BANK OF CANADA
- What is BANK of CANADA?
- History of This Special Corporation
- The functionalities of the Bank of Canada
- Bank of Canada National Obligations
- What is Overnight Rate?
- Updates by BoC
- Uncertainty, changes, and adaptation
- Bank of Canada National Obligations
- The Chief of the Crown Corporation
- Conclusion
- Prime Rate History Chart
What is BANK of CANADA?
The Bank of Canada (BoC) is a crown corporation, i.e. owned and managed by the Federal Government of Canada, corporated and chartered under the Bank of Canada Act 1935. The central bank is headquartered in Ottawa, the capital city of Canada. It was a consequence of the economic conditions posed by the Great Depression. Per the aforementioned act, it has been formulated “to promote the economic and financial welfare of Canada”. To safeguard the nation's economic health, it conducts open market operations and takes other financial actions to exercise control over the country's monetary regulation.
History of This Special Corporation
Until the central bank opened its doors in 1934, several large private financial institutions were printing and circulating their currency; satisfying the needs of the Canadian citizens. Post Great Depression and World War II, the contraction in the money supply caused a heavy strain on the country's economic and social conditions. The then Prime Minister Richard Bedford Bennet summoned and headed a Royal Commission that suggested and eventually led to the creation of the
Bank of Canada. The new bank set the interest rate at 2%- low enough to promote the infrastructure, economic and social development of the country.
It would act as a banker to the federal government and manage public debt, loans, mortgages, etcetera. However, the bank wasn’t nationalized until 1938 through an amendment in the
Bank of Canada Act 1938.
In late 1978, the BoC rate hit a double-digit for the first time in the country’s history at 10.25% owing to the stagflation (a mixture of the high rate of inflation and unemployment) due to the sudden demand or supply shocks it was facing. The 1980s made the country see a severe recession mainly due to the Oil and Petroleum Exporting Countries (OPEC) embargo and a global oil crisis. Just when the economy started recovering in the 1990s and stabilizing towards the end of the 2000s, the Canadian economy saw another recession in 2014. The inflation target rate was set in motion during the recovery period itself. The 2014 recessions’ main cause is Canadas’ oil export-driven economy- the oil prices dropped by a shocking 60%! As a result, the interest rate dropped to a historic low of 0.75% in 2015.
The Bank has not been able to raise its rate above 1.75% in recent years due to continued low inflation. The years 2018 and 2019 saw a good deal of economic growth for Canada. However, the
COVID-19 has greatly impacted the Canadian economy, much like the rest of the world. The reduced purchasing power, joblessness, salary cuts, and the like have led to a condition of deflation. The rate now rests approximately near 0.25% and isn’t expected to change anytime soon.
The functionalities of the Bank of Canada
The bank is ultimately the banker’s bank (bank of all private banks of the country) as well as the government’s bank. It exercises complete control over the regulation of money and preserves the value of its currency. More comprehensively, at its core, the roles and responsibilities of the bank may be categorized as under:
- Monetary Policy- the monetary policy mechanism works with the help of two important instruments that the institution equips itself with- the inflation-control target (2%) and the flexible exchange rate or the floating dollar. The inflation-control target is revised every five years and is decided jointly by the federal government and Canada Bank. The flexible exchange rate is determined, keeping in mind the demand and supply conditions. This helps the economy adjust to internal and external shocks and independently sets its interest rates. Overall, it is usually a time-consuming process.
- Financial System- while performing other functions diligently, the bank also tries to continuously improve the citizens' general standard of living through its financial system. As part of this function, it. - lends money to private banks as per requirements, - assesses the financial stability of the nation from time to time and takes corrective action accordingly, - collaborates with external agencies and institutions to further its interests, - acts as the apex authority for crucial Financial Market Infrastructures (FMI), - Financial System Research Centre (FSRC) researches, analyses, and informs policies.
- Currency- as you might have already guessed, the bank has the sole responsibility of printing and circulating currency notes. In addition to that, it ensures public trust in the currency and preserves the value of the same by regularly authenticating and verifying the notes. It also oversees its destruction and renewal. These notes are designed in a manner to ensure security features in them, making it difficult to counterfeit them.
- Funds Management- apart from the management of its funds and those of the government, the bank also has external clients whose funds it is responsible for managing. It has the country’s foreign exchange reserves and other than being a fiscal agent for the government; it also provides routine banking services to the designated payment system participants. Transactions are carried out in CAD with important FMIs to ensure the overall stability of the financial structure of the nation. Specific important crown organizations enjoy the facility of provision of CAD cash and securities accounts with the central bank itself.
Bank of Canada National Obligations
The Bank of Canada carries out its obligations in three fundamental ways:
- Interest rates the rate charged by the central bank has an indirect but large impact on the amount and cost of money held by individuals, groups, and businesses. These rates also affect the Canadian Dollar exchange rate as foreign investors lookout for higher rates to increase their share in Canadian investments.
- Money supply the supply of money and credit in the economy is controlled by this institution and has a direct impact on the overall economic activity conducted. This results in inflation or deflation of the economy.
- Moral suasion as the banker’s bank, the central bank has the power to influence private banks to maintain their moral ground, when it feels necessary. Time and again, BoC applies pressure on these companies according to its research and analysis of their performance.
What is Overnight Rate?
The Bank carries out monetary policy by influencing short-term interest rates. It does this by raising and lowering the target for the overnight rate.
The overnight rate is the interest rate at which major financial institutions borrow and lend one-day (or "overnight") funds among themselves; the Bank sets a target level for that rate. This target for the overnight rate is often referred to as the Bank's policy interest rate.
