u r i t i e s . T h i s i s a u n i q u e f e a t u r e of the b a n k i n g s y s t e m . " C o m m e r c i a l b a n k s a r e i n s t i t u t i o n s w h i c h e x t e n d c r e d i t out of f u n d s t h e y o w n , b o r r o w , o r c r e a t e . T h e m o s t c h a r a c t e r i s t i c f e a t u r e of c o m m e r c i a l b a n k s , o n e w h i c h d i s t i n g u i s h e s t h e m f r o m o t h e r p r i v a t e c r e d i t i n s t i t u t i o n s , i s t h e i r ab i l i t y to c r e a t e m o n e y . " (8 ) " T h e s t a t e m e n t s that b a n k s c r e a t e c r e d i t a n d that a l o a n c r e a t e s a d e p o s i t h a v e b e e n u s e d t i m e a n d t ime a g a i n to s u g g e s t that b a n k s p o s s e s s s o m e u n i q u e a n d m y s t i c p o w e r to c r e a t e s o m e t h i n g out of n o t h i n g a n d that a l l o n e n e e d s to o p e r a t e a b a n k i s a f oun ta in p e n in g o o d w o r k i n g o r d e r . W h i l e the t e r m m a y b e c o n v e n i e n t , the w o r d ' c r e a t e ' i s u n f o r t u n a t e - a n d on the b a s i s of a n y r e a l i s t i c a n a l y s i s , i s i n c o r r e c t . M o b i l i z e o r m o n e t i z e w o u l d h a v e b e e n h a p p i e r a d d i t i o n s to e c o n o m i c p h r a s e o l o g y , but the d a m a g e i s n o w d o n e . " ( 9 ) It s h o u l d n o w b e e v i d e n t , that a b a n k d o e s not c r e a t e d e p o s i t s ; but o n l y m o b i l i z e s the r e s o u r c e s p l a c e d at i ts d i s p o s a l f o r the p r o d u c t i o n of r e v e n u e . It s h o u l d a l s o b e e v i d e n t that b y the p r o c e s s of l o a n i n g m o n e y o r p u r c h a s i n g s e c u r i t i e s a n d (8 ) H a l m , G . N . , E c o n o m i c s of M o n e y a n d B a n k i n g , H o l m w o I l l i n o i s , 1 9 6 1 , P a g e 1 4 1 . (9 ) H a c k e t t , W . T . G . , T h e B a c k g r o u n d of B a n k i n g T h e o r y , T o r o n t o , O n t a r i o , 1 9 4 5 , P a g e 3 8 . 2 0 . c r e d i t i n g the p r o c e e d s to d e p o s i t a c c o u n t s , o u r s i n g l e b a n k c a n e x p a n d i ts d e p o s i t s to a l imit d e t e r m i n e d o n l y by the r e - s e r v e r e q u i r e m e n t , a n d of c o u r s e the a v a i l a b i l i t y of r e v e n u e p r o d u c i n g a s s e t s f o r p u r c h a s e . D E P O S I T E X P A N S I O N - A M u l t i - B a n k E x a m p l e W e h a v e s e e n the d e p o s i t e x p a n s i o n w h i c h c a n b e a c h i e v e d in a o n e b a n k s y s t e m . H o w e v e r , a o n e b a n k s y s t e m i s u n r e a l i s t i c a n d in a n attempt to b e c o m e m o r e r e a l i s t i c w e w i l l n o w p r e s e n t a m u l t i - b a n k m o d e l . T o s o d o , let u s f o l l o w t h r o u g h o u r p r e v i o u s e x a m p l e ; that of a $ 1 0 0 c a s h d e p o s i t , a s s u m i n g that w e n o w h a v e t h r e e b a n k s : B a n k A , B a n k B , a n d B a n k C . I_et u s a s s u m e o u r o r i g i n a l d e p o s i t of $ 1 0 0 i s d i s - t r i b u t e d a m o n g the t h r e e b a n k s in the f o l l o w i n g m a n n e r : $ 5 0 to B a n k A , $ 3 0 to B a n k B , a n d $ 2 0 to B a n k C , a n d that the p r o c e e d s a r e c r e d i t e d to d e p o s i t a c c o u n t s . T h e b a l a n c e s h e e t s f o r e a c h i n d i v i d u a l b a n k a n d f o r the a g g r e g a t e of a l l t h r e e b a n k s a f t e r t h e s e c a s h d e p o s i t t r a n s a c t i o n s h a v e t a k e n p l a c e w i l l b e a s i s s h o w n in F i g u r e 2 - A o n the f o l l o w i n g p a g e . U n d e r the s a m e a s s u m p t i o n s w e p r e v i o u s l y u s e d , that 2 1 . F I G U R E 2 D E P O S I T E X P A N S I O N : M U L T I - B A N K E X A M P L I A s s e t s C a s h L i a b i l i t i e s D e p o s i t s F I G U R E 2 - A B a n k A B a n k B B a n k C A l l B a n k s 50 50 30 30 20 20 100 100 A s s e t s C a s h L o a n s L i a b i l i t i e s D e p o s i t s F I G U R E 2 - B B a n k A B a n k B B a n k C A l l B a n k s 50 150 200 200 30 150 180 180 20 150 170 170 100 4 5 0 550 550 A s s e t s C a s h L o a n s S e c u r i t i e s L i a b i l i t i e s D e p o s i t s F I G U R E 2 - C B a n k A B a n k B B a n k C A l l B a n k s 50 250 200 500 500 30 220 50 3 0 0 300 20 150 30 200 200 100 620 280 I000 1000 2 2 . i s a 10% c a s h r e s e r v e r e q u i r e m e n t , it i s e v i d e n t that a l l t h r e e of the b a n k s p r e s e n t l y h a v e a 100% c a s h r e s e r v e , in that a l l h a v e c a s h e q u a l l i n g the total of t h e i r d e p o s i t l i a b i l i t i e s . E a c h b a n k b e i n g p r o f i t o r i e n t a t e d , w i l l t h e r e f o r e attempt to i n v e s t f u n d s in o r d e r to d e r i v e r e v e n u e . L e t u s a s s u m e that e a c h b a n k g r a n t s a l o a n of $ 1 5 0 , i n i t i a l l y d e p o s i t i n g the p r o c e e d s in e a c h c a s e in d e p o s i t a c c o u n t s . T h e b a l a n c e s h e e t s f o l l o w i n g t h i s t r a n s a c t i o n w o u l d l o o k a s i s s h o w n in F i g u r e 2 - B f o r e a c h of the b a n k s a n d f o r the total of a l l b a n k s . It i s e v i d e n t , that the c a s h r e s e r v e s n o w h e l d b y e a c h of the b a n k s a r e 25%, 17% a n d 12% of t h e i r total d e p o s i t l i a b i l - i t i e s , f o r B a n k s A , B a n d C r e s p e c t i v e l y . A s the c a s h r e s e r v e f o r e a c h b a n k i s g r e a t e r than the 10% s t a t u t o r y r e q u i r e m e n t , e a c h b a n k w i l l a g a i n attempt to s e c u r e f u r t h e r i n c o m e p r o d u c i n g a s s e t s . L e t u s a s s u m e that the f o l l o w i n g t r a n s a c t i o n s n o w t a k e p l a c e . B a n k A l o a n s a f u r t h e r $ 1 0 0 a n d p u r c h a s e s $ 2 0 0 w o r t h of s e c u r i t i e s ; B a n k B l o a n s a f u r t h e r $ 7 0 a n d p u r c h a s e s $ 5 0 w o r t h of s e c u r i t i e s ; a n d B a n k C p u r c h a s e s $ 3 0 w o r t h of s e c u r - i t i e s . A l l p r o c e e d s of the l o a n s a n d p u r c h a s e s of s e c u r i t i e s a r e c r e d i t e d to d e p o s i t a c c o u n t s w i t h the r e s p e c t i v e b a n k s . T h e b a l a n c e s h e e t of e a c h b a n k , a n d of a l l b a n k s in t o t a l , n o w l o o k s a s F i g u r e 2 - C e x h i b i t s . 2 3 . S i m p l e o b s e r v a t i o n s h o w s that a l l t h r e e b a n k s a r e n o w at t h e i r m i n i m u m c a s h r e s e r v e r e q u i r e m e n t of 10% of t h e i r d e p o s i t l i a b i l i t i e s , a n d that a n y f u r t h e r i n c r e a s e in t h e i r l o a n s o r f u r t h e r s e c u r i t y p u r c h a s e s w o u l d p l a c e t h e i r r e s p e c t i v e c a s h r e s e r v e s b e l o w the l e g a l r e q u i r e m e n t of 10% of t h e i r d e p o s i t l i a b i l i t i e s . F o r e a c h b a n k , d e p o s i t s h a v e b e e n e x p a n d e d ten t i m e s the o r i g i n a l c a s h d e p o s i t s ; a s h a v e d e p o s i t s f o r the a g - g r e g a t e of a l l t h r e e b a n k s . N o t e that the a g g r e g a t e of the l o a n s a n d s e c u r i t y i n v e s t m e n t s , a n d the total d e p o s i t s f o r a l l t h r e e b a n k s , a r e e x a c t l y e q u a l to the s i m i l a r f i g u r e s f o r " O u r B a n k " p r e v i o u s l y d i s c u s s e d in o u r o n e b a n k m o d e l . T h u s , w e c a n s e e that if e a c h of t h r e e i n d i v i d u a l b a n k e x p a n d s i t s i n v e s t m e n t s to the l e g a l m a x i m u m , w h e t h e r in l o a n s o r s e c u r i t i e s p u r c h a s e d , the r e s u l t w o u l d b e the s a m e in the a g g r e g a t e a s if o n l y o n e b a n k h a d b e e n in o p e r a t i o n in the e c o n o m y . P R I M A R Y A N D D E R I V E D D E P O S I T S F r o m the a b o v e d i s c u s s i o n s of d e p o s i t e x p a n s i o n , it m a y b e n o t i c e d that t h e r e a r e t w o t y p e s of d e p o s i t s : t h o s e that c a m e in f r o m o u t s i d e the b a n k , a n d t h o s e that w e r e a r e - su l t of the b a n k ' s r e v e n u e s e e k i n g f u n c t i o n s . T h e s e t w o t y p e s of d e p o s i t s h a v e b e e n c a l l e d p r i m a r y a n d d e r i v e d d e p o s i t s r e s p e c t i v e l y . 2 4 . " A c o m m e r c i a l b a n k c a n c r e a t e d e m a n d d e p o s i t s p a s s i v e l y a g a i n s t the r e c e i p t of c u r r e n c y o r c h e q u e s f r o m i ts d e p o s i t o r s . T h e s e a r e the s o - c a l l e d p r i m a r y d e p o s i t s a r i s i n g f r o m a n a c t u a l d e p o s i t of m o n e y in a b a n k . " ( 1 0 ) B y p a s s i v e l y , w e m e a n that it d o e s not t a k e a n a c t i v e a c t i o n o n the p a r t of the b a n k to o b t a i n t h e s e d e p o s i t s ; they a r e r e - c e i v e d b y the b a n k in r e s p o n s e to a n a c t i o n b y o n e of i ts c u s t o m e r s . M o s t d e p o s i t s in the c o m m e r c i a l b a n k i n g s y s t e m a r e p r i m a r y d e p o s i t s , a n d f o r a b a n k w i t h a n y s u b s t a n t i a l n u m b e r of d e p o s i t o r s , the i n f l o w of d e p o s i t s of t h i s t y p e w i l l t e n d to m a t c h the o u t f l o w of f u n d s f r o m t h e s e a c c o u n t s , t h u s y i e l d i n g a m o r e o r l e s s c o n s t a n t a v e r a g e b a l a n c e in the d e - p o s i t a c c o u n t s , at l e a s t o v e r a s h o r t r u n . T h e s e b a l a n c e s a r e e s s e n t i a l l y the " w o r k i n g c a p i t a l " of the b a n k s c u s t o m e r s . " A c o m m e r c i a l b a n k c a n a l s o c r e a t e d e p o s i t s a c t i v e l y b y c r e a t i n g c l a i m s a g a i n s t i tse l f in f a v o r of a b o r - r o w e r o r a s e l l e r of s e c u r i t i e s . T h e s e a c t i v e l y c r e a t e d d e p o s i t s a r e t e r m e d d e r i v e d d e p o s i t s . " ( 11 ) T h u s , the d e p o s i t s c r e a t e d b y " O u r B a n k " w h e n it l o a n e d m o n e y o r p u r c h a s e d s e c u r i t i e s in the p r e c e d i n g s e c t i o n w e r e d e r i v e d d e p o s i t s . A s d e r i v e d d e p o s i t s n e c e s s i t a t e a n a c t i v e (10 ) H a l m , G . N . , o p . c i t . , P a g e 1 4 6 . ( 11 ) I b i d . , P a g e 1 4 6 . 2 5 . a c t i o n o n the p a r t of the c o m m e r c i a l b a n k , the a m o u n t of d e - r i v e d d e p o s i t s c a n be r e g u l a t e d b y the b a n k m a n a g e m e n t to s o m e e x t e n t : i . e . if no n e w l o a n s a r e g i v e n o r no n e w s e c u r i t i e s p u r c h a s e d , no n e w d e r i v e d d e p o s i t s a r e c r e a t e d . H o w e v e r , the extent to w h i c h d e r i v e d d e p o s i t s c a n b e c r e a t e d b y a s i n g l e b a n k i s l i m i t e d b y a r e s e r v e r e q u i r e m e n t , a s w e s a w in the e x a m p l e s in the p r e c e d i n g s e c t i o n . In c o n t r a s t to p r i m a r y d e p o s i t s , d e r i v e d d e p o s i t s do not t e n d to be m a t c h e d w i t h e q u a l o u t f l o w s , a n d a s a b a n k e x p a n d s i ts d e r i v e d d e p o s i t s it m u s t e x p e c t to s u f f e r a n o u t - f l o w of f u n d s r e s u l t i n g f r o m the g i v i n g of the l o a n s o r the p u r c h a s i n g of s e c u r i t i e s . In b a n k i n g t e r m s the b a n k m u s t e x - p e c t to h a v e a c l e a r i n g l o s s . T h i s fact w i l l b e d i s c u s s e d at g r e a t e r length in l a t e r s e c t i o n s of t h i s s t u d y . It i s i n t e r e s t i n g to note that a s the d e r i v e d d e p o s i t s f l o w out of o n e i n d i v i d u a l b a n k , they b e c o m e the p r i m a r y d e - p o s i t s of a n o t h e r b a n k . A n e x a m p l e w i l l i l l u s t r a t e . If a c u s t o m e r of B a n k A i s l o a n e d m o n e y to p u r c h a s e a c a r , the d e r i v e d d e p o s i t s c r e a t e d by g i v i n g the l o a n b e c o m e s a w i t h - d r a w a l a l m o s t i m m e d i a t e l y w h e n a c h e q u e i s d r a w n o n h i s a c c o u n t o n B a n k A to p a y f o r the a u t o m o b i l e . If the f i r m f r o m w h i c h the c a r i s p u r c h a s e d b a n k s at B a n k B , t h i s d e r i v e d 2 6 . d e p o s i t c r e a t e d by B a n k A b e c o m e s a p r i m a r y d e p o s i t of B a n k B , in that it i s a p o r t i o n of the n o r m a l w o r k i n g c a p i t a l of the a u t o m o b i l e f i r m a n d w i l l b e m a t c h e d by s u b s e q u e n t w i t h - d r a w a l s of a p p r o x i m a t e l y the s a m e a m o u n t , s a y to p a y the m a n u f a c t u r e r of the c a r , the s a l e s m a n f o r the s a l e , a n d f o r the s e r v i c i n g e x p e n s e s i n c u r r e d u n d e r the w a r r a n t y . P r i m a r y d e p o s i t s do not i n c r e a s e the a g g r e g a t e s u p - p ly of m o n e y in that they r e p r e s e n t o n l y the i n t e r c h a n g e of a l r e a d y e x i s t i n g m o n e y a m o n g v a r i o u s i n d i v i d u a l s in the c o m - m u n i t y . D e r i v e d d e p o s i t s d o , h o w e v e r , i n c r e a s e the a g g r e g a t e m o n e y s u p p l y , in that they a r e a r e s u l t of the a c t of c r e d i t c r e a t i o n a n d r e p r e s e n t n e w m o n e y m a d e a v a i l a b l e to a n i n d i v i d u a l w i thou t the l o s s of m o n e y to a n y o t h e r i n d i v i d u a l , a s i s the c a s e w i t h p r i m a r y d e p o s i t s . In s u m m a r y , b a n k s m a y c r e a t e d e p o s i t s in o n e of t w o m a n n e r s : - A g a i n s t v a l u e r e c e i v e d in the f o r m of c a s h o r c h e q u e s f r o m i n d i v i d u a l s ; - O r by p u r c h a s i n g the a s s e t s in the f o r m of s e c u r i t i e s a n d / o r n o t e s , f o r w h i c h the b a n k i n i t i a l l y p r o v i d e s p a y m e n t by e s t a b l i s h i n g a c l a i m a g a i n s t i tse l f in the f o r m of a d e p o s i t l i a b i l i t y in f a v o r of t h o s e s u r r e n d e r i n g the a s s e t s s o a c q u i r e d . 