FINA Committee Meeting

STANDING COMMITTEE ON FINANCE

COMITÉ PERMANENT DES FINANCES

EVIDENCE

[Recorded by Electronic Apparatus]

Wednesday, May 12, 1999

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[English]

The Chairman (Mr. Maurizio Bevilacqua (Vaughan—King—Aurora, Lib.)): I'd like to call the meeting to order and welcome everyone here this afternoon.

As you know, in accordance with the order of reference of the House of Commons of Tuesday, April 13, 1999, the committee now resumes a study of Bill C-67, an act to amend the Bank Act, the Winding-up and Restructuring Act, and other acts relating to financial institutions, and to make consequential amendments to other acts.

We have the pleasure to have with us this afternoon Mr. Gennaro Stammati, chairman of the schedule II foreign banks executive committee of the Canadian Bankers Association and president and CEO of Banca Commerciale Italiana of Canada. With him is Mr. Bill Randle, assistant general counsel, foreign banks secretary; and Harvey Naglie, president, BT Bank of Canada.

Welcome. As you know—you've been here before—you have approximately five to ten minutes to make your opening remarks. Thereafter, we will engage in a question and answer session. Welcome, Mr. Stammati.

Mr. Gennaro Stammati (Chairman, Schedule II Foreign Banks Executive Committee, Canadian Bankers Association): Thank you, Mr. Chairman. First of all, let me congratulate you for your good Italian pronunciation.

[Translation]

Thank you, Mr. Chairman, members of the committee, for this opportunity to address you today.

My name is Gennaro Stammati and I am the President and CEO of the Banca Commerciale Italiana of Canada. I am also the Chairman of Schedule II, Foreign Banks' Executive Committee. With me this afternoon are Mr. Bill Randle, Assistant Counsel for the Canadian Bankers' Association, and Mr. Harvey Naglie, President of the BT Bank of Canada. Together we represent all foreign banks in Canada that belong to the Canadian Bankers' Association.

[English]

Almost all the foreign bank subsidiaries currently active in Canada are members of the Canadian Bankers Association. Our committee exists to represent their interests within the association and present their views on matters that affect their activities and operation in Canada.

You will no doubt be pleased to hear that I intend to keep my opening remarks fairly short today, within the timeframe you just dictated to me, Mr. Chairman.

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My colleagues and I want to thank you for the invitation to appear before your committee and the opportunity to comment on Bill C-67. As the committee is well aware, for many years the foreign bank community has recommended that foreign banks be permitted to operate in Canada as direct branches of their parent institutions. We believe all sectors of the financial and business communities, as well as all the major political parties, media, and general public support foreign bank branching and agree it will be very beneficial to Canadians.

Our members were obviously pleased, therefore, when the federal government tabled Bill C-67 on February 11, 1999. We also have welcomed the willingness of Minister Peterson and officials to consult with us on the branching regime. We appreciate the strenuous efforts they have made to ensure that foreign bank branching will bring as much competition as possible to the financial services industries in Canada.

When we appeared before this committee a few months ago, during its review of the MacKay task force report, and discussed foreign bank branching, we noted that to be truly competitive in the Canadian financial services marketplace and bring the fullest benefit to Canadian companies, consumers, and the economy, it was imperative that the branching proposals include measures to accommodate the conversion of a foreign bank subsidiary to a foreign bank branch.

Once Bill C-67 was tabled in February, we discussed this matter with the Department of Finance. We were naturally pleased with the announcement yesterday by the minister that the government has decided to provide traditional tax rules that will allow a foreign bank subsidiary to transfer its business to a foreign bank branch on a tax-deferred rollover basis. This measure will remove a very negative impediment to the conversion of a subsidiary to a branch, and will encourage foreign banks to provide greater competition and innovative financial products and services to the Canadian public.

Minister Peterson also noted yesterday that the government would be recommending a number of other amendments to Bill C-67, including allowing full-service branches to hold certain types of deposits, as prescribed by regulations.

We feel these changes are very positive and demonstrate the commitment of the government—one we obviously share—to ensure the foreign bank branching regime works for both the government and the foreign banks and, most important of all, brings maximum benefit to Canadians.

In conclusion, I would like to emphasize two things. First, my colleagues and I strongly endorse the changes to Bill C-67 proposed yesterday by Minister Peterson. Second, we wish to express our appreciation for the consistent support of foreign bank branching by the members of the House finance committee and acknowledge their key role in this initiative.

