HOW THE CASH RESERVE
REQUIREMENT WORKS

Let us suppose that the Government of Canada wishes to increase the money supply by $30 billion.

Let us further suppose that the Cash Reserve Requirement (CRR) is 10%.

1. The Canadian Government sells $3 billlion in T-bills to the Bank of Canada.

2. This $3 billion of 'high powered' money (money created by the Bank of Canada) will work its way into the commercial banking system. For the sake of simplicity, let us say that it is deposited in commercial bank A.

3. Bank A may loan out 90% ($2.7 billion) by making loans to new accounts, let's say, through bank B. $2.7 billion worth of deposits will now occur in bank B, which will demand $2.7 billion from bank A. On transferring this amount, bank A will be left with the required 10% Cash Reserve of $300 million.

4. Bank B will now make new loans by creating new accounts equal to 90% of 2.7 billion ($2.43 billion); and so the money supply increases by an additional $2.43 billion. The loans of bank B will be spent by cheques (as was the case between A and B) resulting in new deposits of $2.43 billion in bank C. When bank B transfers this amount to bank C, bank B will be left with the CRR of 10% of $2.7 billion: $270 million.

5. Bank C may now make new loans by creating new accounts equal to 90% of $2.43 billion ($2.187 billion), eventually retaining a CRR of $243 million. And so on.

At the limit, the money supply will have increased by 10 fold. The initial $3 billion created by the Bank of Canada will have increased to $30 billion- with $27 billion having been created by commercial banks- to their profit.

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COMMENTARY

If signs of inflation emerge during this process, the CRR may be increased to reduce the creation of more of the money supply; or, conversely, should the economy show signs of restricting, the CRR could be reduced.


The CRR is inversely proportional to the number of times the bank can reloan money. If the CRR is 2%, commercial banks may loan the money out 50x; if it is 25%, it may only loan it out 4x.


At the moment there are no CRR in Canada! Technically, commercial banks could loan out the same money- an infinte number of times. Canada did away with the CRR in 1991-93.


Such a situation is truly preposterous. Why should commercial banks be 'given' such limitless powers? You might as well give them a printing press and be done with it!


CRR need to be (i) reinstated! (ii) high, to reduce the unconscionable leverage commercial banks now have. Let us say- 2:1 (50%), whereby the same amount may only be loaned out 2x; or 3:1.


Canadian banks serve a useful purpose for the private sector, and should be limited to activities in that area, through the 3-6-3 Rule: 3% interest on savings; 6% ceiling on loans; knock off at 3pm for Golf.