2 7 . H a v i n g d i s c u s s e d p r i m a r y a n d d e r i v e d d e p o s i t s a n d r e c o g n i z i n g that p r i m a r y d e p o s i t s f o r a n y b a n k at l e a s t in p a r t m a y b e r e p r e s e n t e d by c h e q u e s d r a w n o n o t h e r b a n k s , it b e - c o m e s e v i d e n t that t h e r e m u s t b e a n e x c h a n g e of t h e s e c h e q u e s b e t w e e n b a n k s . T h i s e x c h a n g e i s t e r m e d the " c l e a r i n g " of the c h e q u e s , a n d it w i l l n o w be o u r t a s k to d i s c u s s the c l e a r i n g s y s t e m in e x i s t e n c e in C a n a d a . T H E I N T E R B A N K C L E A R I N G S Y S T E M T h e t e r m " c l e a r i n g s " , r e f e r s to the e x c h a n g e a m o n g b a n k s of c h e q u e s a n d o t h e r i t e m s d r a w n o n o n e b a n k a n d n e g o t i a t e d o r p a i d by a n o t h e r . T h i s e x c h a n g e i s m a d e n e c - e s s a r y by the fact that a c u s t o m e r of o n e b a n k m a y , a n d often d o e s , d e a l w i t h o t h e r than c u s t o m e r s of the s a m e b a n k . If a c u s t o m e r of B a n k A t e n d e r s a c h e q u e in p a y m e n t of a debt to a : c u s t o m e r of B a n k B , a n d the c u s t o m e r of B a n k B d e p o s i t s t h i s c h e q u e in h i s a c c o u n t w i t h B a n k B , in o r d e r f o r the c u s - t o m e r ' s a c c o u n t in B a n k A to b e c h a r g e d w i t h the c h e q u e , a n e x c h a n g e b e t w e e n the t w o b a n k s m u s t t a k e p l a c e . T h e e x c h a n g e of t h i s c h e q u e b e t w e e n B a n k A a n d B a n k B i s t e r m e d c l e a r i n g the c h e q u e . T h i s e x c h a n g e t a k e s p l a c e , u s u a l l y o n a d a i l y b a s i s , a n d s e t t l e m e n t s a r e g i v e n a n d r e c e i v e d to c o v e r a n y 2 8 . net c l e a r i n g l o s s o r net c l e a r i n g g a i n s u f f e r e d b y i n d i v i d u a l b a n k s . A c l e a r i n g l o s s i s i n c u r r e d w h e n a b a n k p r e s e n t s l e s s f o r s e t t l e m e n t than i s p r e s e n t e d to i t , a n d a c l e a r i n g g a i n i s i n c u r r e d w h e n a b a n k p r e s e n t s m o r e f o r s e t t l e m e n t than it i s p r e s e n t e d . P o s s i b l y a n e x a m p l e w o u l d b e s t s e r v e the p u r - p o s e of e x p l a i n i n g w h a t c l e a r i n g s a r e , a n d h o w i t e m s a r e c l e a r e d . A s s u m e w e h a v e f o u r b a n k s ; B a n k A , B a n k B , B a n k C a n d B a n k D , e a c h p o s s e s s i n g c h e q u e s w h i c h h a v e b e e n p a i d in c a s h o r d e p o s i t e d to o n e of t h e i r c u s t o m e r ' s a c c o u n t s . D a i l y , e a c h b a n k p r o c e e d s w i t h i ts c h e q u e s to a c e n t r a l point of e x c h a n g e t e r m e d " a c l e a r i n g h o u s e " , w h e r e the a c t u a l i t e m s a r e e x c h a n g e d a m o n g the b a n k s . A c l e a r i n g s h e e t i s then m a d e up by the p e r s o n in c h a r g e of the c l e a r i n g h o u s e ; t h i s s h e e t s h o w s w h i c h b a n k h a v e p r e s e n t e d m o r e f o r p a y m e n t than t h e y h a v e r e c e i v e d , a n d w h i c h h a v e r e c e i v e d m o r e than they h a v e p r e s e n t e d . T h e d i f f e r e n c e b e t w e e n the a m o u n t p r e s e n t e d a n d the a m o u n t r e c e i v e d f o r a n y o n e b a n k i s the d a i l y c l e a r i n g g a i n o r l o s s f o r that b a n k . F i g u r e 3 - A , o n the f o l l o w i n g p a g e , s h o w s a t y p i c a l c l e a r i n g h o u s e s t a t e - ment f o r o u r b a n k s , w i t h the h y p o t h e t i c a l a m o u n t s p r e s e n t e d a n d r e c e i v e d by e a c h b a n k , a n d the r e s p e c t i v e c l e a r i n g g a i n o r l o s s i n c u r r e d b y e a c h b a n k s h o w n . 2 9 . F I G U R E 3 C L E A R I N G S A N D C L E A R I N G G A I N S A N D L O S S E S F I G U R E 3 - A A T y p i c a l C l e a r i n g H o u s e S t a t e m e n t (In D o l l a r s ) T o t a l 1 , 4 8 2 1 , 2 7 3 1 , 2 4 9 2 , 3 3 9 F I G U R E 3 - B C a l c u l a t i o n O f N e t C l e a r i n g G a i n ( L o s s ) B a n k A B C D P r e s e n t e d 1 , 5 5 8 2 , 0 0 7 1 , 2 2 9 1 , 5 4 9 R e c e i v e d 1 , 4 8 2 1 , 2 7 3 1 , 2 4 9 2 , 3 3 9 N e t C l e a r i n g G a i n ( L o s s ) 76 + 7 3 4 + ( 2 0 ) + ( 7 9 0 ) = O 3 0 . T h e r e s p e c t i v e g a i n s a n d l o s s e s f o r e a c h b a n k m a y be s e t t l e d in o n e of t w o m a n n e r s : b y the e x c h a n g e of c a s h , o r , b y the a u t h o r i z a t i o n to c h a r g e a n a c c o u n t e a c h b a n k m a i n - t a i n s in the c e n t r a l b a n k w i t h the p a r t i c u l a r d a i l y g a i n o r l o s s . In C a n a d a , the p r a c t i c e i s to c h a r g e the i n d i v i d u a l b a n k ' s r e - s e r v e a c c o u n t in the B a n k of C a n a d a , w i t h a n y c l e a r i n g l o s s , a n d c r e d i t the s a m e a c c o u n t w i t h a n y c l e a r i n g g a i n . T h u s , e a c h b a n k h a v i n g a net c l e a r i n g l o s s a u t h o r i z e s the B a n k of C a n a d a to c h a r g e i ts a c c o u n t w i t h the l o s s ; a n d e a c h b a n k that h a s a g a i n i s c r e d i t e d w i t h the p r o c e e d s of t h i s g a i n . A t the e n d of e a c h c l e a r i n g p e r i o d , u s u a l l y o n e d a y , the b a n k s h a v e s e t t l e d f o r a n y d i f f e r e n c e b e t w e e n the a m o u n t s they h a v e p r e s e n t e d a n d the a m o u n t s they h a v e r e c e i v e d , e i t h e r in c h e q u e s o n o t h e r b a n k s , o r in t r a n s f e r s of f u n d s w i t h i n the c e n t r a l b a n k i n g a u t h o r i t i e s ' a c c o u n t s . T h e net r e s u l t s of a l l the c l e a r - i n g s a m o n g the b a n k s i s a l w a y s z e r o , a s i s s h o w n in F i g u r e 3 - B f o r o u r e x a m p l e . In C a n a d a , c h e q u e s a n d o t h e r n e g o t i a b l e i n s t r u m e n t s a r e c l e a r e d o r e x c h a n g e d at 9 p o i n t s d e s i g n a t e d b y the B a n k of C a n a d a a s c l e a r i n g h o u s e p o i n t s , a n d at w h i c h the B a n k of C a n a d a m a i n t a i n s a g e n c i e s . C u r r e n t l y , t h e s e a r e , H a l i f a x , S t . J o h n ' s , M o n t r e a l , O t t a w a , T o r o n t o , W i n n i p e g , R e g i n a , 3 1 . C a l g a r y a n d V a n c o u v e r . T h e b a l a n c e s r e s u l t i n g f r o m the r e s p e c t i v e c l e a r i n g g a i n s o r l o s s e s f o r e a c h b a n k at e a c h point a r e f o r w a r d e d by d i r e c t w i r e f r o m the B a n k of C a n a d a A g e n c i e s at t h e s e c i t i e s to the B a n k of C a n a d a ' s C e n t r a l O f f i c e in O t t a w a , w h e r e t h e s e s u m s a r e a d d e d to o r d e l e t e d f r o m the i n d i v i d u a l b a n k ' s r e s e r v e a c c o u n t s . T h u s , w e h a v e d e f i n e d " c l e a r i n g s " a s the e x c h a n g e a m o n g b a n k s of c h e q u e s a n d o t h e r i t e m s d r a w n o n o n e b a n k a n d n e g o t i a t e d o r p a i d b y a n o t h e r , a n d w e h a v e s e e n h o w t h e s e i t e m s a r e e x c h a n g e d a m o n g b a n k s a n d f i na l l y s e t t l e d f o r o r p a i d a m o n g b a n k s . It w i l l b e o u r t a s k in t h i s s t u d y to i s o l a t e the c a u s e s of the d i f f e r e n c e s b e t w e e n the a m o u n t p r e s e n t e d a n d the a m o u n t r e c e i v e d b y a n y o n e b a n k , both in the s h o r t - r u n a n d the l o n g - r u n ; that i s to l o o k at the f a c t o r s i n f l u e n c i n g c l e a r i n g g a i n s o r l o s s e s . T H E L O C A L I N T E R - B A N K C L E A R I N G S Y S T E M In a d d i t i o n to the c l e a r i n g of c h e q u e s a m o n g the b a n k s at the A g e n c y p o i n t s of the B a n k of C a n a d a , c h e q u e s d r a w n o n l o c a l b r a n c h e s of d i f f e r e n t b a n k s in the s a m e c o m m u n i t y a r e e x c h a n g e d in w h a t might b e c a l l e d a n i n f o r m a l l o c a l c l e a r i n g h o u s e . 3 2 . S u p p o s e f o r i n s t a n c e that t w o b a n k s , both m a i n t a i n b r a n c h e s in a s m a l l c o m m u n i t y w h i c h d o e s not h a v e a n A g e n c y of the B a n k of C a n a d a , a n d i s t h u s not a n o f f i c i a l c l e a r i n g p o i n t . In t h e i r d a i l y b u s i n e s s , e a c h b r a n c h of t h e s e t w o b a n k s a c c u m - m u l a t e s a c e r t a i n n u m b e r of c h e q u e s d r a w n o n the o t h e r . It i s t h e s e i t e m s , d r a w n o n e a c h l o c a l b r a n c h o n l y , that a r e e x - c h a n g e d a m o n g the b a n k s o n a d a i l y b a s i s . T h e m a i n i n c e n t i v e f o r s u c h a p r o c e d u r e i s to r e d u c e the c l e a r i n g f loat b e t w e e n the t w o b a n k s . A n e x a m p l e w i l l i l l u s t r a t e . B a n k s A a n d B e a c h m a i n t a i n b r a n c h e s in the s a m e c o m m u n i t y w h i c h i s not a B a n k of C a n a d a c l e a r i n g p o i n t . D u r i n g the c o u r s e of a b u s i n e s s d a y , the l o c a l b r a n c h of B a n k A a c c u m m u l a t e s $ 1 , 0 0 0 w o r t h of c h e q u e s d r a w n o n the l o c a l b r a n c h of B a n k B . D u r i n g the s a m e b u s i n e s s d a y , the l o c a l b r a n c h of B a n k B a c c u m m u l a t e s $ 8 0 0 w o r t h of c h e q u e s d r a w n o n the l o c a l b r a n c h of B a n k A . A t the c l o s e of the b u s i n e s s d a y , the l o c a l b r a n c h of B a n k A p r e s e n t s h i s $ 1 , 0 0 0 w o r t h of c h e q u e s d r a w n o n the l o c a l b r a n c h of B a n k B , to the l o c a l b r a n c h of B a n k B . L i k e w i s e , the l o c a l b r a n c h of B a n k B p r e s e n t s h i s $ 8 0 0 w o r t h of c h e q u e s d r a w n o n the l o c a l b r a n c h of B a n k A to the l o c a l b r a n c h of B a n k A . T h e d i f f e r e n c e of $ 2 0 0 , o w e d to the l o c a l b r a n c h of B a n k A by the l o c a l b r a n c h 3 3 . of B a n k B , ( a s the b r a n c h of A p r e s e n t e d $ 2 0 0 m o r e to the b r a n c h of B f o r p a y m e n t than the b r a n c h of B p r e s e n t e d to the b r a n c h of A ) , c a n b e s e t t l e d in o n e of t w o m a n n e r s : ( 1 ) B y the l o c a l b r a n c h of B a n k B g i v i n g the l o c a l b r a n c h of B a n k A a " b a n k s e t t l e m e n t " f o r the d i f f e r e n c e , o r , (2 ) B y the b r a n c h of B s e t t i n g up a l i a b i l i t y a c c o u n t a s to i t s i n d e b t e d n e s s to the b r a n c h of A , a n d the b r a n c h of A s e t t i n g up an a s s e t a c c o u n t to s h o w the i n d e b t e d n e s s of the b r a n c h of B to i t . If p r o c e d u r e 1 i s u s e d , B a n k A f o r w a r d s the " b a n k s e t t l e m e n t " ( m e r e l y a f o r m a u t h o r i z i n g a c h a r g e a g a i n s t B a n k B t h r o u g h the c e n t r a l c l e a r i n g h o u s e ) r e c e i v e d f r o m B a n k B , to a c e n t r a l c l e a r i n g h o u s e p o i n t , t h r o u g h B a n k A ' s i n t e r n a l b r a n c h c l e a r i n g s y s t e m , w h e r e the b a n k s e t t l e m e n t i s p r o c e s s e d t h r o u g h the c e n t r a l c l e a r i n g h o u s e in a s i m i l a r m a n n e r to a n y o t h e r i tem d r a w n o n B a n k B . O n the o t h e r h a n d , if a l t e r n a t i v e 2 i s u s e d , w h i c h i s u s u a l , e a c h b a n k m e r e l y k e e p s t r a c k of the r e s p e c t i v e i n d e b t - e d n e s s of the o t h e r b a n k to i t ; s e t t l i n g t h i s i n d e b t e d n e s s w e e k l y o r w h e n a c e r t a i n a m o u n t of i n d e b t e d n e s s i s i n c u r r e d in f a v o u r 3 4 . of o n e o r o t h e r of the b a n k s in a m a n n e r s i m i l a r to p r o c e d u r e 1; that i s by the e x c h a n g e of a " b a n k s e t t l e m e n t " . In e s s e n c e t h i s l o c a l i n t e r - b a n k c l e a r i n g s y s t e m r e - d u c e s the c l e a r i n g float b e t w e e n the b a n k s , a s c h e q u e s d r a w n o n o n e a n o t h e r a r e not s u b j e c t to the d e l a y that w o u l d be i n - c u r r e d b y the f o r w a r d i n g of t h e s e i t e m s , d r a w n o n e a c h o t h e r , t h r o u g h t h e i r r e s p e c t i v e i n t e r n a l b r a n c h c l e a r i n g s y s t e m s f o r e x c h a n g e at a c e n t r a l c l e a r i n g p o i n t , a n d a g a i n t h r o u g h t h e i r r e s p e c t i v e i n t e r n a l c l e a r i n g s y s t e m s to the b r a n c h e s in the s a m e c o m m u n i t y f r o m w h i c h the c h e q u e s o r i g i n a t e d . In o u r e x a m p l e , the c l e a r i n g f loat s a v e d w o u l d b e $ 1 , 8 0 0 ( B a n k A ' s $ 1 , 0 0 0 o n B a n k B , p l u s B a n k B ' s $ 8 0 0 o n B a n k A ) t i m e s the n u m b e r of d a y s i n v o l v e d b e t w e e n the t i m e the c h e q u e s w e r e n e g o t i a t e d at the n e g o t i a t i n g b a n k s a n d w o u l d h a v e b e e n f i n a l l y p a i d at the d r a w e e b a n k s a n d put t h r o u g h the n e a r e s t c e n t r a l c l e a r i n g p o i n t . T h e s u m s s a v e d b y t h i s l o c a l c l e a r i n g s y s t e m c a n b e c o n s i d e r a b l e o v e r a p e r i o d of t i m e . T H E I N T E R N A L . B A N K C L E A R I N G S V S T E M T h e i n t e r n a l b a n k c l e a r i n g s y s t e m i s c o n c e r n e d w i t h the e x c h a n g e of c h e q u e s a n d o t h e r n e g o t i a b l e i t e m s b e t w e e n b r a n c h e s of the s a m e b a n k , a n d the f o r w a r d i n g of i t e m s , d r a w n o n o t h e r than l o c a l b r a n c h e s of o t h e r b a n k s , to a c e n t r a l c l e a r i n g h o u s e p o i n t . E a c h b r a n c h of e a c h b a n k i s a s e p a r a t e a c c o u n t i n g e n t i t y , h a v i n g a s s e t s a n d l i a b i l i t i e s but no e q u i t y . W i th s u c h a n e n t i t y , the total a s s e t s m u s t e q u a l the total l i a b i l i t i e s . If a n y b r a n c h n e g o t i a t e s a c h e q u e w h e t h e r f o r d e p o s i t o r c a s h , w h i c h i s d r a w n on o t h e r t h a n i t s e l f , a p r o b l e m in m a i n t a i n i n g the equal i ty b e t w e e n a s s e t s a n d l i a b i l i t i e s of that b r a n c h i s c r e a t e d . T o c r e d i t a d e p o s i t e d a c c o u n t o r p a y out c a s h in r e c o g n i t i o n of the n e g o t i a t i o n of the c h e q u e w i t h o u t a n o f f se t t ing deb i t e n t r y c a n n o t b e a l l o w e d , w h i l e s t i l l m a i n t a i n i n g the a s s e t - l i ab i l i t y e q u a t i o n . T o c o m b a t t h i s e a c h b r a n c h m a i n t a i n s a b r a n c h c l e a r i n g a c c o u n t , w h i c h f o r a n y b r a n c h m a y e i t h e r b e a n a s s e t o r a l i a b i l i t y , d e p e n d i n g o n w h e t h e r it h a s h i s t o r i c a l l y n e g o t i a t e d m o r e c h e q u e s d r a w n o n o t h e r b a n k s a n d b r a n c h e s , than it h a s h a d n e g o t i a t e d f o r it by o t h e r b a n k s a n d b r a n c h e s . A n e x p l a n a t i o n i s n e e d e d to c l a r i f y t h i s p o i n