We look forward to the speedy passage of Bill C-67 and being able to use the ability to establish foreign bank branches to bring greater investment and competition to Canada.

[Translation]

My colleagues and I would be honoured to answer your questions, Mr. Chairman.

[English]

The Chairman: Thank you very much, Mr. Stammati.

We'll now hear from Mr. Epp. Do you have any questions?

Mr. Ken Epp (Elk Island, Ref.): Are these other gentlemen here in support of Mr. Stammati?

The Chairman: I think they're in full agreement with what Mr. Stammati said.

Mr. Ken Epp: I would like to see them argue with each other a bit.

Voices: Oh, oh.

Mr. Ken Epp: I thank you for your very short and succinct presentation.

I take it the foreign banks you represent are ready to come to give us some competition and lower prices than the present Canadian banks on all the banking services. Is that true?

Mr. Gennaro Stammati: Let me answer this way. Foreign banks already present in Canada will take great advantage of this bill, in order to convert their operations into full branches. This will give more flexibility to their operations and therefore they will really try to be more competitive and offer more choices to Canadians. We also believe this bill will allow banks not yet established in Canada to come to Canada and also bring their expertise and additional services.

So we feel this bill overall will serve better the Canadian market and allow for more competition in this country.

Mr. Ken Epp: Are you concerned at all about some of the limitations that are still in place with respect to the difference between foreign banks and our domestic banks?

Mr. Gennaro Stammati: As you may imagine, we believe this is a first step toward a greater reform of the financial system of Canada. We were pleased when we were in front of this committee to hear the recommendations of the MacKay committee. If you allow us to also be part of the discussions around this new legislation to be put through, we will be more than glad to bring you our experience.

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Mr. Ken Epp: In the past you had some concerns about the bill. What is Mr. Peterson's title?

The Chairman: He's the Secretary of State for International Financial Institutions.

Mr. Ken Epp: I keep wanting to call him a junior minister. That's not very fair, is it?

You indicated in your presentation some of the things Mr. Peterson, the Secretary of State for International Financial Institutions, has announced. Do you presently have further concerns about this bill?

Mr. Gennaro Stammati: All the major concerns we had have been addressed by the changes the government announced. Foreign banks might have expected different wordings here and there, but overall these all reflect the spirit of our conversation. So I believe, in all fairness to the teamwork in these situations, we are being given the chance to respond to the original bill and bring forward our cases. The major concerns have been addressed.

Mr. Ken Epp: I'm sure your membership doesn't include only foreign banks. Do you also represent present Canadian banks in your association?

Mr. Gennaro Stammati: No. The Canadian Bankers Association is the association that represents the industry. However, it is composed of two groups. There are the so-called schedule I banks, or the domestic banks. The schedule II banks are the foreign banks. We represent the schedule II banks and I chair the executive committee of the schedule II banks.

Mr. Ken Epp: So have you talked to the schedule I people?

Mr. Gennaro Stammati: We have talked to the schedule I people, and we are pleased that they have no opposition and support this legislation for us.

Mr. Ken Epp: Can you say that officially?

Mr. Gennaro Stammati: I can say that officially, because this also was stated by the chairman of the Canadian Bankers Association.

Mr. Ken Epp: We would hate to bring in a new bill that brings foreign banks in here and then have our own banks declare war on us or something.

Mr. Gennaro Stammati: I'm glad to say that in this case it was a truce, not a war.

Mr. Ken Epp: Okay. Assuming this bill is passed, how long will it be until you are clamouring at our door for amendments?

Mr. Gennaro Stammati: We are satisfied that the bill, as it has been presented, is fair. We are looking forward to working with you on the next piece of legislation that will deal with the MacKay recommendation.

Mr. Ken Epp: Are you satisfied with the limitations on the size of deposits? Should it be higher or lower?

Mr. Gennaro Stammati: Given the fact that the foreign banks will not be competing with the schedule I banks in the retail business, we feel that the threshold that has been fixed, together with the modification and clarification that has been given, is a fair threshold to give us the possibility to work very effectively in the field in which we are specialized.

Mr. Ken Epp: Do you foresee that in the next five or ten years—let's keep it to that, at least—there will be a push for foreign banks to get into the domestic market?