Changes in the target for the overnight rate influence other interest rates, such as those for consumer loans and mortgages. They can also affect the exchange rate of the Canadian dollar.
In November 2000, the Bank introduced a system of eight fixed dates each year on which it announces whether or not it will change the policy interest rate.
Updates by BoC
On the 9th of December, 2020 the Bank of Canada maintained the target overnight rate (discussed later in the article) at an all-time low of 0.25% and gave hints that it might remain unmodified until the economy shows positive signs of revival. 0.25% is the lower bound rate. The prime and variable mortgage rates are expected to remain constant too. The consumer price index (CPI) is expected to be approximately 0.2% in the year 2020 and not rise above 2% till the year 2023. The central bank had earlier initiated a quantitative easing (QE) program to prod a rather slow economy. As part of this program, it is purchasing bonds worth $4 billion every week. This step intends to increase asset purchase amongst the citizens and gradually revive the economy. The apex body holds a total of eight meetings per year in and this was the last meeting for the year 2020. The meeting schedule for the year 2021 remains undecided as of now.
Governors’ take on negative interest rate- negative interest rates, as the name suggests, are when the borrower is credited with the interest amount rather than getting debited. It is done to incentivize the public so that they keep their cash with the banks rather than withdrawing it. While the central banks of several other countries have experimented and controlled it time and again, the governor of BoC has stated that Canada will not be experimenting with negative interest rates due to the negative consequences it usually has on the private financial institutions.
Uncertainty, changes, and adaptation
The bank commits to maintaining inflation at 2%- a mid-range between 1-3%, their target inflation rate. It reviews the rate eight times a year and considers various factors in the process. The bank has pre-determined regulations and policies that help keep inflation at a healthy, controlled rate. This improves its credibility with private banks and the general public at large.
Private banks may borrow and lend funds amongst each other at an ‘overnight’ interest rate to cover their daily transactions. This is conducted electronically through a system called the Large Value Transfer System (LVTS). This target for the overnight rate is determined by the central bank and is known as the policy rate. It is determined keeping in mind the prevailing market conditions and future predictions. A change in these rates consequently leads to the amount of cash borrowing, spending, and holding with the general public. The central bank lends only in the capacity of the lender of the last resort when the rate is high and cash consequently, low. Opposing that, when the rate is relatively low, and there is surplus cash, the private banks may lend money to the central bank. For obvious reasons, however, the central bank tries to keep the overnight target rate as close to the ideal rate, i.e. 2% as possible.
How the Overnight Rate Works- private banks in Canada have a friendly relation with them which means they easily borrow and lend money to each other. None of them prefer to hold surplus cash and hence, lend it out at a specific rate of interest. This rate of interest is known as an ‘overnight rate’ as it is borrowed overnight. This overnight rate is determined by the apex financial institution of the country- the Bank of Canada. When there is surplus cash with these institutions, they lend it to the central bank. In case of a situation of cash deficit, BoC acts as the lender of the last resort i.e. lends money to them. In this manner, BoC exercises absolute control over the lending and borrowing amongst the private financial institutions and makes the overnight interest rate system work successfully.
Overnight rate forecasts for the near future- the overnight rate had fallen to a record low of 7.5% in March this year owing to the COVID-19 but the third quarter had slightly better results in store for the citizens of Canada. As already mentioned, the rate has been unchanged at 0.25% and will remain the same till the end of the year 2022. As the forecast period increases, the uncertainty of predictions increase. 2023 onwards, the predictions are unclear but the rate might increase to a maximum of 1.75% by 2025 depending on the conditions at the time. The federal reserves and central banks of most other European and Asian countries show that it would take the respective countries’ economies at least late 2022 to recover. The more delayed the recovery will be, the longer 0.25% is expected to remain as the overnight interest rate.
Bank of Canada National Obligations
The Bank of Canada carries out its obligations in three fundamental ways:
- Interest rates- the rate charged by the central bank has an indirect but large impact on the amount and cost of money held by individuals, groups, and businesses. These rates also affect the Canadian Dollar exchange rate as foreign investors lookout for higher rates to increase their share in Canadian investments.
- Money supply- the supply of money and credit in the economy is controlled by this institution and has a direct impact on the overall economic activity conducted. This results in inflation or deflation of the economy.
- Moral suasion- as the banker’s bank, the central bank has the power to influence private banks to maintain their moral ground, when it feels necessary. Time and again, BoC applies pressure on these companies according to its research and analysis of their performance.
The Chief of the Crown Corporation
The chieftain of the apex financial institution of Canada is known as the governor of the bank. He or she exercises control for a seven-year tenure which means that the bank's board of directors appoints every seven years, a new governor to the bank upon the approval of the governor in council. This governor then also assumes the role of the chief of the board of directors. The current presiding governor is Tiff Macklem, who is responsible to the federal government for all of the banks' operations through the minister of finance.
The Bank of Canada works in close coordination with the Federal Department of Finance. The deputy finance minister sits on the governing council but does not get a vote in it. While the Bank does submit a yearly report concerning the functioning of the bank, the governor is required to answer all questions posed by the House of Commons Standing Committee. The governor is also required to consult the finance minister regularly about the general monetary policy.
Conclusion
In conclusion, we may say that for the success of any country's economic system, it is of paramount importance that its central bank can preserve the value of its currency and the trust of the public in the said currency. It is also important that the economy is stable and predictable for most parts of the year. The Bank of Canada is accountable to the public regarding all the aforementioned functions and many more, through its comprehensive framework and other national and international operations.