t . E a c h t i m e a b a n k n e g o t i a t e s a c h e q u e o n beha l f of a n o t h e r b a n k o r a n o t h e r b r a n c h of the s a m e b a n k , the t r a n s - a c t i o n r e s u l t s in a n i n c r e a s e in the n e g o t i a t i n g b a n k s d e p o s i t l i a b i l i t i e s , ( o r a d e c r e a s e in i ts a s s e t s if c a s h i s g i v e n in p a y m e n t f o r the c h e q u e ) , a n d in a n i n c r e a s e in i t s c l a i m s a g a i n s t 3 6 . o t h e r b a n k s o r b r a n c h e s of the s a m e b a n k , a s it i s t h e s e o t h e r b r a n c h e s o n w h o m the c h e q u e n e g o t i a t e d w a s d r a w n . T h u s , if a c u s t o m e r p r e s e n t s a c h e q u e d r a w n o n o t h e r t h a n the b r a n c h n e g o t i a t i n g the c h e q u e , the t r a n s a c t i o n i s to c r e d i t a d e p o s i t a c c o u n t ( o r c a s h if the c h e q u e i s n e g o t i a t e d f o r c a s h ) a n d to deb i t a n a c c o u n t r e p r e s e n t i n g c h e q u e s a g a i n s t o t h e r b a n k s a n d b r a n c h e s , u s u a l l y t e r m e d the " B r a n c h C l e a r i n g A c c o u n t " . T h i s t r a n s a c t i o n i s s h o w n in R i g u r e 4 - A o n the f o l l o w i n g p a g e , a n d m a i n t a i n s the n e g o t i a t i n g b r a n c h e s e q u a l i t y of a s s e t s a n d l i a b i l i t i e s . T h e a c t u a l c h e q u e i s m a i l e d to e i t h e r the m a i n b r a n c h of the n e g o t i a t i n g b a n k at a c e n t r a l c l e a r i n g p o i n t , o r d i r e c t l y to a n o t h e r b r a n c h of the n e g o t i a t i n g b a n k . If the c h e q u e i s d r a w n o n a n o t h e r b a n k , o t h e r than the l o c a l b r a n c h of t h i s o t h e r b a n k , it w i l l be f o r w a r d e d to the m a i n b r a n c h of the n e g o t i a t i n g b a n k at a c e n t r a l c l e a r i n g point to b e p r e s e n t e d to the p a y i n g b a n k t h r o u g h the c e n t r a l c l e a r i n g h o u s e . If the c h e q u e i s d r a w n o n a n o t h e r ( n o n - l o c a l ) b r a n c h of the s a m e b a n k , a n d i s o v e r a d e s i g n a t e d a m o u n t , d e p e n d i n g o n the p o l i c y of the p a r t i c u l a r b a n k in q u e s t i o n , it w i l l b e f o r w a r d e d d i r e c t l y to the b r a n c h o n w h i c h it i s d r a w n . H o w e v e r , if the a m o u n t of the c h e q u e ( o r total c h e q u e s o n that b r a n c h f o r o n e d a y ) 3 7 . F I G U R E 4 In te rna l B a n k C l e a r i n g S y s t e m E n t r i e s F I G U R E 4 - A C h e q u e N e g o t i a t e d F o r A C u s t o m e r D r a w n O n O t h e r T h a n T h e N e g o t i a t i n g B r a n c h D E B I T C R E D I T B r a n c h C l e a r i n g s A / C D e p o s i t L i a b i l i t i e s o r C a s h F I G U R E 4 - B C h e q u e R e c e i v e d F r o m N e g o t i a t i n g B r a n c h D r a w n O n T h i s B r a n c h D E B I T C R E D I T D e p o s i t L i a b i l i t i e s B r a n c h C l e a r i n g s A / C F I G U R E 4 - C C h e q u e R e c e i v e d F r o m N e g o t i a t i n g B r a n c h B y T h e M a i n O f f i c e O f T h e S a m e B a n k A t A C e n t r a l C l e a r i n g H o u s e P o i n t D r a w n on A n o t h e r B a n k D E B I T C R E D I T C l e a r i n g H o u s e A / C B r a n c h C l e a r i n g A / C 3 8 . i s l e s s than the d e s i g n a t e d a m o u n t , it ( they ) w o u l d b e f o r w a r d e d to the m a i n o f f i ce at a c e n t r a l c l e a r i n g point f o r r e f o r w a r d i n g to the b r a n c h o n w h i c h they a r e d r a w n . T h e b r a n c h u l t i m a t e l y r e c e i v i n g the c h e q u e in the m a i l , d r a w n o n i t s e l f , c r e d i t s i t s b r a n c h c l e a r i n g a c c o u n t a n d d e b i t s the d e p o s i t a c c o u n t o n w h i c h the c h e q u e i s d r a w n . T h i s t r a n s a c t i o n i s s h o w n in R i g u r e 4 - B , w i t h the r e s u l t i n g e q u a l i t y b e t w e e n a s s e t s a n d l i a b i l i t i e s . If the c h e q u e n e g o t i a t e d by a b r a n c h i s d r a w n o n o t h e r than a l o c a l b r a n c h of a n o t h e r b a n k , it i s f o r w a r d e d to the m a i n o f f i ce of the n e g o t i a t i n g b a n k at a c e n t r a l c l e a r i n g h o u s e p o i n t . T h e t r a n s a c t i o n f o r the m a i n o f f i c e r e c e i v i n g the c h e q u e d r a w n o n a n o t h e r b a n k i s a s s h o w n in R i g u r e 4 - C , w h e r e the b r a n c h c l e a r i n g ' s a c c o u n t i s c r e d i t e d a n d the c e n t r a l c l e a r i n g h o u s e a c c o u n t i s d e b i t e d . E x a m p l e s of t h i s c o m p l i c a t e d s y s t e m w i l l r e i n f o r c e t h i s d i s c u s s i o n . A s s u m e a b r a n c h of B a n k A n e g o t i a t e s the f o l l o w i n g c h e q u e s : - $ 2 0 0 d r a w n o n a b r a n c h of B a n k B in a n o t h e r c e n t r e ; a n d , - $ 1 0 0 d r a w n o n a n o t h e r b r a n c h of B a n k A in a n o t h e r c e n t r e . 3 9 . F o r the s a k e of s i m p l i c i t y , let u s a s s u m e both c h e q u e s a r e d e p o s i t e d to a d e p o s i t a c c o u n t in the n e g o t i a t i n g b r a n c h of B a n k A . T a k i n g the $ 1 0 0 c h e q u e d r a w n o n a n o t h e r b r a n c h of B a n k A in a n o t h e r c o m m u n i t y f i r s t , the e n t r i e s o n the b o o k s of the b r a n c h n e g o t i a t i n g the c h e q u e w o u l d be a s i s s h o w n in F i g u r e 5 - A o n the f o l l o w i n g p a g e : a deb i t to b r a n c h c l e a r i n g ' s a c c o u n t , a n d a c r e d i t to d e p o s i t l i a b i l i t i e s in the a m o u n t of $ 1 0 0 e a c h . T h i s c h e q u e w o u l d then b e f o r w a r d e d to the b r a n c h of B a n k A o n w h i c h it w a s d r a w n , a n d the e n t r i e s w o u l d b e m a d e o n the b o o k s of t h i s b r a n c h a s i s s h o w n in F i g u r e 5 - A a l s o ; that i s a $ 1 0 0 c r e d i t to b r a n c h c l e a r i n g s , a n d a l i k e a m o u n t d e b i t e d to the d e p o s i t o r ' s a c c o u n t w h o i s s u e d the c h e q u e . F r o m the c o n s o l i d a t i o n of the s t a t e m e n t s of both b r a n c h e s of B a n k A , a s i s s h o w n in F i g u r e 5 - B , it i s e v i d e n t that no c h a n g e h a s t a k e n p l a c e in the total a c c o u n t ' s of B a n k A , a s a r e s u l t of the c l e a r i n g of the c h e q u e t h r o u g h the i n t e r n a l b r a n c h c l e a r i n g s y s t e m , o n l y a r e d i s t r i b u t i o n of i t s d e p o s i t s . T a k i n g the $ 2 0 0 c h e q u e d r a w n on a b r a n c h of B a n k B in a n o t h e r c o m m u n i t y , a n d n e g o t i a t e d at the B r a n c h of B a n k A , F i g u r e 6 o n the f o l l o w i n g p a g e , t r a c e s the path of t h i s c h e q u e a n d the e n t r i e s n e c e s s a r y to c o m p l e t e t h i s t r a n s a c t i o n . 4 0 F I G U R E 5 " C l e a r i n g " A C h e q u e D r a w n O n A B r a n c h O f T h e S a m e B a n k F I G U R E 5 - A B r a n c h of B a n k A N e g o t i a t i n g C h e q u e - B r a n c h C l e a r i n g s A / C - D e p o s i t L - i a b i l i t i e s B r a n c h of B a n k A O f W h o m C h e q u e W a s D r a w n - D e p o s i t L i a b i l i t i e s - B r a n c h C l e a r i n g s A / C D e b i t C r e d i t $ 1 0 0 $ 1 0 0 $ 1 0 0 $ 1 0 0 F I G U R E 5 - B C o n s o l i d a t e d S t a t e m e n t O f B a n k A D e b i t C r e d i t C h a r g e - D e p o s i t L i a b i l i t i e s $ 1 0 0 - B r a n c h C l e a r i n g s A / C $ 1 0 0 $ 1 0 0 $ 1 0 0 0 0 41 F I G U R E 6 T h e E n t r i e s F o r C l e a r i n g A C h e q u e B r a n c h of B a n k A N e g o t i a t i n g C h e q u e D e b i t C r e d i t - B r a n c h C l e a r i n g s A / C $ 2 0 0 - D e p o s i t L i a b i l i t i e s $ 2 0 0 M a i n O f f i c e of B a n k A A t C e n t r a l C l e a r i n g H o u s e P o i n t - C l e a r i n g H o u s e A / C $ 2 0 0 - B r a n c h C l e a r i n g s A / C $ 2 0 0 C e n t r a l C l e a r i n g H o u s e - R e s e r v e A / C ' s Wi th B a n k of C a n a d a - B a n k B $ 2 0 0 - B a n k A $ 2 0 0 M a i n O f f i c e of B a n k B A t C e n t r a l C l e a r i n g H o u s e P o i n t - B r a n c h C l e a r i n g s A / C $ 2 0 0 - C l e a r i n g H o u s e A / C $ 2 0 0 B r a n c h of B a n k B O n W h o m C h e q u e W a s D r a w n - D e p o s i t L i a b i l i t i e s - B r a n c h C l e a r i n g s A / C $ 2 0 0 $ 2 0 0 4 2 . S u b s e q u e n t to t h i s t r a n s a c t i o n , B a n k A h a s i n c r e a s e d i t s d e p o s i t l i a b i l i t i e s a n d , if t h i s w a s the o n l y t r a n s a c t i o n that d a y , i n c u r r e d a net c l e a r i n g g a i n of $ 2 0 0 by f o r w a r d i n g the c h e q u e to B a n k B . C o n v e r s e l y , B a n k B h a s i n c u r r e d a net c l e a r i n g l o s s of $ 2 0 0 a s a r e s u l t of h a v i n g b e e n p r e s e n t e d w i t h t h i s c h e q u e , a n d B a n k B ' s d e p o s i t l i a b i l i t i e s h a v e b e e n d e c r e a s e d in a l i k e a m o u n t . In the a b o v e e x a m p l e s , w e h a v e d e m o n s t r a t e d both the i n t e r - b a n k c l e a r i n g s y s t e m a n d the i n t e r n a l b r a n c h c l e a r i n g s y s t e m , w h i c h h a v e b e e n at w o r k in e a c h b a n k . A R E C L E A R I N G G A I N S G O O D O R B A D ? It h a s b e e n t r a d i t i o n a l a m o n g b a n k e r s to s a y that a c l e a r i n g g a i n i s g o o d a n d a c l e a r i n g l o s s b a d . T h i s i d e a h a d b e e n b r o u g h t about b y the fact that a c l e a r i n g g a i n i n c r e a s e s a n y b a n k ' s r e s e r v e s a n d d e p o s i t s w h i l e a c l e a r i n g l o s s d e - c r e a s e s t h e s e r e s e r v e s a n d d e p o s i t s . A n i n c r e a s e in the r e s e r v e s m e a n s that m o r e l e n d i n g o r s e c u r i t y p u r c h a s i n g c a n t a k e p l a c e a n d " n e w m o n e y " c a n b e c r e a t e d . If a b a n k i s fu l ly l o a n e d u p a n d a p p r o a c h i n g the point w h e r e f u r t h e r i n c r e a s e s in l o a n s o r f u r t h e r s e c u r i t y p u r c h a s e s w o u l d put it in a p o s i t i o n of not h a v i n g a d e q u a t e r e s e r v e s , then a c l e a r i n g g a i n i s g o o d , 4 3 . a s it i n c r e a s e s the c a s h r e s e r v e s a n d u s u a l l y d e p o s i t s , t h u s e n a b l i n g f u r t h e r l o a n s to b e m a d e . H o w e v e r , s h o u l d a b a n k b e in the p o s i t i o n that it h a s a n e x c e s s of d e p o s i t s a n d r e s e r v e s o v e r w h a t it c a n p l a c e , then a c l e a r i n g g a i n i s b a d , a s the i n c r e a s e in r e s e r v e s a n d d e p o s i t s c a n n o t b e put to u s e p r o d u c i n g a d d i t i o n a l r e v e n u e . If a p o r t i o n of the e x c e s s in d e p o s i t s h a p p e n s to b e i n t e r e s t b e a r - i n g , the b a n k m a y b e out of p o c k e t a s a r e s u l t of the c l e a r i n g g a i n a s it n o w m u s t p a y i n t e r e s t o n d e p o s i t s it d i d not f o r m e r l y h a v e ! T h u s , it i s e v i d e n t that a c l e a r i n g l o s s c a n b e b e n e f i c i a l o r d e t r i m e n t a l to a n y b a n k , d e p e n d i n g u p o n the s t a t e of that b a n k at the t i m e of the c l e a r i n g g a i n o r l o s s . C H A P T E R I V T H E B A N K I N G S V S T E M O F C A N A D A D E P O S I T E X P A N S I O N A N D T H E R E S E R V E R A T E In the e x a m p l e s w e h a v e u s e d to d a t e , w e h a v e a s s u m e d a m o n g o t h e r t h i n g s , that the r e q u i r e d r e s e r v e s w e r e 10% of the d e p o s i t l i a b i l i t i e s , a n d that t h e s e r e s e r v e s h a d to be h e l d in c a s h - that i s , n o t e s of the c e n t r a l b a n k i n g a u t h o r i t y . M o v i n g to the b a n k i n g c o m m u n i t y in C a n a d a , w e f ind that the p r i m a r y r e s e r v e r a t i o f o r C a n a d i a n C h a r t e r e d B a n k s i s c u r - r e n t l y 8% of t h e i r C a n a d i a n d o l l a r d e p o s i t l i a b i l i t i e s ; but that t h i s r e s e r v e m a y c o n s i s t of e i t h e r n o t e s of the c e n t r a l b a n k - the B a n k of C a n a d a - h e l d by the c h a r t e r e d b a n k s , o r , d e p o s i t s by the c h a r t e r e d b a n k s w i t h the B a n k of C a n a d a . T h e note p o r t i o n of t h e s e p r i m a r y r e s e r v e s i s the f u n c t i o n of the p u b l i c ' s d e m a n d f o r c u r r e n c y a n d the c h a r t e r e d b a n k s a r e but p a s s i v e a c c e p t o r s of t h i s d e m a n d , a l w a y s k e e p i n g on h a n d s u f f i c i e n t c a s h to s u p p l y the p u b l i c d e m a n d f o r c u r r e n c y . O n the o t h e r h a n d , the p o r t i o n of the p r i m a r y r e s e r v e s m a d e u p of d e p o s i t s w i t h the B a n k of C a n a d a , i s d i r e c t l y u n d e r 4 5 . the c o n t r o l of the m a n a g e m e n t of the c h a r t e r e d b a n k s , a n d a s t h e s e d e p o s i t s do not b e a r i n t e r e s t , e a c h b a n k a t t e m p t s to k e e p just su f f i c i en t d e p o s i t s w i t h the c e n t r a l b a n k to m e e t the l e g a l r e q u i r e m e n t . In o t h e r w o r d s , the c h a r t e r e d b a n k s w i l l o n l y k e e p s u f f i c i e n t f u n d s o n d e p o s i t w i t h the B a n k of C a n a d a to m a i n t a i n the 8% s t a t u t o r y r e q u i r e d r e s e r v e s , e m p l o y i n g the r e m a i n i n g f u n d s to p r o d u c e r e v e n u e . T h i s r e s e r v e a c c o u n t w h i c h e a c h c h a r t e r e d b a n k m a i n - t a i n s w i t h the B a n k of C a n a d a i s the a c c o u n t to w h i c h a l l net c l e a r i n g g a i n s o r l o s s e s f o r a n y p a r t i c u l a r d a y a r e d i s t r i b u t e d . T h u s , the c h a n g e s in the net c l e a r i n g g a i n o r l o s s f i g u r e s f r o m d a y to d a y h a v e a v e r y r e a l i n f l u e n c e o n the total p r i m a r y r e - s e r v e s of a n y c h a r t e r e d b a n k , a n d t h e r e f o r e e a c h b a n k ' s l i qu id i t y w i t h r e l a t i o n s h i p to the r e q u i r e d p r i m a r y r e s e r v e s . It w i l l b e r e c a l l e d that w i t h the r e s e r v e r a t e of 10%, a c a s h d e p o s i t c o u l d b e e x p a n d e d ten t i m e s b y the b a n k i n g s y s t e m a s a w h o l e b e f o r e r e a c h i n g the r e s t r a i n i n g c o n d i t i o n of r e q u i r e d p r i m a r y r e s e r v e s . W i th a p r i m a r y r e s e r v e r a t e of 8%, it i s t h e o r e t i c a l l y p o s s i b l e to e x p a n d d e p o s i t s f o r the b a n k i n g s y s t e m a s a w h o l e 1 2 - 1 / 2 t i m e s the in i t ia l c a s h d e p o s i t s b e f o r e b e i n g r e s t r a i n e d f r o m f u r t h e r e x p a n s i o n by the p r i m a r y r e s e r v e r e s t r a i n t . O n F e b r u a r y 2 8 t h , 1 9 6 6 , d e p o s i t l i a b i l i t i e s w e r e 4 6 . 