Mr. Gennaro Stammati: That depends on the openness the MacKay recommendations bring to this market. I believe banks are motivated by satisfying their existing customers and exploring new markets. If this market is going to be flexible, as MacKay is recommending, we will definitely be glad to see other banks coming over here.

Mr. Ken Epp: Do you think that might develop in the next five to ten years?

Mr. Gennaro Stammati: I am positively thinking so.

Mr. Ken Epp: You're positively thinking so. That's called changing your words in the middle of a sentence, isn't it?

Mr. Gennaro Stammati: No. Let's say if you spoke Italian with me, I would not speak with any hesitation, but I was trying to find the right word in English.

Mr. Ken Epp: Yes, I know the business well. Thank you.

Thank you, Mr. Chairman. I think those are all my questions.

The Chairman: Ms. Bennett.

Ms. Carolyn Bennett (St. Paul's, Lib.): Obviously there was an appetite for this bill. Were there any foreign banks that were actually at the point of maybe even considering leaving Canada if we hadn't done this? Are you aware of any new banks that might want to come into Canada because of this bill?

Mr. Gennaro Stammati: Of course, specific strategies by the banks are sometimes kept confidential and not always communicated to the public. The fact that the number of schedule II banks decreased from more than 59, or whatever, to the present 42, out of which probably 10 are just paper companies and not really active in this market, in my opinion is already proof that there was a limitation in the flexibility of their services. I believe that these documents indeed should give to them the expected possibility to be more effective in this market.

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About the new players to come to Canada, although no one has contacted me particularly and requested a full explanation of the inside out of the Canadian legislation, I know there are banks that are really expecting that Canada will move to a branch regime, because Canada among the industrialized countries was the only one that did not have this possibility. I'm sure that this one will permit other banks to come to Canada.

Ms. Carolyn Bennett: Thank you.

The Chairman: Mr. Limoges.

Mr. Rick Limoges (Windsor—St. Clair, Lib.): We have here that the foreign banks will not be permitted to maintain both the foreign bank subsidiary and a lending branch except during a short conversion period. I'm told that the foreign banks want to be able to operate both in perpetuity. Really, what you're looking for is to be treated more like the schedule I banks. Is that the trend we're setting here? What are your comments with regard to these restrictions?

Mr. Gennaro Stammati: Let me say that the two different branches that have been designed respond to a different vision. One is mainly to allow banks to be lending vehicles, and therefore the restriction is mainly on their funding. The other one is a more complicated scenario where banks are more allowed to have a larger latitude. Of course you may imagine that in any environment more openness and more flexibility is the one that is being desired by all the players. We understand that the government at this moment prefers to make a limitation on the possibility of operating both of them together for, as you said, a long period of time, only because at this very moment there might have been not a fair treatment with the domestic banks. Therefore, they are reserving to revise this particular item when the MacKay committee recommendation has been fully analysed by the government.

As far as whether or not foreign banks would like to be equal to domestic banks, I would say yes and no, in the sense that we would like to be effective in the market where we can give value added. There are of course segments in which we might not be effective players because it is difficult to penetrate areas such as the countryside of a country that's not your own country, where you do not have infrastructure and so on and so forth.

So probably foreign banks would like to be treated equally in terms of latitude of operation, then within their latitude they will choose what is the best field in which they can be effective and competitive.

Mr. Rick Limoges: Thank you.

The Chairman: Any further questions?

Mr. Ken Epp: I have some questions, but not for these gentlemen. I have some for our own people who come later.

The Chairman: Okay.

Mr. Stammati, on behalf of the committee I'd like to thank you very much for your presentation and also for bringing to our attention a number of issues related to this particular bill. You certainly helped our committee, and will help our committee make the changes required to improve the bill. As always, you've been very helpful with the study of MacKay and your input has been certainly a valuable component of our study. Thank you.

Mr. Gennaro Stammati: Thank you, Mr. Chairman. Thank you, ladies and gentlemen.

The Chairman: Bon fortuna.

Mr. Gennaro Stammati: Grazie.

The Chairman: I'm going to suspend just for five minutes and then we'll come back with Mr. Mike Bradfield, professor of economics, Dalhousie University.

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The Chairman: I'd like to call the meeting to order.

As I did previously, I'd like to welcome Mr. Mike Bradfield, an economist and professor in the Department of Economics, Dalhousie University.

As you probably know, you have around five to ten minutes to make your presentation, and thereafter we'll engage in a question and answer session. Welcome.