1 2 . 2 t i m e s the p r i m a r y r e s e r v e s , o r o n l y . 3 t i m e s p r i m a r y r e s e r v e s a w a y f r o m the 1 2 . 5 m u l t i p l e that i s t h e o r e t i c a l l y p o s - s i b l e . ( 12 ) T h r o u g h o u t the r e m a i n d e r of t h i s p a p e r w h e n w e r e f e r to p r i m a r y r e s e r v e s , w e s h a l l b e r e f e r r i n g to the 8% s t a t u t o r y r e s e r v e r e q u i r e m e n t , w h i c h i s a g u a r a n t e e of e a c h b a n k ' s l i q u i d i t y . D E P O S I T L I A B I L I T I E S T h e m a j o r f a c t o r o n the l i a b i l i t y s i d e of the C a n a d i a n C h a r t e r e d B a n k ' s b a l a n c e s h e e t , i s t h e i r d e p o s i t l i a b i l i t i e s to t h e i r c u s t o m e r s , w h i c h i s a p p r o x i m a t e l y 90% of t h e i r total l i a - b i l i t i e s a n d e q u i t y . ( 1 3 ) T h e r e m a i n i n g 10% of the l i a b i l i t y a n d equ i ty p o r t i o n of the b a l a n c e s h e e t s of C a n a d i a n C h a r t e r e d B a n k s , c o n s i s t s of c o n t i n g e n t l i a b i l i t i e s a n d the s h a r e h o l d e r s e q u i t i e s . ( 1 2 ) ( 1 3 ) S o u r c e : B a n k of C a n a d a , S t a t i s t i c a l S u m m a r y , Q u e e n ' s P r i n t e r , O t t a w a , F e b r u a r y 1 9 6 6 , P a g e 1 2 3 . S o u r c e : T h e R o y a l B a n k of C a n a d a , A n n u a l R e p o r t , 1 9 6 5 . 4 7 . M E T H O D O F D E T E R M I N I N G R E Q U I R E D C H A R T E R E D B A N K D E P O S I T S W I T H T H E B A N K O F C A N A D A A s w a s p r e v i o u s l y m e n t i o n e d , the p r i m a r y r e s e r v e s the C a n a d i a n C h a r t e r e d B a n k s m u s t m a i n t a i n a r e 8% of t h e i r C a n a d i a n d o l l a r d e p o s i t l i a b i l i t i e s . T h e s e f u n d s m u s t e i t h e r b e in the f o r m of B a n k of C a n a d a n o t e s , o r in d e p o s i t s w i t h the C e n t r a l B a n k . T h e m e t h o d of a r r i v i n g at t h i s r e s e r v e a m o u n t i s of i m p o r t a n c e to o u r f u t u r e d i s c u s s i o n s a n d w i l l t h e r e f o r e b e d i s c u s s e d h e r e . T h e d e p o s i t l i a b i l i t i e s a r e a v e r a g e d a s of the c l o s e of b u s i n e s s o n the f o u r c o n s e c u t i v e W e d n e s d a y s e n d i n g in the l a s t W e d n e s d a y but o n e of the p r e c e d i n g m o n t h . O f t h i s a v e r a g e f i g u r e , 8% i s r e q u i r e d a s p r i m a r y r e s e r v e s . T o t h i s f i g u r e s o d e r i v e d i s r e l a t e d the s u m of the b a n k ' s h o l d i n g s of B a n k of C a n a d a n o t e s ( c a l c u l a t e d o n a s i m i l a r b a s i s to that of d e p o s i t l i a b i l i t i e s ) a n d the a v e r a g e a m o u n t of the b a n k ' s d e p o s i t s w i t h the B a n k of C a n a d a a s of the c l o s e of e a c h b u s i n e s s d a y of the c u r r e n t m o n t h i s d e t e r m i n e d . N o t e that the a m o u n t w h i c h m u s t b e r e t a i n e d o n d e p o s i t i s a n a v e r a g e f i g u r e o v e r the c u r - r e n t m o n t h , a n d t h e r e f o r e the r e q u i r e m e n t d a i l y m a y go a b o v e o r b e l o w t h i s f i g u r e . T h e e x a m p l e f o l l o w i n g t h i s p a g e w i l l d e m o n s t r a t e h o w the a v e r a g e r e q u i r e d p r i m a r y r e s e r v e i s c a l c u l a t e d . 4 8 . A s s u m e the d e p o s i t l i a b i l i t i e s a n d the B a n k of C a n a d a note h o l d i n g s of " O u r B a n k " a s of the c l o s e of b u s i n e s s o n the f o u r c o n s e c u t i v e W e d n e s d a y s e n d i n g w i t h the s e c o n d to l a s t W e d n e s d a y in the p r e v i o u s m o n t h , w e r e a s i s s h o w n in R i g u r e 7 - A o n the f o l l o w i n g p a g e . T h e a v e r a g e d e p o s i t l i a b i l i t i e s s o c a l c u l a t e d i s $ 1 , 4 5 0 a n d the a v e r a g e B a n k of C a n a d a n o t e s h e l d i s $ 3 8 , c a l c u l a t e d in a s i m i l a r m a n n e r . In t h i s e a s e , " O u r B a n k " w o u l d b e r e q u i r e d to m a i n t a i n $ 7 8 o n the a v e r a g e in t h e i r d e p o s i t a c c o u n t w i t h the B a n k of C a n a d a f o r the c u r r e n t m o n t h . T h e c a l c u l a t i o n of t h i s a m o u n t i s s h o w n in F i g u r e 7 - B . Wi th t h i s f o r m u l a , e a c h b a n k k n o w s at the b e g i n n i n g of the m o n t h w h a t i ts m i n i m u m a v e r a g e d e p o s i t at the B a n k of C a n a d a m u s t b e f o r the c u r r e n t m o n t h . F r o m t h i s f o r m u l a , it i s a l s o e v i d e n t that the f l u c t u a t i o n s in the d e p o s i t l i a b i l i t i e s a n d the B a n k of C a n a d a note h o l d i n g s d u r i n g the c u r r e n t m o n t h do not ef fect the r e s e r v e p o s i t i o n of the b a n k in t h i s c u r r e n t m o n t h , but w i l l ef fect the r e q u i r e d d e p o s i t r e s e r v e s w i t h the B a n k of C a n a d a f o r the s u c c e e d i n g m o n t h . T h u s , a l l that b e - c o m e s of i m p o r t a n c e to c u r r e n t f u n d s m a n a g e m e n t f o r " O u r B a n k " , a r e the f a c t o r s that ef fect the r e s e r v e a c c o u n t w i t h the B a n k of C a n a d a , a n d t h i s r e s e r v e a c c o u n t w i t h the B a n k of C a n a d a i s d a i l y e f f e c t e d b y the net c l e a r i n g g a i n o r l o s s f i g u r e s . 4 9 . F I G U R E 7 C a l c u l a t i o n O f A v e r a g e D e p o s i t L i a b i l i t i e s F I G U R E 7 - A " O u r B a n k " B a l a n c e A s O f T h e C l o s e O f B u s i n e s s B a n k of C a n a d a D e p o s i t L i a b i l i t i e s N o t e s F i f t h W e d n e s d a y P r e c e d i n g T h e E n d O f P r e v i o u s M o n t h $ 1 , 5 4 0 $ 31 F o u r t h W e d n e s d a y P r e c e d i n g T h e E n d O f P r e v i o u s M o n t h $ 1 , 7 5 0 $ 4 2 T h i r d W e d n e s d a y P r e c e d i n g T h e E n d O f P r e v i o u s M o n t h $ 1 , 6 8 0 $ 28 S e c o n d W e d n e s d a y P r e c e d i n g T h e E n d O f P r e v i o u s M o n t h $ 1 , 8 3 0 $ 51 T O T A L $ 6 , 8 0 0 $ 1 5 2 A V E R A G E $1 , 4 5 0 $ 38 F I G U R E 7 - B D e t e r m i n a t i o n O f A v e r a g e R e q u i r e d D e p o s i t s F o r " O u r B a n k " F o r T h e C u r r e n t M o n t h A v e r a g e D e p o s i t L i a b i l i t i e s $ 1 , 4 5 0 R e q u i r e d A v e r a g e P r i m a r y R e s e r v e s 8% of D e p o s i t L i a b i l i t i e s $ 116 L e s s A v e r a g e B a n k of C a n a d a N o t e H o l d i n g s | 38 $ 7 8 C H A P T E R V S H O R T R U N F A C T O R S A F F E C T I N G C L E A R I N G G A I N S A N D L O S S E S H a v i n g d i s c u s s e d the c l e a r i n g s y s t e m a s it w o r k s i n C a n a d a , a n d the i m p o r t a n c e of a g a i n o r l o s s to a n y b a n k , let u s n o w m o v e to the c l e a r i n g g a i n a n d l o s s e s t h e m s e l v e s a n d attempt to i s o l a t e t h o s e f a c t o r s w h i c h af fect the s i z e a n d m o d e of the c l e a r i n g g a i n o r l o s s . T h e d i s c u s s i o n s w h i c h f o l l o w w i l l b e w i t h o u t e m p i r i c a l s u p p o r t , a s the t e s t i n g of the v a r i o u s p r o p o s i t i o n s h a s p r o v e d i m p o s s i b l e d u e , not to a l a c k of c o - o p e r a t i o n but to a l a c k of s u i t a b l e f i g u r e s b e i n g kept b y the c h a r t e r e d b a n k s o r the B a n k of C a n a d a . A s a r e s u l t of the i m p o s s i b i l i t y of t e s t i n g the p r o p o - s i t i o n s , w e w i l l b e r e l y i n g e n t i r e l y o n e x a m p l e s of t y p i c a l but h y p o t h e t i c a l b a n k s to s u p p o r t o u r p r o p o s i t i o n s a n d t h e o r i z i n g . S P E N D I N G H A B I T S O F B A N K C U S T O M E R S T h e t i m i n g of p a y m e n t s by i n d i v i d u a l s a n d c o m m e r c i a l b a n k c u s t o m e r s c a n h a v e a s u b s t a n t i a l ef fect o n the c l e a r i n g g a i n o r l o s s of i n d i v i d u a l b a n k s f o r a n y p a r t i c u l a r d a y . If the 5 1 . i n d i v i d u a l b a n k c u s t o m e r h a b i t u a l l y p a y s h i s b i l l s by c h e q u e o n the 20th of e a c h m o n t h , then t h i s w i l l e f fect h i s b a n k ' s c l e a r - i n g s a s t h e s e c h e q u e s a r e n e g o t i a t e d t h r o u g h a b a n k i n g s y s t e m , p o s s i b l y on the 2 1 s t o r the 2 2 n d of the m o n t h , a n d a r e p r e - s e n t e d to the d r a w e r ' s b a n k f o r p a y m e n t . A n e x a m p l e w i l l i l l u s t r a t e t h i s c o n c e p t . S u p p o s e a c h a r t e r e d b a n k c u s t o m e r m a i l s c h e q u e s in p a y m e n t f o r h i s o u t s t a n d i n g d e b t s to t h r e e c r e d i t o r s : t w o of w h o m b a n k w i t h o t h e r than the c u s t o m e r ' s b a n k , a n d o n e w h o b a n k s w i t h a n o t h e r b r a n c h of the c u s t o m e r ' s b a n k , " O u r B a n k " . T h e s e c h e q u e s , d r a w n in the a m o u n t s of $ 1 0 0 , $ 2 0 0 , a n d $ 3 0 0 r e s p e c t i v e l y , a r e d e p o s i t e d by o u r c u s t o m e r ' s c r e d i t o r s in t h e i r r e s p e c t i v e b a n k s o r b r a n c h e s , a n d f o r w a r d e d b y e a c h c r e d i t o r s ' b a n k to " O u r B a n k " f o r p a y m e n t . T h e t w o c h e q u e s in the a m o u n t s of $ 1 0 0 a n d $ 2 0 0 d o l l a r s that w e r e d e p o s i t e d in B a n k s A a n d B r e s p e c t i v e l y , w i l l b e p r e s e n t e d to " O u r B a n k " t h r o u g h the C e n t r a l C l e a r i n g H o u s e f o r p a y m e n t . S h o u l d t h e s e t w o c h e q u e s b e the o n l y i t e m s p r e s e n t e d o n t h i s d a y , then the b a l - a n c e s h e e t of " O u r B a n k " b e f o r e a n d a f t e r t h e s e t r a n s a c t i o n s w o u l d b e a s s h o w n in F i g u r e 8 o n the f o l l o w i n g p a g e . N o t e that the c l e a r i n g l o s s f o r t h i s d a y e q u a l l e d the total of the c h e q u e s p r e s e n t e d to " O u r B a n k " b y the o t h e r b a n k s ; w h i c h 5 2 . F I G U R E 8 E x a m p l e O f C l e a r i n g L o s s " O U R B A N K " C l e a r i n g G a i n ( L o s s ) B e f o r e A f t e r P r i m a r y R e s e r v e s 800 ( 3 0 0 ) 500 A l l O t h e r A s s e t s 9 , 2 0 0 9 , 2 0 0 T O T A L 1 0 . 0 0 0 9 , 7 0 0 D e p o s i t s ( W i t h d r a w a l s ) D e p o s i t o r ' s L i a b i l i t y 9 , 0 0 0 ( 3 0 0 ) 8 , 7 0 0 A l l O t h e r L i a b i l i t i e s 1 , 0 0 0 1 , 0 0 0 T O T A L 1 0 . 0 0 0 9 , 7 0 0 5 3 . e q u a l l e d the a m o u n t w i t h d r a w n f r o m the d e p o s i t a c c o u n t by o u r c u s t o m e r f o r p a y m e n t of h i s d e b t s . N e e d l e s s to s a y , the b a l a n c e s h e e t s of B a n k s A a n d B w o u l d s h o w c l e a r i n g g a i n s , a n d i n c r e a s e d d e p o s i t l i a b i l i t i e s , of $ 1 0 0 a n d $ 2 0 0 r e s p e c t i v e l y . B u t w h a t of the c h e q u e g i v e n to o u r c u s t o m e r ' s d e b t o r w h o b a n k e d , a n d t h e r e f o r e d e p o s i t e d the c h e q u e , w i t h a b r a n c h of o u r b a n k ? T h i s c h e q u e w i l l not b e p r o c e s s e d t h r o u g h the C e n t r a l C l e a r i n g H o u s e a s the o t h e r c h e q u e s w e r e , but w i l l b e p r o c e s s e d t h r o u g h the i n t e r n a l b r a n c h c l e a r i n g s y s t e m of o u r b a n k . In e f f e c t , the $ 3 0 0 d o l l a r c h e q u e w i l l i n c r e a s e the d e p o s i t l i a b i l i t i e s of the b r a n c h r e c e i v i n g it o n d e p o s i t a n d r e - d u c e the d e p o s i t l i a b i l i t i e s of the b r a n c h o n w h i c h it w a s d r a w n . H o w e v e r , the total d e p o s i t l i a b i l i t i e s of " O u r B a n k " a s a w h o l e w i l l not be d e c r e a s e d , a s the i n c r e a s e in the d e p o s i t s of o n e b r a n c h h a s b e e n of fset by the d e c r e a s e in the d e p o s i t s of a n o t h e r b r a n c h of the s a m e b a n k . W i t h i n " O u r B a n k " , t h e r e w i l l b e a n i n t e r n a l c l e a r i n g g a i n f o r the b r a n c h r e c e i v i n g the c h e q u e o n d e p o s i t a n d a n i n t e r n a l c l e a r i n g l o s s f o r the b r a n c h o n w h o m the c h e q u e w a s d r a w n . H o w e v e r , t h i s i n t e r n a l c l e a r - i n g g a i n o r l o s s i s just a n a c c o u n t i n g e n t r y w i t h i n " O u r B a n k " , a n d i s of no c o n c e r n to " O u r B a n k " a s a w h o l e , n o r d o e s it in a n y w a y effect " O u r B a n k s " l i q u i d i t y . 5 4 . T h e e x a m p l e u s e d h e r e c o n c e r n e d a n i n d i v i d u a l c u s t o m e r . O f f a r g r e a t e r i m p o r t a n c e than the s p e n d i n g h a b i t s of i n d i v i d u a l s , a r e the s p e n d i n g h a b i t s of c o r p o r a t e e n t i t i e s . T h e p a y m e n t h a b i t s of c o r p o r a t i o n s a r e f a r m o r e i m p o r t a n t f o r t w o r e a s o n s : the a m o u n t s i n v o l v e d a r e s u b s t a n t i a l l y l a r g e r ; a n d j b u s i n e s s e s tend to h a v e a m o r e se t p a t t e r n o r r o u t i n e of p a y i n g t h e i r o b l i g a t i o n s than do i n d i v i d u a l s . T a k e f o r i n s t a n c e the p a y m e n t of a p a y r o l l f o r a l a r g e i n d u s t r i a l f i r m . G e n e r a l l y t h e s e p a y m e n t s a r e m a d e at s e t p e r i o d s , s a y the 14th a n d 29th of the m o n t h . T h e m a j o r i t y of the c h e q u e s i s s u e d in p a y m e n t of w a g e s a r e c a s h e d u p o n r e c e i p t . A s a s u b s t a n t i a l p o r t i o n of the r e c i p i e n t s of t h e s e c h e q u e s w i l l b a n k at o t h e r t h a n the b a n k o n w h i c h the c h e q u e s a r e d r a w n , a l a r g e p o r t i o n of t h e s e c h e q u e s w i l l b e p r e s e n t e d t h r o u g h the C e n t r a l C l e a r i n g H o u s e to the d r a w e e b a n k f o r p a y m e n t , t h u s c r e a t i n g a c l e a r i n g l o s s f o r the d r a w e e b a n k o n that d a y in a m a n n e r s i m i l a r to that e x p l a i n e d w i t h the e x a m p l e of the i n d i v i d u a l . T h e a r g u m e n t that i s a p p l i e d to p a y r o l l s c a n b e a p p l i e d to a n y o t h e r p a y m e n t , f o r e x a m p l e d i v i d e n d c h e q u e s w h i c h a r e u s u a l l y d r a w n o n o n e b a n k a n d d e p o s i t e d ( o r c a s h e d ) at m a n y b a n k s . A p e r s o n a l e x a m p l e w i l l s e r v e to d e m o n s t r a t e the h a p p e n i n g s in a n a c t u a l c a s e . 55. T h e C a n a d a W h e a t B o a r d m a k e s p e r i o d i c p a y m e n t s to f a r m e r s o n w h o s e beha l f the W h e a t B o a r d s e l l s g r a i n . T h e p a y m e n t c h e q u e s a r e a l l d r a w n o n o n e a c c o u n t w h i c h the C a n a d i a n W h e a t B o a r d m a i n t a i n s w i t h o n e b a n k in W i n n i p e g . T h e s e m a n y t h o u s a n d s of c h e q u e s a r e m a i l e d out to a l l p a r t s of the P r a i r i e s , a n d a s h o r t t i m e a f t e r a r e d e p o s i t e d o r c a s h e d b y the r e c i p i e n t in a l l b a n k s , o r w i t h c u s t o m e r s of a l l b a n k s , t h r o u g h o u t W e s t e r n C a n a d a . T h e c h e q u e s n e g o t i a t e d by the b r a n c h e s of the b a n k o n w h i c h the c h e q u e s a r e d r a w n a r e f o r w a r d e d t h r o u g h the b a n k ' s i n t e r n a l b r a n c h c l e a r i n g s y s t e m a n d no c l e a r i n g g a i n o r l o s s f o r the d r a w e e b a n k a s a w h o l e i s e f f e c t e d . H o w e v e r , the c h e q u e s n e g o t i a t e d at b r a n c h e s of o t h e r b a n k s a r e p r e s e n t e d t h r o u g h the C e n t r a l C l e a r i n g H o u s e to the d r a w e e b a n k f o r p a y m e n t , t h u s , c r e a t i n g c l e a r i n g l o s s e s f o r the d r a w e e b a n k a s a w h o l e , a n d s u b s e q u e n t l y g a i n s f o r the o t h e r b a n k s . With the C a n a d i a n W h e a t B o a r d a c c o u n t , the a m o u n t of c l e a r i n g l o s s s u f f e r e d by the d r a w e e b a n k m a y b e t e n s of m i l l i o n s of d o l l a r s , w h i c h c a n g r e a t l y a l t e r the l i qu id i t y p o s i t i o n of the d r a w e e b a n k . P r o m t h e s e e x a m p l e s , w e c a n s e e that the p a y m e n t h a b i t s of the c u s t o m e r s of a n y p a r t i c u l a r b a n k c e r t a i n l y a r e a n i m p o r t a n t d e t e r m i n a n t of the c l e a r i n g g a i n o r l o s s to that b a n k in a s i n g l e d a y . 5 6 . S H O R T R U N F A C T O R S A F F E C T I N G C L E A R I N G G A I N S A N D L O S S E S M O N E Y M A R K E T T R A N S A C T I O N S T h e m a g n i t u d e a n d f r e q u e n c y of t r a n s a c t i o n s in the m o n e y m a r k e t m a k e it e x c e e d i n g l y i m p o r t a n t to l o o k at i ts af fect o n c l e a r i n g g a i n s a n d l o s s e s . H e r e w e w i l l b e t r y i n g to s h o w h o w v a r i o u s m o n e y m a r k e t t r a n s a c t i o n s c a n h a v e a b e a r i n g o n a n y o n e , o r a l l b a n k ' s c l e a r i n g g a i n s o r l o s s e s . A s w i t h the m a j o r i t y of the w o r k p r e s e n t e d in t h i s t o p i c , w e w i l l h a v e to r e l y o n e x a m p l e s to d e m o n s t r a t e the af fect of m o n e y m a r k e t t r a n s a c t i o n s o n c l e a r i n g g a i n s a n d l o s s e s , a s e m p e r i c a l d a t a i s not a v a i l a b l e . L e t u s s u p p o s e a c o r p o r a t e t r e a s u r e r h a s $100,000 w h i c h h e w i s h e s to p l a c e in a s h o r t - t e r m s e c u r i t y . H i s b r o k e r , h a s f o u n d a c o r p o r a t i o n w i l l i n g to b o r r o w t h i s s u m f o r the g i v e n p e r i o d . L e t u s a l s o a s s u m e that the c o r p o r a t i o n p u r c h a s i n g the note ( w i t h s u r p l u s f u n d s ) d e a l s w i t h B a n k A , the b r o k e r w i t h B a n k B , a n d the c o r p o r a t i o n w i s h i n g to s e l l the note ( r e c e i v i n g the m o n e y ) at B a n k C . T h e t r a n s a c t i o n w o u l d b e c o n s u m m a t e d a s f o l l o w s . T h e b r o k e r w o u l d g i v e 5 7 . the c o r p o r a t i o n s e l l i n g the note h i s c h e q u e d r a w n o n B a n k B , w h i c h w o u l d b e d e p o s i t e d in B a n k C . T h e b r o k e r w o u l d , in the s a m e d a y , e x c h a n g e the note p u r c h a s e d , f o r a c h e q u e of the c o r p o r a t i o n p u r c h a s i n g the n o t e , w h i c h i s d r a w n o n B a n k A . T h i s c h e q u e w o u l d b e d e p o s i t e d by the b r o k e r to h i s a c c o u n t in B a n k B . T h e r e s u l t of t h i s t r a n s a c t i o n a s e x p e c t e d , w o u l d b e that the c o r p o r a t i o n p u r c h a s i n g the note w o u l d h a v e e x c h a n g e d w i t h the c o r p o r a t i o n s u p p l y i n g the note $ 1 0 0 , 0 0 0 — the b r o k e r m e r e l y a c t i n g jus t a s a m i d d l e m a n . 1—et u s n o w s e e the af fect of t h i s t r a n s a c t i o n on the r e s p e c t i v e b a n k s c l e a r i n g g a i n s a n d / o r l o s s e s . P r i o r to t h i s t r a n s a c t i o n , the b a l a n c e s h e e t of the r e - s p e c t i v e b a n k s l o o k e d a s i s s h o w n in F i g u r e 9 - A o n the f o l l o w i n g p a g e . A s a r e s u l t of t h i s t r a n s a c t i o n , B a n k B r e c e i v e s a c h e q u e f r o m B a n k C t h r o u g h the C e n t r a l C l e a r i n g H o u s e , d r a w n o n h i s b r o k e r c u s t o m e r ' s a c c o u n t . T h i s r e d u c e s h i s p r i m a r y r e s e r v e s a n d d e p o s i t l i a b i l i t i e s b y $ 1 0 0 , 0 0 0 e a c h . H o w e v e r , o n the s a m e d a y , h e h a s p r e s e n t e d t h r o u g h the C l e a r i n g H o u s e a c h e q u e d r a w n o n B a n k A , w h i c h h e r e c e i v e d f r o m h i s b r o k e r c u s t o m e r , that i n c r e a s e s h i s p r i m a r y r e s e r v e s a n d h i s d e p o s i t l i a b i l i t i e s b y $ 1 0 0 , 0 0 0 e a c h . T h u s , at the c l o s e 5 8 . F I G U R E 9 M o n e y M a r k e t T r a n s a c t i o n s a n d C l e a r i n g G a i n s a n d L o s s e s F I G U R E 9 - A B A N K P r i m a r y R e s e r v e s 8 0 0 , 0 0 0 8 0 0 , 0 0 0 8 0 0 , 0 0 0 O t h e r A s s e t s 9 , 2 0 0 , 0 0 0 9 , 2 0 0 , 0 0 0 9 , 2 0 0 , 0 0 0 T O T A L 1 0 . 0 0 0 , 0 0 0 1 0 , 0 0 0 , 0 0 0 1 0 . 0 0 0 , 0 0 0 D e p o s i t L i a b i l i t i e s 9 , 0 0 0 , 0 0 0 9 , 0 0 0 , 0 0 0 9 , 0 0 0 , 0 0 0 O t h e r L i a b i l i t i e s & E q u i t y 1 , 0 0 0 , 0 0 0 1 , 0 0 0 , 0 0 0 1 , 0 0 0 , 0 0 0 T O T A L 1 0 , 0 0 0 , 0 0 0 1 0 , 0 0 0 , 0 0 0 1 0 . 0 0 0 , 0 0 0 F I G U R E 9 - B A G A I N S T T O T A L 0 0 £ B 1 0 0 , 0 0 0 0 0 1 0 0 , 0 0 0 "5 0 C 0 1 0 0 , 0 0 0 0 1 0 0 , 0 0 0 T o t a l P r e s e n t e d 1 0 0 , 0 0 0 1 0 0 , 0 0 0 0 L e s s T o t a l R e c ' d (0 ) ( 1 0 0 , 0 0 0 ) ( 1 0 0 , 0 0 0 ) G a i n o r (Loss) 1 0 0 , 0 0 0 0 ( 1 0 0 , 0 0 0 ) 59 F I G U R E 9 - C B A N K P r i m a r y R e s e r v e s 9 0 0 , 0 0 0 8 0 0 , 0 0 0 7 0 0 , 0 0 0 O t h e r A s s e t s 9 , 2 0 0 , 0 0 0 9 , 2 0 0 , 0 0 0 9 , 2 0 0 , 0 0 0 T O T A L 1 0 . 1 0 0 , 0 0 0 1 0 . 0 0 0 . 0 0 0 9 . 9 0 0 . 0 0 0 D e p o s i t L i a b i l i t i e s 9 , 1 0 0 , 0 0 0 9 , 0 0 0 , 0 0 0 8 , 9 0 0 , 0 0 0 O t h e r L i a b i l i t i e s & E q u i t y 1 , 0 0 0 , 0 0 0 1 , 0 0 0 , 0 0 0 1 , 0 0 0 , 0 0 0 T O T A L 1 0 , 1 0 0 , 0 0 0 1 0 . 0 0 0 . 0 0 0 9 . 9 0 0 . 0 0 0 6 0 . of the d a y , B a n k B h a s s u f f e r e d n e i t h e r a c l e a r i n g g a i n o r l o s s . B a n k A h o w e v e r , h a s r e c e i v e d a c h e q u e f r o m B a n k B t h r o u g h the C e n t r a l C l e a r i n g H o u s e w h i c h h e p a y s by c h a r g i n g to h i s c o r p o r a t e c u s t o m e r ' s a c c o u n t , t h u s , r e d u c i n g h i s d e p o s i t l i a b i l i t i e s . A s a r e s u l t of p a y i n g t h i s c h e q u e , h e h a s s u f f e r e d a c l e a r i n g l o s s of $ 1 0 0 , 0 0 0 , t h u s , r e d u c i n g h i s p r i m a r y r e s e r v e s by the l i k e a m o u n t . B a n k C o n the o t h e r h a n d h a s r e c e i v e d a $ 1 0 0 , 0 0 0 c l e a r i n g g a i n t h r o u g h the C e n t r a l C l e a r i n g H o u s e , b y p r e - s e n t i n g the b r o k e r ' s c h e q u e d r a w n o n B a n k B f o r p a y m e n t . H e h a s c r e d i t e d the c o r p o r a t i o n ' s a c c o u n t s e l l i n g the note w i t h the p r o c e e d s of t h i s c h e q u e , t h u s , i n c r e a s i n g h i s d e p o s i t l i a - b i l i t i e s by $ 1 0 0 , 0 0 0 . H i s p r i m a r y r e s e r v e s a r e a l s o i n c r e a s e d b y the c l e a r i n g g a i n in a l i k e a m o u n t . What h a s h a p p e n e d i s p r e s e n t e d in t a b u l a r f o r m in R i g u r e 9 - B . T h i s s h o w s that B a n k A h a s r e c e i v e d a c l e a r i n g g a i n of $ 1 0 0 , 0 0 0 : B a n k B h a s s u f f e r e d n e i t h e r a g a i n o r l o s s in the c l e a r i n g s : a n d B a n k C h a s s u f f e r e d a c l e a r i n g l o s s of $ 1 0 0 , 0 0 0 . T h e r e s u l t i n g b a l a n c e s h e e t s a r e s h o w n in R i g u r e 9 - C . 6 1 . T h i s i s o n l y o n e e x a m p l e of the m a n y p o s s i b l e m a n - n e r s in w h i c h m o n e y m a r k e t t r a n s a c t i o n s c a n ef fect b a n k ' s c l e a r i n g g a i n s a n d l o s s e s . N o f u r t h e r l a b o u r i n g of the point that m o n e y m a r k e t t r a n s a c t i o n s c a n ef fect b a n k i n g c l e a r i n g g a i n s a n d l o s s e s i s n e c e s s a r y . T H E B A N K O F C A N A D A B e s i d e s the p o s s i b i l i t y of a m o n e y m a r k e t d e a l e r r e - d i s c o u n t i n g s e c u r i t i e s w i t h the B a n k of C a n a d a , t h i s i ns t i tu t ion c a n a n d d o e s ef fect the c l e a r i n g g a i n s o r l o s s e s of b a n k s in the s h o r t r u n . O n e s u c h p r a c t i c e u s e d , to e x p a n d o r c o n t r a c t the d e p o s i t l i a b i l i t i e s of the c h a r t e r e d b a n k s , a c c o r d i n g to the d e s i r e d m o n e t a r y p o l i c y , i s the p l a c i n g of the G o v e r n m e n t of C a n a d a d e p o s i t f u n d s . A s H o o d p o i n t s o u t , the B a n k of C a n a d a i n f l u e n c e s c l e a r i n g g a i n s a n d l o s s e s " i n a d v i s i n g the g o v e r n m e n t a s to the a l l o c a t i o n of i ts d e p o s i t s a s b e t w e e n the c e n t r a l b a n k s a n d the c o m m e r c i a l b a n k s " . ( 1 4 ) S u c h a d v i c e , u s u a l l y a c c e p t e d b y the F e d e r a l G o v e r n m e n t , c a n ( 1 4 ) H o o d , W . C . , F i n a n c i n g E c o n o m i c A c t i v i t y in C a n a d a , Q u e e n ' s P r i n t e r , O t t a w a , 1 9 5 8 , P a g e 4 1 9 . 6 2 . c a u s e w i d e c l e a r i n g g a i n s o v e r l o s s e s f o r the c h a r t e r e d b a n k i n g i n s t i t u t i o n s a s a w h o l e . T h e F e d e r a l G o v e r n m e n t b y m o v i n g i ts d e p o s i t a c c o u n t s to the c e n t r a l b a n k f r o m the c h a r t e r e d b a n k s , c a u s e s c l e a r i n g l o s s e s to the c h a r t e r e d b a n k s ; w h i l e a m o v i n g of F e d e r a l d e p o s i t s f r o m the B a n k of C a n a d a to the c h a r t e r e d b a n k s , c a u s e s a c l e a r i n g g a i n to t h e s e c h a r t e r e d b a n k s . T h e fact that the r e d e m p t i o n of T r e a s u r y B i l l s , C a n a d a S a v i n g s B o n d s , a n d m a t u r e d G o v e r n m e n t of C a n a d a B o n d s , i s t h r o u g h the c h a r t e r e d b a n k s a n d then to the B a n k of C a n a d a , a l s o e f f e c t s the c h a r t e r e d - b a n k ' s c l e a r i n g g a i n s . T h u s , a C a n a d a S a v i n g s B o n d p r e s e n t e d f o r r e d e m p t i o n at a c h a r t e r e d b a n k i s r e d e e m e d a n d f o r w a r d e d to the c e n t r a l b a n k f o r s e t t l e m e n t , c a u s i n g the r e d e e m i n g c h a r t e r e d b a n k to i n c u r a c l e a r i n g g a i n . T h e f o l l o w i n g e x a m p l e of a t y p i c a l t r a n s a c t i o n w i l l d e m o n s t r a t e t h i s p o i n t . A c u s t o m e r of a b r a n c h of " O u r B a n k " , p r e s e n t s a C a n a d a S a v i n g s B o n d f o r r e d e m p t i o n . T h e b r a n c h r e d e e m s the b o n d f o r the f a c e v a l u e p l u s e a r n e d i n t e r e s t f o r the m o n t h , a n d in s e t t l e m e n t c r e d i t s the i n d i v i d u a l ' s d e p o s i t a c c o u n t w i t h that b r a n c h . ( T h e b r a n c h m a y a l s o r e d e e m the b o n d f o r c a s h , t h u s 6 3 . r e d u c i n g the p r i m a r y r e s e r v e s of the b a n k . B u t a s the c a s h p o r t i o n of the p r i m a r y r e s e r v e s i s a n a v e r a g e f i g u r e a n d f i x e d o v e r the s h o r t - r u n , the ef fect of s u c h a p a y m e n t in c a s h o n the p r i m a r y r e s e r v e s w o u l d not be felt unti l the f o l l o w i n g a v e r a g i n g p e r i o d . ) T h e r e d e e m e d b o n d i s t h e n f o r w a r d e d t h r o u g h the r e d e e m i n g b a n k ' s i n t e r n a l b r a n c h c l e a r i n g s y s t e m to a c e n t r a l c l e a r i n g point w h e r e the B a n k of C a n a d a m a i n t a i n s a n a g e n c y . T h e r e d e e m e d b o n d i s f o r w a r d e d to the C e n t r a l C l e a r i n g H o u s e f o r s e t t l e m e n t , a n d i s p a i d f o r b y the B a n k of C a n a d a w i t h a c r e d i t to the r e d e e m i n g b a n k ' s r e s e r v e a c c o u n t w i t h the B a n k of C a n a d a , t h u s , r e s u l t i n g in a c l e a r i n g g a i n f o r the r e d e e m i n g b a n k , p r o v i d i n g t h i s i s the o n l y t r a n s a c t i o n that d a y . M a t u r e d G o v e r n m e n t of C a n a d a B o n d s a n d G o v e r n m e n t of C a n a d a C o u p o n s a r e h a n d l e d in a s i m i l a r m a n n e r , e a c h t i m e c o n t r i b u t i n g to a c l e a r i n g g a i n f o r the n e g o t i a t i n g c h a r t e r e d b a n k . T h e s i z e of the T r e a s u r y B i l l i s s u e r e p r e s e n t s a u n i q u e s i t u a t i o n in r e g a r d s to c l e a r i n g g a i n s a n d l o s s e s f o r the c h a r t e r e d b a n k s . A l t h o u g h b i d s a r e o p e n e d at 1 2 : 0 0 n o o n T h u r s d a y a n d a l l o c a t i o n s a n n o u n c e d at 2 : 0 0 p . m . the s a m e d a y , p a y m e n t o r s e t t l e m e n t f o r the T r e a s u r y B i l l s i s s u e d d o e s not t a k e p l a c e unti l F r i d a y , w h i c h h a p p e n s to b e the d a y the T r e a s u r y B i l l s i s s u e d 91 o r 182 d a y s p r e v i o u s l y m a t u r e . If 6 4 . the a m o u n t of the n e w i s s u e h e l d o u t s i d e of the G o v e r n m e n t of C a n a d a a n d the C e n t r a l B a n k , i s g r e a t e r in a m o u n t t h a n the a m o u n t of the m a t u r i n g i s s u e h e l d o u t s i d e the G o v e r n m e n t of C a n a d a a n d the C e n t r a l B a n k , the c h a r t e r e d b a n k s k n o w that o n the w h o l e they a r e g o i n g to s u f f e r a net c l e a r i n g l o s s o n the t r a n s a c t i o n , a s m o r e f u n d s w i l l h a v e to b e p a i d to the B a n k of C a n a d a f o r the n e w i s s u e , than the B a n k of C a n a d a i s p a y i n g in r e d e e m i n g the o l d i s s u e . S i m i l a r l y , if the a m o u n t of the n e w i s s u e h e l d o u t s i d e of the G o v e r n m e n t of C a n a d a a n d the C e n t r a l B a n k , i s l e s s than the a m o u n t m a t u r i n g h e l d o u t s i d e of the G o v e r n m e n t of C a n a d a a n d the C e n t r a l B a n k , the c h a r t e r e d b a n k s k n o w that o n the w h o l e they w i l l s u f f e r a net c l e a r i n g g a i n , a s the B a n k of C a n a d a w i l l b e p a y i n g a g r e a t e r a m o u n t out f o r r e d e e m i n g the o l d i s s u e than it w i l l b e t a k i n g in a s p a y m e n t f o r the n e w i s s u e . Y o u w i l l note that w e s t a t e d o n the w h o l e c h a r t e r e d b a n k s w i l l k n o w w h e t h e r they w i l l h a v e a c l e a r i n g g a i n o r l o s s r e s u l t i n g f r o m a r e d e m p t i o n a n d n e w i s s u e of T r e a s u r y B i l l s . W h e t h e r a n y p a r t i c u l a r c h a r t e r e d b a n k h a s a c l e a r i n g g a i n o r l o s s a s a r e s u l t of the T r e a s u r y B i l l i s s u e a n d r e - d e m p t i o n w i l l d e p e n d on the a m o u n t of r e d e m p t i o n s a n d p u r c h a s e s b e i n g h a n d l e d by the r e s p e c t i v e c h a r t e r e d b a n k , a n d the a m o u n t 6 5 . of the n e w I s s u e they a n d t h e i r c l i e n t s w i l l b e p u r c h a s i n g . If a n y c h a r t e r e d b a n k i s r e d e e m i n g m o r e T r e a s u r y B i l l s than it i s p u r c h a s i n g ( w h e t h e r f o r i t s o w n a c c o u n t o r i t s c l i e n t s ) it w i l l s u f f e r a c l e a r i n g g a i n , r e g a r d l e s s of the total a m o u n t of the r e d e m p t i o n o r n e w i s s u e . C o n v e r s e l y , a n y c h a r t e r e d b a n k that i s p u r c h a s i n g m o r e T r e a s u r y B i l l s than it i s r e - d e e m i n g ( a g a i n w h e t h e r f o r i t s o w n a c c o u n t o r f o r i t s c l i e n t s ) w i l l s u f f e r a net c l e a r i n g l o s s , r e g a r d l e s s of the total a m o u n t of the r e d e m p t i o n o r n e w i s s u e . T h u s , w e h a v e s e e n that the a c t i o n s of the B a n k of C a n a d a c a n i n f l u e n c e the s h o r t - r u n net c l e a r i n g g a i n s o r l o s s e s f o r the c h a r t e r e d b a n k s a s a w h o l e o r i n d i v i d u a l l y . A F R U S T R A T I N G D I V E R S I O N A t t i m e s , in o r d e r to r e s t o r e the l i qu id i t y o r p r i m a r y r e s e r v e p o s i t i o n of a c h a r t e r e d b a n k , it i s n e c e s s a r y to at tempt to c r e a t e a c l e a r i n g g a i n . H o p e f u l l y , t h i s i s a c c o m p l i s h e d by the f o l l o w i n g a c t i o n o n the p a r t of the b a n k d e s i r i n g g r e a t e r l i q u i d i t y . If it i s d e c i d e d f u n d s a r e n e e d e d to r e s t o r e the d e s i r e d l i qu id i t y l e v e l of the b a n k , the f i r s t t h i n g d o n e i s to " c a l l " a l o a n . 6 6 . U s u a l l y , the f i r s t l o a n s to b e c a l l e d a r e the " C a l l " o r " D a y " l o a n s to the f i f teen m o n e y m a r k e t d e a l e r s . O u r f i r s t a c t i v i t y a s the b a n k i s to i n f o r m the d e a l e r w e w i s h h i m to r e p a y h i s l o a n . In o r d e r to r a i s e the f u n d s d e m a n d e d by the b a n k , the m o n e y m a r k e t d e a l e r w i l l do o n e of t h r e e t h i n g s : 1 . B o r r o w su f f i c i en t f u n d s f r o m s o m e o n e e l s e a n d p a y u s off w i t h the p r o c e e d s ; 2 . S e l l s o m e s e c u r i t i e s h e i s h o l d i n g in i n v e n t o r y ; o r 3 . R e d i s c o u n t s o m e of h i s a c c e p t a b l e i n v e n t o r y w i t h the B a n k of C a n a d a . O n l y the t h i r d a l t e r n a t i v e w i l l " g u a r a n t e e " , that w e a s the b a n k w i l l r e c e i v e the f u n d s w e r e q u i r e to r e s t o r e o u r l i q u i d i t y . T h e f i r s t a l t e r n a t i v e w i l l ( u s u a l l y ) g i v e the d e s i r e d r e s u l t s w h i l e the s e c o n d ( m a y ) a c h i e v e the d e s i r e d c l e a r i n g g a i n . ( A f o u r t h p o s s i b i l i t y d o e s e x i s t but it i s h i g h l y u n l i k e l y . T h i s w o u l d be w h e r e the b r o k e r p a i d off h i s l o a n w i t h c u r - r e n c y — that i s B a n k of C a n a d a n o t e s . A s w e a r e d e a l i n g in h u n d r e d s of t h o u s a n d s a n d of ten m u l t i - m i l l i o n s of d o l l a r s , it i s u n l i k e l y that t h i s w i l l b e the m o d e of r e p a y m e n t . ) In d e a l i n g w i t h the " g u a r a n t e e d " i tem f i r s t , the m o n e y m a r k e t d e a l e r r e d i s c o u n t s w i t h ( in e s s e n c e b o r r o w s f r o m ) the 6 7 . B a n k of C a n a d a , to p a y off h i s l o a n w i t h u s , a n d the p r o - c e e d s do c r e a t e a c l e a r i n g g a i n f o r u s . H i s p a y m e n t i s a c l a i m a g a i n s t the B a n k of C a n a d a w h i c h c a n b e s u b m i t t e d t h r o u g h the C e n t r a l C l e a r i n g H o u s e , c h a r g e d to the B a n k of C a n a d a , r e s u l t i n g in a c l e a r i n g g a i n f o r " O u r B a n k " . 1—et u s n o w m o v e to the s e c o n d a l t e r n a t i v e , w h i c h i s the o n e w i t h the g r e a t e s t p o s s i b i l i t y of not a c h i e v i n g the d e s i r e d r e s u l t s , i . e . p r o d u c i n g a n i n - f j o w of f u n d s t h r o u g h a c l e a r i n g g a i n . S u p p o s e u p o n the c a l l i n g of the l o a n , o u r b r o k e r d e c i d e s to s e l l s e c u r i t i e s h e i s p r e s e n t l y h o l d i n g in i n v e n t o r y . If h e s e l l s t h e s e s e c u r i t i e s to a n o t h e r m o n e y m a r k e t d e a l e r w h o d e a l s w i t h a n o t h e r b a n k , o r a n y o t h e r ent i ty w h o d e a l s w i t h a n o t h e r b a n k , w e w i l l r e c e i v e a c h e q u e in p a y m e n t f o r the s a l e d r a w n o n a n o t h e r b a n k , w h i c h w e m a y s u b m i t t h r o u g h the C l e a r i n g H o u s e , t h u s , r e c e i v i n g a c l e a r i n g g a i n o n the t r a n s a c t i o n . T h i s r e s u l t s in a n i n c r e a s e in o u r p r i m a r y r e s e r v e s , a n d t h u s o u r l i q u i d i t y , w h i c h w a s the d e - s i r e d r e s u l t . H o w e v e r , s h o u l d the m o n e y m a r k e t d e a l e r s e l l the s e c u r i t i e s to a c u s t o m e r w h o b a n k s at " O u r B a n k " o r a n y of o u r b r a n c h e s , p a y m e n t f o r the s a l e , a n d t h e r e f o r e r e - p a y m e n t of the c a l l e d l o a n , w i l l b e m a d e b y g i v i n g u s a c h e q u e d r a w n o n o u r s e l v e s ! T h i s c h e q u e c a n n o t b e p l a c e d into the 6 8 . C e n t r a l C l e a r i n g H o u s e f o r p a y m e n t a n d t h u s w e w i l l not r e - c e i v e the c l e a r i n g g a i n s n e c e s s a r y to r e s t o r e o u r l i q u i d i t y , w h i c h of c o u r s e w a s the p u r p o s e of c a l l i n g the l o a n in the f i r s t p l a c e . E x a c t l y the s a m e m a y h a p p e n in the c a s e of the f i r s t a l t e r n a t i v e , w h e r e the b r o k e r b o r r o w s f r o m s o m e o n e e l s e to p a y off the c a l l e d l o a n . H e r e a g a i n the m o n e y m a r k e t d e a l e r m a y b o r r o w the f u n d s f r o m o n e of o u r c u s t o m e r s o r a c u s t o m e r of o n e of o u r b r a n c h e s , t h e r e b y p a y i n g off h i s l o a n w i t h a c h e q u e d r a w n o n o u r s e l v e s , w h i c h d o e s not net a n y f u n d s to " O u r B a n k " , but m e r e l y r e d i s t r i b u t e s the d e p o s i t l i a b i l i t i e s a m o n g o u r b r a n c h e s . In c l a i m i n g that b o r r o w i n g the f u n d s w i l l " u s u a l l y " g i v e the d e s i r e d r e s u l t s , a n d that s e l l i n g s e c u r i t i e s " m a y " g i v e the d e s i r e d r e s u l t s , w e a r e i n t i m a t i n g that b o r r o w i n g the f u n d s h a s a h i g h e r p r o b a b i l i t y of a c h i e v i n g the d e s i r e d r e s u l t than the s e l l i n g of s e c u r i t i e s . T h i s i s s o a s the n u m b e r of e n t i t i e s the m o n e y m a r k e t d e a l e r c a n b o r r o w f r o m , at the p r e f e r r e d r a t e h e e n j o y s o n c a l l l o a n s , i s l i m i t e d in C a n a d a to the c h a r t e r e d b a n k s . S e l l i n g s e c u r i t i e s i s u s u a l l y a m o r e e c o n o m i c a l w a y of r e p a y i n g a c a l l e d l o a n of o n e b a n k , if a s i m i l a r l o a n c a n n o t be o b t a i n e d f r o m s o m e o t h e r b a n k . 6 9 . B o r r o w i n g f r o m a n y o t h e r b a n k w o u l d y i e l d the c l e a r i n g g a i n d e s i r e d , a s the c h e q u e g i v e n a s p r o c e e d s f r o m the n e w l o a n a n d t e n d e r e d a s p a y m e n t f o r o u r l o a n , w i l l b e d r a w n o n the n e w l o a n i n g b a n k , t h u s , t h i s c h e q u e c a n b e f o r w a r d e d to the C e n t r a l C l e a r i n g H o u s e f o r s e t t l e m e n t a n d a c l e a r i n g g a i n f o r " O u r B a n k " w i l l r e s u l t . W h e n the d e a l e r c h o o s e s to s e l l s e c u r i t i e s , the p o s s i b l e n u m b e r of p u r c h a s e r s i n c r e a s e s m a n y t i m e s , a n d a p o r t i o n of t h e s e potent ia l p u r c h a s e r s of s e c u r i t i e s f r o m the m o n e y m a r k e t d e a l e r a r e g o i n g to b e c u s t o m e r s of " O u r B a n k " , t h u s , a g a i n if the b r o k e r s o l d the s e c u r i t i e s to o n e of t h e m , h e w o u l d b e p r e s e n t i n g a c h e q u e to p a y off h i s l o a n w i t h u s , w h i c h i s d r a w n o n o u r s e l v e s . A n a c t u a l h a p p e n i n g w i l l d e m o n s t r a t e the f r u s t r a t i o n that c a n r e s u l t f r o m t h i s t y p e of at tempt to g a i n l i q u i d i t y . A s a r e s u l t of a top m a n a g e m e n t m e e t i n g , it w a s d e c i d e d that the l i qu id i t y d e s i r e d b y " O u r B a n k " w a s not b e i n g a c h i e v e d , a n d that in o r d e r to i m p r o v e the l i qu id i t y p o s i t i o n a b r o k e r ' s l o a n s h o u l d b e c a l l e d . T h e b r o k e r w a s i n f o r m e d of the b a n k ' s d e c i s i o n , a n d a f t e r b e i n g u n s u c c e s s f u l at a t t e m p t i n g to b o r r o w f r o m the o t h e r b a n k s , h e s o l d s o m e s e c u r i t i e s f r o m h i s i n v e n t o r y to a t r u s t c o m p a n y , o b t a i n i n g a c h e q u e in e x c h a n g e f o r the s e c u r i t i e s d e l i v e r e d . Wi th t h i s c h e q u e h e r e p a y e d h i s b a n k l o a n w i t h u s . H o w e v e r , the s e c u r i t i e s w e r e s o l d to a t r u s t c o m p a n y w h o dea l t w i t h " O u r B a n k " , a n d the t r u s t c o m p a n y m e r e l y d r e w d o w n i ts e x i s t i n g l i n e of c r e d i t w i t h " O u r B a n k " to m e e t the p u r c h a s e of the s e c u r i t i e s f r o m a m o n e y m a r k e t d e a l e r . A s a r e s u l t of t h i s t r a n s a c t i o n , " O u r B a n k " h a d not a c h i e v e d i ts goa l of o b t a i n i n g f u n d s , but h a d i n s t e a d i n c u r r e d a c e r t a i n a m o u n t of b a d w i l l w i t h the b r o k e r w h o s e l o a n w a s c a l l e d b y the b a n k . T h e w h o l e p r o c e s s w o u l d h a v e to b e r e p e a t e d a g a i n — h o p e f u l l y , t h i s t i m e w i t h m o r e f ru i t fu l r e s u l t s . T H E R A T E O F I N V E S T M E N T G R O W T H T h e r a t e of i n v e s t m e n t g r o w t h , r e l a t i v e to o t h e r b a n k s , c a n i n f l u e n c e i n d i v i d u a l b a n k ' s net c l e a r i n g g a i n a n d l o s s e s in the s h o r t r u n . In o r d e r to d e m o n s t r a t e t h i s f a c t o r it w i l l b e n e c e s s a r y f o r u s to e x p a n d the a s s e t s i d e of the b a l a n c e s h e e t s of o u r h y p o t h e t i c a l b a n k s to s h o w t h r e e f a c t o r s : p r i m a r y r e - s e r v e s , i n v e s t m e n t s a n d o t h e r a s s e t s . It i s to b e r e m e m b e r e d h e r e that the t e r m i n v e s t m e n t s i s the total of a l l l o a n s a n d a l l s e c u r i t i e s h e l d b y e a c h r e s p e c t i v e b a n k . A g a i n u s i n g o u r t h r e e b a n k e x a m p l e , let u s a s s u m e 7 1 . that the b a l a n c e s h e e t s of B a n k A , B a n d C a r e a s i s s h o w n in R i g u r e 1 0 - A o n the f o l l o w i n g p a g e . In t h i s e x a m p l e , s u p - p o s e B a n k A e x p a n d s i ts i n v e s t m e n t s by 12%, w h i l e B a n k s B a n d C e x p a n d t h e i r i n v e s t m e n t s by o n l y 6%, e a c h b a n k m a i n - t a i n i n g i ts c u s t o m e r l o y a l t y o r s h a r e of the fotal d e p o s i t m a r k e t . T h u s , B a n k A ' s i n v e s t m e n t s i n c r e a s e by $ 1 2 , 0 0 0 , w h i l e B a n k B ' s a n d B a n k C ' s i n v e s t m e n t s e x p a n d b y o n l y $ 6 , 0 0 0 e a c h . A s the p r o c e e d s of t h e s e i n c r e a s e d i n v e s t m e n t s a r e d e p o s i t e d to the d e p o s i t a c c o u n t s of the r e s p e c t i v e b a n k s , a total of $ 2 4 , 0 0 0 in n e w d e p o s i t s i s c r e a t e d , a n d a s e a c h b a n k m a i n - t a i n s i t s s h a r e of the d e p o s i t m a r k e t , e a c h b a n k ' s d e p o s i t l i a b i l i t i e s w i l l i n c r e a s e by $ 8 , 0 0 0 , r e g a r d l e s s of the a m o u n t of n e w d e p o s i t s e a c h b a n k c r e a t e s . If the p r o c e s s of s h a r i n g of d e r i v e d d e p o s i t s e q u a l l y i s e f f e c t i v e , then B a n k A w i l l r e - c e i v e o n e - t h i r d of B a n k B ' s d e r i v e d d e p o s i t s of $ 6 , 0 0 0 p l u s o n e - t h i r d of B a n k C ' s d e r i v e d d e p o s i t s of $ 6 , 0 0 0 , o r $ 4 , 0 0 0 in t o t a l . T h i s $ 4 , 0 0 0 w i l l b e in the f o r m of a c l e a r i n g g a i n to B a n k A , a n d t h e r e f o r e c l e a r i n g l o s s e s of $ 2 , 0 0 0 to e a c h of B a n k s B a n d C . H o w e v e r , B a n k A m u s t e x p e c t to l o s e t w o - t h i r d s of i ts d e r i v e d d e p o s i t s r e s u l t i n g f r o m i t s i n c r e a s e d i n v e s t m e n t s to B a n k s B a n d C , w h i c h a m o u n t s to a c l e a r i n g l o s s of $ 8 , 0 0 0 . T h u s the net r e s u l t to B a n k A w i l l b e a net c l e a r i n g l o s s of $ 4 , 0 0 0 , w h i l e B a n k s B a n d C w i l l i n c u r net c l e a r i n g g a i n s of $ 2 , 0 0 0 e a c h . T h i s e x c h a n g e p r o c e s s i s 7 2 F I G U R E 10 E x a m p l e O f C l e a r i n g G a i n s A n d L o s s e s F r o m I n v e s t m e n t E x p a n s i o n F I G U R E 1 0 - A B a n k A B a n k B B a n k C A l l B a n k s P r i m a r y R e s e r v e s 1 5 , 0 0 0 1 5 , 0 0 0 1 5 , 0 0 0 4 5 , 0 0 0 I n v e s t m e n t s 1 0 0 , 0 0 0 1 0 0 , 0 0 0 1 0 0 , 0 0 0 3 0 0 , 0 0 0 O t h e r A s s e t s 1 0 , 0 0 0 1 0 , 0 0 0 1 0 , 0 0 0 3 0 , 0 0 0 T O T A L 1 2 5 , 0 0 0 1 2 5 , 0 0 0 1 2 5 , 0 0 0 3 7 5 , 0 0 0 D e p o s i t L i a b i l i t i e s O t h e r L i a b i l i t i e s T O T A L 1 0 0 , 0 0 0 1 0 0 , 0 0 0 2 5 , 0 0 0 2 5 , 0 0 0 1 2 5 , 0 0 0 1 2 5 , 0 0 0 1 0 0 , 0 0 0 3 0 0 , 0 0 0 2 5 , 0 0 0 2 5 , 0 0 0 1 2 5 , 0 0 0 3 7 5 , 0 0 0 7 3 . F I G U R E 1 0 - B B A N K " A " C l e a n i n g G a i n s l / 3 of B a n k B ' s i n c r e a s e d i n v e s t m e n t s of $ 6 , 0 0 0 $ 2 , 0 0 0 1 / 3 of B a n k C ' s i n c r e a s e d i n v e s t m e n t s of $ 6 , 0 0 0 $ 2 . 0 0 0 $ 4 , 0 0 0 C l e a r i n g L o s s e s 2 / 3 of o u r o w n i n c r e a s e d i n v e s t m e n t s of $ 1 2 , 0 0 0 ( $ 8 , 0 0 0 ) N E T C l e a r i n g G a i n ( L o s s ) ( $ 4 . 0 0 0 ) B A N K " B " C i e a r i n g G a i n s 1 / 3 of B a n k A ' s i n c r e a s e d i n v e s t m e n t s of $ 1 2 , 0 0 0 $ 4 , 0 0 0 1 / 3 of B a n k C ' s i n c r e a s e d i n v e s t m e n t s of $ 6 , 0 0 0 $ 2 . 0 0 0 $ 6 , 0 0 0 C i e a r i n g L o s s e s 2 / 3 of o u r o w n i n c r e a s e d i n v e s t m e n t s of $ 6 , 0 0 0 $ 4 , 0 0 0 N E T C l e a r i n g G a i n ( L o s s ) $ 2 , 0 0 0 7 4 . F I G U R E 1 0 - B ( c o n t ' d ) B A N K " C " C l e a n i n g G a i n s l / 3 of B a n k A ' s i n c r e a s e d i n v e s t m e n t s of $ 1 2 , 0 0 0 $ 4 , 0 0 0 l / 3 of B a n k B ' s i n c r e a s e d i n v e s t m e n t s of $ 6 , 0 0 0 $ 2 , 0 0 0 $ 6 , 0 0 0 C l e a r i n g L o s s e s 2 / 3 of o u r o w n i n c r e a s e d i n v e s t m e n t s of $ 6 , 0 0 0 $ 4 , 0 0 0 N E T C l e a r i n g G a i n ( L o s s ) $ 2 , 0 0 0 F I G U R E 1 0 - C B a n k A B a n k B B a n k C A l l B a n k s P r i m a r y R e s e r v e s 1 1 , 0 0 0 1 7 , 0 0 0 1 7 , 0 0 0 4 5 , 0 0 0 I n v e s t m e n t s 1 1 2 , 0 0 0 1 0 6 , 0 0 0 1 0 6 , 0 0 0 3 2 4 , 0 0 0 O t h e r A s s e t s 1 0 , 0 0 0 1 0 , 0 0 0 1 0 , 0 0 0 3 0 , 0 0 0 T O T A L 1 3 3 , 0 0 0 1 3 3 , 0 0 0 1 3 3 , 0 0 0 3 9 9 . 0 0 0 D e p o s i t L i a b i l i t i e s 1 0 8 , 0 0 0 1 0 8 , 0 0 0 1 0 8 , 0 0 0 3 2 4 , 0 0 0 O t h e r L i a b i l i t i e s 2 5 , 0 0 0 2 5 , 0 0 0 2 5 , 0 0 0 7 5 , 0 0 0 T O T A L 1 3 3 , 0 0 0 1 3 3 , 0 0 0 1 3 3 , 0 0 0 3 9 9 , 0 0 0 s h o w n in F i g u r e 1 0 - B , a n d the r e s u l t i n g b a l a n c e s h e e t s of the i n d i v i d u a l b a n k s a f t e r the i n c r e a s e s in i n v e s t m e n t s a n d d e p o s i t s h a v e t a k e n ef fect a s s h o w n in F i g u r e 1 0 - C . N o t e f r o m F i g u r e 1 0 - C that the a g g r e g a t e of a l l i n v e s t m e n t s h a s i n c r e a s e d the a v e r a g e of e a c h b a n k ' s i n c r e a s e , a s h a v e a g g r e g a t e d e p o s i t s . A l l o t h e r a s s e t a n d l i ab i l i t y c a t e g o r i e s h a v e r e m a i n e d c o n s t a n t in the a g g r e g a t e , a l t h o u g h the d i s - t r i b u t i o n of the p r i m a r y r e s e r v e s a m o n g the v a r i o u s b a n k s h a s c h a n g e d , r e f l e c t i n g t h e i r r e s p e c t i v e net c l e a r i n g g a i n s a n d l o s s e s r e s u l t i n g f r o m u n e q u a l i n c r e a s e s in i n v e s t m e n t s . With the h e l p of the a b o v e e x a m p l e , w e h a v e d e m o n - s t r a t e d that a b a n k w h i c h i n c r e a s e s i ts i n v e s t m e n t s at a f a s t e r r a t e than i ts c o m p e t i t o r s m u s t e x p e c t to s u f f e r a net c l e a r i n g g a i n . T h i s i s in k e e p i n g w i t h the f i n d i n g s of G . H . H a l m , w h o s t a t e d : " w h e n e v e r a b a n k e x p a n d s i ts c r e d i t f u r t h e r a n d f a s t e r than o t h e r b a n k s it m u s t f a c e a n u n f a v o u r a b l e c l e a r i n g b a l a n c e . " ( 1 5 ) T h e r e c i p r o c a l of t h i s s t a t e m e n t i s a l s o t r u e , that a b a n k w h i c h i n c r e a s e s i t s i n v e s t m e n t s at a s l o w e r r a t e t h a n i ts c o m p e t i t o r s c a n e x p e c t to i n c u r a net c l e a r i n g g a i n in the l o n g r u n . ( 1 5 ) H a l m , G . H . , o p . c i t . , P a g e 5 5 . C H A P T E R V I L O N G R U N F A C T O R S A F F E C T I N G C L E A R I N G G A I N S A N D L O S S E S H a v i n g l o o k e d at the s h o r t r u n f a c t o r s that af fect the net c l e a r i n g g a i n s o r l o s s e s f o r b a n k s , let u s n o w m o v e f r o m the s h o r t r u n to the l o n g r u n , a n d c o n s i d e r the l o n g r u n f a c t o r s that af fect a n y b a n k ' s r e s p e c t i v e net c l e a r i n g g a i n o r l o s s . C U S T O M E R L O Y A L T Y C u s t o m e r l o y a l t y i s the o n l y i m p o r t a n t f a c t o r w h i c h in the l o n g r u n w o u l d effect a n y g i v e n b a n k ' s net c l e a r i n g g a i n o r l o s s . A b a n k w h o s e s h a r e of the m a r k e t f o r i n c o m e p r o d u c i n g a s s e t s o r d e p o s i t l i a b i l i t i e s w a s s h r i n k i n g , w o u l d o v e r the l o n g r u n , s u f f e r a net c l e a r i n g l o s s . T h e f o l l o w i n g e x a m p l e w i l l i l l u s t r a t e t h i s p r o p o s i t i o n . S u p p o s e B a n k s A , B a n d C h a v e b a l a n c e s h e e t s a s i s e x h i b i t e d in F i g u r e 1 1 - A o n the f o l l o w i n g p a g e . L e t u s a s s u m e that o v e r a p e r i o d of t ime B a n k B l o s e s 10% of i ts d e p o s i t s to B a n k A a n d a 5% of i ts d e p o s i t s to B a n k C . T h i s 7 7 . F I G U R E 1 1 C u s t o m e r 1— o y a l t y A n d C l e a r i n g G a i n s A n d L o s s e s F I G U R E 1 1 - A B a n k A B a n k B B a n k C A l l B a n k s P r i m a r y R e s e r v e s 8 , 0 0 0 8 , 0 0 0 8 , 0 0 0 2 4 , 0 0 0 O t h e r A s s e t s 1 0 7 , 0 0 0 1 0 7 , 0 0 0 1 0 7 , 0 0 0 3 2 1 , 0 0 0 B a n k A B a n k B B a n k C P r i m a r y R e s e r v e s 1 8 , 0 0 0 6 , 8 0 0 1 3 , 0 0 0 O t h e r A s s e t s 1 0 7 , 0 0 0 9 3 , 2 0 0 1 0 7 , 0 0 0 T O T A L 1 2 5 , 0 0 0 1 0 0 , 0 0 0 1 2 0 , 0 0 0 D e p o s i t L i a b i l i t i e s 1 1 0 , 0 0 0 8 5 , 0 0 0 1 0 5 , 0 0 0 O t h e r L i a b i l i t i e s 1 5 , 0 0 0 1 5 , 0 0 0 1 5 , 0 0 0 T O T A L 1 1 5 , 0 0 0 1 1 5 , 0 0 0 1 1 5 . 0 0 0 3 4 5 , 0 0 0 D e p o s i t L i a b i l i t i e s 1 0 0 , 0 0 0 1 0 0 , 0 0 0 1 0 0 , 0 0 0 3 0 0 , 0 0 0 O t h e r L i a b i l i t i e s 1 5 , 0 0 0 1 5 , 0 0 0 1 5 , 0 0 0 4 5 , 0 0 0 T O T A L 1 1 5 , 0 0 0 1 1 5 . 0 0 0 1 1 5 , 0 0 0 3 4 5 , 0 0 0 F I G U R E 1 1 - B T O T A L 1 2 5 , 0 0 0 1 0 0 , 0 0 0 1 2 0 , 0 0 0 78 F I G U R E 1 1 - C B a n k A B a n k B B a n k C A l l B a n k s P r i m a r y R e s e r v e s 8 , 8 0 0 6 , 8 0 0 8 , 4 0 0 2 4 , 0 0 0 O t h e r A s s e t s 1 1 6 , 2 0 0 9 3 , 2 0 0 1 1 1 , 6 0 0 3 2 1 , 0 0 0 T O T A L . 1 2 5 , 0 0 0 1 0 0 , 0 0 0 1 2 0 , 0 0 0 3 4 5 , 0 0 0 D e p o s i t L i a b i l i t i e s O t h e r L i a b i l i t i e s T O T A L 1 1 0 , 0 0 0 8 5 , 0 0 0 1 5 , 0 0 0 1 5 , 0 0 0 1 2 5 , 0 0 0 1 0 0 , 0 0 0 1 0 5 , 0 0 0 3 0 0 , 0 0 0 1 5 , 0 0 0 4 5 , 0 0 0 1 2 0 , 0 0 0 3 4 5 , 0 0 0 w o u l d m e a n that o v e r a p e r i o d of t ime the c u s t o m e r s of B a n k B w o u l d r e m o v e t h e i r d e p o s i t s f r o m B a n k B a n d p l a c e t h e m w i t h e i t h e r B a n k A o r B a n k C . A l t h o u g h s o m e of B a n k B ' s c u s t o m e r s m ight m a k e t h i s t r a n s f e r by w i t h d r a w i n g c a s h f r o m B a n k B a n d c a r r y i n g it to the o t h e r b a n k s , t h u s , not e f f e c t i n g the c l e a r i n g s y s t e m at a l l , it i s m o r e l i k e l y that the t r a n s f e r s w o u l d b e m a d e b y c h e q u e o r o t h e r n e g o t i a b l e i n s t r u m e n t , a n d t h e s e i t e m s w o u l d e n t e r the c l e a r i n g s y s t e m . If t h i s w e r e the c a s e , o v e r a p e r i o d of t i m e B a n k A w o u l d p r e s e n t to B a n k B t h r o u g h the c l e a r i n g s y s t e m , c h e q u e s a m o u n t i n g to $ 1 0 , 0 0 0 , o v e r a n d a b o v e the n o r m a l c l e a r i n g s , r e p r e s e n t i n g 10% of the d e p o s i t l i a b i l i t i e s of B a n k B . S i m i l a r i l y , o v e r a p e r i o d of t ime B a n k C w o u l d p r e s e n t to B a n k B t h r o u g h the c l e a r i n g s y s t e m , n e g o t i a b l e i t e m s a m o u n t i n g to $ 5 , 0 0 0 , o v e r a n d a b o v e the n o r m a l c l e a r i n g s , r e p r e s e n t i n g the 5% of B a n k B ' s d e p o s i t l i a b i l i t i e s g a i n e d by B a n k C . B y s o d o i n g , o v e r the p e r i o d i n v o l v e d , B a n k s A a n d C w o u l d i n c u r a net c l e a r i n g g a i n of $ 1 0 , 0 0 0 a n d $ 5 , 0 0 0 r e s p e c t i v e l y w h i l e o v e r the s a m e p e r i o d B a n k B w o u l d i n c u r a c l e a r i n g l o s s of $ 1 5 , 0 0 0 . A s a r e s u l t of t h i s c l e a r i n g l o s s s u f f e r e d b y B a n k B , i ts p r i m a r y r e s e r v e s w o u l d b e r e d u c e d to m i n u s $ 7 , 0 0 0 , a n d t h o s e of B a n k A a n d B a n k C w o u l d b e i n c r e a s e d to $ 1 8 , 0 0 0 , a n d $ 1 3 , 0 0 0 r e - s p e c t i v e l y . In o r d e r f o r B a n k B to r e s t o r e i ts r e q u i r e d 8% 8 0 . p r i m a r y r e s e r v e , it w o u l d b e n e c e s s a r y f o r B a n k B to s e l l , o v e r the p e r i o d i n v o l v e d , o t h e r a s s e t s t o t a l l i n g $ 1 3 , 8 0 0 , t h u s e s t a b l i s h i n g the r e q u i r e d p r i m a r y r e s e r v e at $ 6 , 8 0 0 w h i c h i s 8% of the n e w d e p o s i t l i a b i l i t i e s of B a n k B . T h e b a l a n c e s h e e t s of the r e s p e c t i v e b a n k s a f t e r t a k i n g into a c c o u n t t h e i r r e s p e c t i v e net c l e a r i n g g a i n s a n d l o s s e s o v e r the p e r i o d of t ime a n d the s e l l i n g of o t h e r a s s e t s by B a n k B to m a i n t a i n i t s p r i m a r y r e s e r v e s , w o u l d b e a s i s s h o w n in F i g u r e 1 1 - B . N o t e f r o m F i g u r e 1 1 - B , that the p r i m a r y r e s e r v e of B a n k A a n d that of B a n k C a r e a b o v e the 8% that i s r e q u i r e d by l a w , a n d a s s u c h t h e s e b a n k s w o u l d p u r c h a s e o t h e r r e v e n u e p r o d u c i n g a s s e t s ( i . e . l o a n n o t e s o r s e c u r i t i e s ) in the a m o u n t s of $ 9 , 2 0 0 f o r B a n k A a n d $ 4 , 6 0 0 f o r B a n k C , t h u s , r e - e s t a b l i s h i n g t h e i r r e q u i r e d r e s e r v e s at 8% of t h e i r r e s p e c t i v e n e w d e p o s i t l i a b i l i t i e s . T h e r e s p e c t i v e b a l a n c e s h e e t s a f t e r t h e s e t r a n s a c t i o n s w o u l d b e a s i s s h o w n in F i g u r e 1 1 - C . N o t e that the t o t a l s f o r a l l b a n k s in a l l a s s e t a n d l i ab i l i t y c a t - e g o r i e s in F i g u r e 1 1 - C a r e i d e n t i c a l to t h o s e f ound in F i g u r e 1 1 - A , a n d that a l l b a n k s a r e a g a i n in e q u i l i b r i u m a s i s the b a n k i n g s y s t e m in t o t a l . W e c a n c o n c l u d e f r o m the a b o v e that if t h e r e i s a s w i t c h in c u s t o m e r l o y a l t y o v e r a p e r i o d of t i m e , t h i s s w i t c h 8 1 . w o u l d s h o w in the r e s p e c t i v e c l e a r i n g g a i n s a n d l o s s e s f o r the i n d i v i d u a l b a n k s o v e r the p e r i o d of t i m e i n v o l v e d . W e h a v e d e m o n s t r a t e d that c u s t o m e r l o y a l t y a n d the a b u n d a n c e o r l a c k of it c a n ef fect the net c l e a r i n g g a i n s o r l o s s e s f o r a n y i n d i v i d u a l b a n k o v e r the l o n g r u n . In o r d e r to s e e jus t h o w m u c h c u s t o m e r l o y a l t y h a s a f f e c t e d the C a n a d i a n C h a r t e r e d B a n k s c l e a r i n g g a i n s a n d l o s s e s o v e r the y e a r s , let u s l o o k at the c h a n g e s in the d i s - t r i b u t i o n of the total d e p o s i t s in C a n a d a o v e r the l a s t t w e n t y - f i v e y e a r s . F r o m t h i s d a t a a n d the p r e v i o u s e x a m p l e w e w i l l b e a b l e to s e e m a g n i t u d e that c u s t o m e r l o y a l t y h a s o n the net c l e a r i n g g a i n a n d l o s s f i g u r e s o v e r t i m e . F i g u r e 12 o n the f o l l o w i n g p a g e s h o w s the d i s t r i b u t i o n of the C a n a d i a n D o l l a r D e p o s i t s a m o n g the C a n a d i a n C h a r t e r e d B a n k s f o r s e l e c t e d y e a r s f r o m 1939 to 1964 i n c l u s i v e . F i g u r e 13 s h o w s the s a m e i n f o r m a t i o n in p e r c e n t a g e f o r m . L o o k i n g at t h e s e f i g u r e s , o n e c a n s e e that the s h a r e of the d e p o s i t m a r k e t a n y o n e b a n k h a s d o e s v a r y c o n s i d e r a b l y o v e r the l o n g r u n . N o t e that the B a n k of M o n t r e a l ' s s h a r e of the total d e p o s i t m a r k e t d e c r e a s e d by o n e p e r c e n t f r o m 1959 to 1 9 6 4 . T h i s l o s s c o u l d b e f r o m o n e of t w o c a u s e s ; both p a r t of c u s t o m e r l o y a l t y . 8 2 . 1 . T h i s p a r t i c u l a r b a n k c o u l d b e l o s i n g c u s t o m e r s to o t h e r b a n k s , o r , 2 . T h i s p a r t i c u l a r b a n k c o u l d not be a t t r a c t i n g the " n e w m o n e y " a s w e l l a s the o t h e r b a n k s . In the f i r s t c a s e , w h e r e the b a n k i s l o s i n g c u s t o m e r s , w e h a v e s e e n that t h i s w i l l c a u s e the b a n k to s u f f e r c l e a r i n g l o s s e s . T h i s w a s d e m o n s t r a t e d w i t h a n e x a m p l e e a r l i e r in t h i s s e c t i o n . H o w e v e r , if the B a n k of M o n t r e a l i s not l o s i n g c u s t o m e r s to o t h e r b a n k s but m e r e l y not a t t r a c t i n g i ts p o r t i o n of " n e w m o n e y " , then the c l e a r i n g f i g u r e s of t h i s b a n k w i l l not b e a f f e c t e d by i t s l o s s of a p o r t i o n of the total d e p o s i t m a r k e t . W h i c h e v e r in fact i s the c a s e , w e a r e not a b l e to te l l f r o m the i n f o r m a t i o n a v a i l a b l e , but w e m a y s ta te that if a n y b a n k c a n d e t e r m i n e that it i s not l o s i n g c u s t o m e r s , but s t i l l s u f f e r i n g a d e c l i n e in the p o r t i o n of the d e p o s i t m a r k e t it i s h o l d i n g , then it i s not o b t a i n i n g i ts p o r t i o n of the " n e w m o n e y " b e i n g c r e a t e d in the b a n k i n g s y s t e m a s a w h o l e . F o r b a n k m a n a g e m e n t , the i n f o r m a t i o n a s to w h e t h e r it i s s u f f e r i n g a l o s s of d e p o s i t b u s i n e s s d u e to c u s t o m e r l o y a l t y o r f a i l u r e to a t t r a c t " n e w m o n e y " , i s a v a i l a b l e in the l o n g r u n c l e a r i n g s t a t i s t i c s . If a b a n k in the l o n g r u n i s not s u f f e r i n g 8 3 . F I G U R E 12 C a n a d i a n D o l l a r D e p o s i t s O f C a n a d i a n C h a r t e r e d B a n k s In S e l e c t e d Y e a r s 1939 1944 1949 1954 1959 1964 (In M i l l i o n s O f D o l l a r s ) B a n k of M o n t r e a l 7 8 6 1 , 3 2 0 1 , 8 0 2 2 , 3 1 9 2 , 7 2 0 3 , 5 8 8 T h e B a n k of N o v a - S c o t i a 240 390 627 846 1 , 2 0 2 1 , 7 9 9 T h e T o r o n t o - D o m i n i o n B a n k 2 8 5 522 7 8 4 1 , 0 7 2 1 , 3 7 5 1 , 9 0 2 T h e P r o v i n c i a l B a n k of C a n a d a 27 103 140 206 3 1 3 4 8 0 C a n a d i a n I m p e r i a l B a n k of C o m m e r c e 7 5 7 1 , 3 0 8 1 , 8 5 3 2 , 4 2 8 3 , 175 4 , 181 T h e R o y a l B a n k of C a n a d a 6 2 3 1 , 2 4 6 1 , 6 8 2 2 , 2 8 0 2 , 8 0 0 3 , 8 1 9 N a t i o n a l C a n a d i a n B a n k 145 277 106 526 680 890 T h e M e r c h a n t i l e B a n k of C a n a d a 2 14 86 T O T A L . $ 2 , 8 6 3 $ 5 , 166 $ 6 , 9 9 4 $ 9 , 6 7 9 $ 1 2 , 2 7 9 $ 1 6 , 7 4 5 N O T E : F i g u r e s a r e a m a l g a m a t e d w h e r e n e c e s s a r y f o r m e r g e r s a n d a r e a s of the l a s t b u s i n e s s d a y in e a c h y e a r . S O U R C E : C a n a d a G a z z e t t - V a r i o u s I s s u e s . 8 4 . F I G U R E 13 P e r c e n t a g e O f C a n a d i a n D o l l a r D e p o s i t s O f C a n a d i a n C h a r t e r e d B a n k s In S e l e c t e d V e a r s 1939 1944 1949 1954 1959 1964 B a n k of M o n t r e a l 2 7 . 4 % 2 5 . 5 % 2 5 . 8 % 2 4 . 0 % 2 2 . 3 % 2 1 . 3 % T h e B a n k of N o v a - S c o t i a 8 . 4 % 7 . 5 % 8 . 9 % : 8 . 7 % 9 . 8 % 1 0 . 7 % T h e T o r o n t o - D o m i n i o n B a n k 1 0 . 0 % 1 0 . 1 % 1 1 . 2 % 1 1 . 1 % 1 1 . 2 % 1 1 . 4 % T h e P r o v i n c i a l B a n k of C a n a d a . 9 % 2 . 0 % 2 . 0 % 2 . 1 % 2 . 5 % 2 . 9 % C a n a d i a n I m p e r i a l B a n k of C o m m e r c e 2 6 . 4 % 2 5 . 3 % 2 6 . 7 % 2 5 . 1 % 2 5 . 8 % 2 5 . 1 % T h e R o y a l B a n k of C a n a d a 2 1 . 8 % 2 4 . 2 % 2 3 . 9 % 2 3 . 6 % 2 2 . 8 % 2 2 . 8 % N a t i o n a l C a n a d i a n B a n k 5 . 1 % 5 . 4 % 1.5% 5 . 4 % 5 . 5 % 5 . 3 % T h e M e r c h a n t i l e B a n k of C a n a d a ni l ni l n i l n i l . 1 % . 5 % T O T A L 1 0 0 . 0 % 1 0 0 . 0 % 1 0 0 . 0 % 1 0 0 . 0 % 1 0 0 . 0 % 1 0 0 . 0 % S O U R C E : F i g u r e 1 2 . 8 5 . net c l e a r i n g l o s s e s but i s l o s i n g i ts s h a r e of the total d e p o s i t m a r k e t , then the p r o b l e m i s that it i s not a t t r a c t i n g i ts s h a r e of the " n e w m o n e y " b e i n g c r e a t e d . If o n the o t h e r h a n d , the b a n k i s s u f f e r i n g net c l e a r i n g l o s s e s in the l o n g r u n a n d l o s i n g i t s s h a r e of the total d e p o s i t b u s i n e s s , then the p r o b l e m i s o n e of f a l l i n g c u s t o m e r l o y a l t y . W e h a v e s e e n the i m p o r t a n c e of c u s t o m e r l o y a l t y to a b a n k , a n d i ts p o s s i b l e ef fect o n the net c l e a r i n g g a i n s a n d l o s s e s in the l o n g r u n . W i th b a n k m a n a g e m e n t in C a n a d a t e n d i n g to b e s i m i l a r , at l e a s t o n the s u r f a c e , a n d a l l b a n k ' s t e n d i n g to be fu l l y i n v e s t e d at a n y t i m e , the c u s t o m e r l o y a l t y a n y b a n k in C a n a d a e n j o y s i s the m a j o r f a c t o r h a v i n g i n f l u e n c e o n c l e a r i n g g a i n s a n d l o s s e s in the l o n g r u n . C H A P T E R VII C O N C L U S I O N In t h i s s t u d y w e h a v e a t t e m p t e d to s h o w the m a n y c a u s e s of c l e a r i n g g a i n s a n d l o s s e s . R e l y i n g p r e v i o u s l y o n e x a m p l e s to d e m o n s t r a t e o u r p r o p o s i t i o n s , w e h a v e s h o w n that c l e a r i n g g a i n s a n d l o s s e s a r e i n f l u e n c e d by f o u r f a c t o r s in the s h o r t r u n a n d o n e f a c t o r in the l o n g r u n . B a s e d o n t h e s e e x a m p l e s a n d the d i s c u s s i o n s u r r o u n d i n g e a c h w e w i l l n o w p r o p o s e t w o m a i n h y p o t h e s e s c o n c e r n i n g net c l e a r i n g g a i n s a n d l o s s e s . 1 . In the s h o r t r u n net c l e a r i n g g a i n s a n d l o s s e s f o r a n y s i n g l e b a n k in C a n a d a a r e a f u n c t i o n of : ( a ) the s p e n d i n g h a b i t s of the c u s t o m e r s of that b a n k , (b ) the m o n e y m a r k e t t r a n s a c t i o n s of that b a n k in the s h o r t r u n , ( c ) the a c t i o n s of the B a n k of C a n a d a a c t i n g by i tse l f o r o n beha l f of the M i n i s t e r of F i n a n c e , a n d (d ) the r a t e of i n v e s t m e n t g r o w t h of the p a r t i c u l a r b a n k r e l a t i v e to the r a t e of i n v e s t m e n t g r o w t h of o t h e r b a n k s . 87. 2 . In the l o n g n u n , the net c l e a r i n g g a i n s a n d l o s s e s of a n y b a n k in C a n a d a a r e a f u n c t i o n of the c u s t o m e r l o y a l t y e n j o y e d b y that b a n k r e l a t i v e to the c u s t o m e r s l o y a l t y e n j o y e d by o t h e r b a n k s . W h i l e w e h a v e a t t e m p t e d to s h o w h o w e a c h f a c t o r in e a c h h y p o t h e s e s c o u l d ef fect the net c l e a r i n g g a i n a n d l o s s f i g u r e s f o r a n y s i n g l e b a n k , the a c t u a l s t a t i s t i c a l t e s t i n g of t h e s e h y p o t h e s e s w i l l of n e c e s s i t y a w a i t the e m e r g e n c e of m o r e d a t a o n the r e s p e c t i v e b a n k s c l e a r i n g f i g u r e s . A p p e n d i x A d i s c u s s e s t h i s a u t h o r ' s a t t e m p t s to f ind t h i s i n f o r m a t i o n a n d w h a t i n f o r m a t i o n i s n e e d e d in o r d e r to test the f o r e g o i n g h y p o t h e s e s . A t the ou tse t w e s t a t e d a t w o f o l d p u r p o s e of t h i s s t u d y : to l ook at a n a r e a of i m p o r t a n c e to b a n k m a n a g e m e n t , a n d to attempt to s h e d s o m e l ight o n a n a r e a of b a n k i n g not w e l l u n d e r s t o o d o u t s i d e of t h o s e in the b a n k s w h o a r e c o n - c e r n e d w i t h the c l e a r i n g g a i n a n d l o s s f i g u r e s . It i s h o p e d that both o b j e c t i v e s h e r e h a v e b e e n f u l f i l l e d . 8 8 . B I B L I O G R A P H Y B O O K S B a g e h o t , W a l t e r ; L o m b a r d S t r e e t ; K e g a n , P a u l , T r e n c h , T r u b n e r a n d C o m p a n y L i m i t e d , L o n d o n , E n g l a n d , 1 8 9 6 . G a l b r a i t h , J . A . ; T h e E c o n o m i c s of B a n k i n g O p e r a t i o n s ; M c G i l l U n i v e r s i t y P r e s s , M o n t r e a l , C a n a d a , 1 9 6 3 . H a c k e t t , W . T . G . ; A B a c k g r o u n d of B a n k i n g T h e o r y ; C a n a d i a n B a n k e r s A s s o c i a t i o n , T o r o n t o , C a n a d a , 1 9 4 5 . H a l m , G . N . ; E c o n o m i c s of M o n e y a n d B a n k i n g ; R i c h a r d D . I r w i n I n c o r p o r a t e d , H o m e w o o d , I l l i n o i s , U . S . A . J a m e s , P . C . ; T h e E c o n o m i c s of M o n e y , C r e d i t a n d B a n k i n g ; T h e R o n a l d P r e s s C o m p a n y , N e w Y o r k , U . S . A . , 1 9 4 0 . J a m i e s o n , A . B . ; C h a r t e r e d B a n k i n g in C a n a d a ; T h e R y e r s o n P r e s s , T o r o n t o , C a n a d a , 1 9 6 2 . K e y n e s , J„ M . ; A T r e a t i s e o n M o n e y - V o l u m e I; H a r c o u r t , B r a c e a n d C o m p a n y , N e w Y o r k , U . S . A . , 1 9 3 0 . K l i s e , E . S . ; M o n e y a n d B a n k i n g ; S o u t h - W e s t e r n P u b l i s h i n g C o m p a n y , C i n c i n n a t i , U . S . A . , 1 9 6 4 . M c l v o r , R . C . ; C a n a d i a n M o n e t a r y , B a n k i n g a n d P i s c a l D e v e l o p m e n t ; M a c M i l l i a n C o m p a n y of C a n a d a L i m i t e d , T o r o n t o , C a n a d a , 1 9 5 8 . N o r t o n , P . E . a n d J a c o b y , N . H . ; B a n k D e p o s i t s a n d L e g a l R e s e r v e R e q u i r e m e n t s ; L o s A n g e l e s , U . S . A . , 1 9 5 9 . O ' B r i a n , J . W . ; C a n a d i a n M o n e y a n d B a n k i n g ; M c G r a w - H i l l , T o r o n t o , C a n a d a , 1 9 6 4 . S a y e r s , R . S . ; M o d e r n B a n k i n g ; s i x t h e d i t i o n , C l a r e n d o n P r e s s , L o n d o n , E n g l a n d , 1 9 6 4 . 8 9 . S c h u l l , J o s e p h , 100 Y e a r s of B a n k i n g in C a n a d a ; T h e C o p p C l a r k P u b l i s h i n g C o m p a n y L i m i t e d , T o r o n t o , C a n a d a , 1 9 5 8 . G O V E R N M E N T P U B L I C A T I O N S B o a r d of G o v e r n o r s of the F e d e r a l R e s e r v e S y s t e m , W a s h - i n g t o n , U . S . A . ; D e b i t s a n d C l e a r i n g S t a t i s t i c s a n d T h e i r U s e ; c o m p i l e d by G e o r g e G a r v y , M a y 1 9 5 9 . R e p o r t of the C o m m i t t e e o n F i n a n c e a n d I n d u s t r y - 1 9 3 1 ; ( T h e M a c M i l l a n R e p o r t ) , K i n g ' s P r i n t e r , L o n d o n , E n g l a n d , 1 9 3 1 . R e p o r t of the R o y a l C o m m i s s i o n on B a n k i n g a n d C u r r e n c y in C a n a d a ; K i n g ' s P r i n t e r , O t t a w a , C a n a d a , 1 9 3 3 . R e p o r t of the R o y a l C o m m i s s i o n o n B a n k i n g a n d F i n a n c e ; Q u e e n ' s P r i n t e r , O t t a w a , C a n a d a , 1 9 6 4 . P E R I O D I C A L S A m e r i c a n E c o n o m i c R e v i e w ; V o l u m e 3 0 , S e p t e m b e r 1 9 4 0 , p a g e 5 4 7 ; " A Z e r o D e p o s i t R a t e " . J o u r n a l of F i n a n c e ; V o l u m e 8 , D e c e m b e r 1 9 5 3 , p a g e 4 0 7 ; " T h e I n t e r n a l D r a i n a n d B a n k C r e d i t E x p a n s i o n " . J o u r n a l of F i n a n c e ; V o l u m e 14 , S e p t e m b e r 1 9 5 9 , p a g e 4 0 5 ; " A N o t e o n B a n k E a r n i n g s a n d S a v i n g s D e p o s i t R a t e P o l i c y " . Q u a r t e r l y J o u r n a l of E c o n o m i c s ; V o l u m e 7 3 , N o v e m b e r 1 9 5 9 , p a g e 5 4 4 , " B a n k E a r n i n g s a n d the C o m p e t i t i o n f o r S a v i n g s D e p o s i t s " . T h e C a n a d i a n B a n k e r ; V o l u m e 7 1 , N u m b e r 2 , S u m m e r 1 9 6 4 . T h e C a n a d i a n B a n k e r ; S p e c i a l S u p p l e m e n t to the S p r i n g 1963 i s s u e , " S u b m i s s i o n s to the R o y a l C o m m i s s i o n o n B a n k i n g a n d F i n a n c e " . 9 0 . T h e J o u r n a l of the C a n a d i a n B a n k e r s A s s o c i a t i o n ; " T h e E a r l y H i s t o r y of C a n a d i a n B a n k i n g " , a c o n t i n u i n g a r t i c l e , O c t o b e r 1 8 9 6 , J a n u a r y 1 8 9 7 , A p r i l 1 8 9 7 , a n d J u l y 1 8 9 7 . W h i t e B u l l e t i n of the C a n a d i a n B a n k e r s A s s o c i a t i o n ; V o l u m e 7 , N u m b e r 3 , M a y 1 9 6 4 , " B a n k i n g S t a t i s t i c s " . W h i t e B u l l e t i n of the C a n a d i a n B a n k e r s A s s o c i a t i o n ; V o l u m e 7 , N u m b e r 6 , N o v e m b e r 1 9 6 4 , " S o m e C o m m e n t s o n B a n k D e b i t s a n d C l e a r i n g s a s E c o n o m i c I n d i c a t o r s " . 9 1 . A P P E N D I X " A " T h e f o l l o w i n g i s a l i s t of i n f o r m a t i o n that w o u l d b e n e e d e d in o r d e r to test the v a r i o u s h y p o t h e s e s a n d p r o p o - s i t i o n s p r o p o s e d in t h i s s t u d y . 1 . T h e d a i l y c l e a r i n g g a i n a n d l o s s f i g u r e s f o r e a c h i n d i v i d u a l b a n k e a c h d a y o v e r a c o n - s i d e r a b l e length of t i m e . 2 . T h e i s o l a t i o n of e a c h b a n k ' s t r a n s a c t i o n s w i t h the B a n k of C a n a d a t h r o u g h the c l e a r i n g s y s t e m . 3 . T h e b a l a n c e s h e l d by e a c h b a n k w i t h the B a n k of C a n a d a o n a d a i l y b a s i s , a n d the r e q u i r e d p r i m a r y r e s e r v e s f o r e a c h b a n k in e a c h m o n t h . T h e f o l l o w i n g e x h i b i t s i n d i c a t e the a t t e m p t s to s e r v e t h i s i n f o r m a t i o n . E x h i b i t #1 . C o p y of l e t t e r of M a y 2 7 t h , 1965 to T h e D i r e c t o r of R e s e a r c h , B a n k of C a n a d a . E x h i b i t #2 . C o p y of l e t t e r of J u n e 8 t h , 1 9 6 5 , to T h e D i r e c t o r of R e s e a r c h , B a n k of C a n a d a . 9 2 . E x h i b i t #3 . C o p y of r e p l y to E x h i b i t #2 d a t e d J u n e 17th , 1 9 6 5 . E x h i b i t #4. C o p y of l e t t e r d a t e d M a y 2 7 t h , 1965 to T h e C a n a d i a n B a n k e r s A s s o c i a t i o n . E x h i b i t #5 . C o p y of r e p l y to E x h i b i t #4 d a t e d J u n e 8 t h , 1 9 6 5 . E x h i b i t #6 . C o p y of l e t t e r d a t e d J u n e 11th , 1 9 6 5 , to T h e S e c r e t a r y , T h e C a n a d i a n B a n k e r s A s s o c i a t i o n . E X H I B I T 5 ( c o n t d . ) Debi ts to Indiv idual Accounts Vancouver G a i n Y e a r ( i n c l . New Westminste r ) ( $.000) or L o s s ($000) for Canada ($ 000) G a i n ($ 00d) 1955 11 ,071,650. / 710,496 166 ,537 ,863 . / 13 ,345,336 1956 13 ,296,552. / 2 , 2 2 4 , 9 0 2 198,376,666. / 31 ,838 ,803 1957 14 ,265 ,222 . / 968,670 212,235, 194. / 13 ,858,528 1958 13 ,967 ,573 . - 297,649 228, 173, 162. / 15,937,968 1959 15, 155,990. / l , 188,417 256 ,243 ,217 . / 28 ,070,055 1960 15,517,709 / 361,719 277,810,037. / 21 ,566 ,820 1961 17,766,910 / 2 ,249 ,201 302, 741,442. / 24 ,931,405 1962 19,602,381 / 1 ,835,471 335 ,798 ,492 . / 33 ,057 ,050 1963 21 ,679,909 / 2 ,077 ,528 371 ,824 ,999 . / 36 ,026 ,507 1964 25 ,239 ,274 / 3 ,559 ,365 430,263,557 / 58 ,438 ,558 T o t a l \

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