Mr. Mike Bradfield (Individual Presentation): [Professor] Thank you. Thank you for this opportunity to speak to the committee.

I'm focusing on just one part of the bill. It was interesting to hear the previous discussion where the panel was asked if they accepted the reserve requirements and they said they did, because it is the reserve requirement I'm focusing on in this brief.

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Requiring a reserve of $10 million or 5% on the liabilities is effectively imposing reserve requirements on the foreign banks that are not imposed on domestic banks, the schedule I banks. This puts the foreign banks at a competitive disadvantage, because Canadian banks have operated with zero requirements since 1992 and have desired reserved requirements—what they actually wish to have rather than what they are required to have—of roughly 1%. So Canadian banks can lend out 99% of the money they get in, whereas the foreign banks are restricted to 5% for the larger banks or to holding $10 million. If a bank has only $50 million in deposits, $10 million is effectively a 20% reserve requirement, which is quite high. Obviously, they plan to be much larger.

I should note that in the middle of page 2 I have “because of the important function of deposits”. That should read “because of the important function of reserves”.

What I argue in this paper is that reserves are important for two of the functions of the Bank of Canada: monetary control and debt management. Therefore, what we should do is give a level playing field to the foreign banks by keeping the 5% reserve on them but reintroducing the reserves of 5% on schedule I banks as well as on other financial intermediaries. The reason for that is because of the important functions of the reserves.

In the good old days when reserves were set at 10% for the primary reserve, many people thought that was there to protect the customers so that the banks had the money on hand to pay out if people came in and demanded it. In fact, that was not the case. Those reserves were in place in order to give the Bank of Canada control over the money supply.

The basic proposition is that the reserve ratio—the ratio of the cash reserves to deposit liabilities—determines what we call the money multiplier; that is, when new reserves are put into the private banks, how much they can expand the money supply through their lending and relending process. So when you have a required reserve of 10%, the money multiplier is the reciprocal of that, or 10. The banks would tend to operate somewhere around that figure of 10. They might let it slide up to 11, which would then lower the multiplier to roughly 9, or they might squeeze it a bit and go a bit below, and that would then raise the money multiplier. But basically, you had a range around 10, somewhere between 9 and 10.5.

The Bank of Canada has a number of responsibilities that may be contradictory. In managing the economy they may wish to raise interest rates in order to slow the economy down. That contradicts their function as the fiduciary agent for the Government of Canada with the responsibility of managing the government's debt, because when interest rates rise it becomes more expensive to service the debt.

It becomes more expensive to service the debt for two reasons. Firstly, with rising interest rates, obviously the outstanding debt has ultimately to be rolled over and pay the higher rate. But secondly, the monetary policy for raising the interest rate is one of selling bonds to the public through an open market operation. What that means, then, is that the proportion of the debt held publicly increases. The reason that's significant is the higher the proportion of the debt held by the Bank of Canada, the lower the cost of the debt, simply because debt held by the bank is essentially interest-free, since the interest is returned to the government because the bank is not allowed to make a profit. So the point is that in open market operations that raise interest rates, it has a twofold impact on the cost of the debt: first, the rise in interest rates themselves, and second, the increase in the percentage of the debt that's held external to the Bank of Canada.

The second point is that the money multiplier, as suggested earlier, being a reciprocal of the reserve ratio, then changes when the reserve requirements go down. So when we go from a reserve requirement of one-tenth, with a multiplier of 10, down to a removal of reserve requirements in the banks operating with an effective reserve of around zero, then the money multiplier increases to the figure of 100.

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That's highly significant in terms of the Bank of Canada's debt management, because it means that to get any given increase in the money supply, to get a given change in the lowering of the interest rate, the Bank of Canada, with a money multiplier of 100, now buys up one-tenth of the amount of government bonds that it would have earlier, when the reserve requirement was 10%. So what it means then is that to achieve their monetary goals by expanding the money supply, if only to accommodate a growing economy, the Bank of Canada now is buying one-tenth as much government debt as they did before.

So what you have had going on in the last two decades or more in Canada is with diminishing reserves and finding reserves down to the effective rate of 1% now, the Bank of Canada has been forced to hold less and less of the federal debt. So you see that from the 1960s, the Bank of Canada has gone from holding more than 20% of the debt, down now to holding roughly 5% of the debt. At the same time, what's happened is that foreign holdings have reversed positions with the bank, from about 3% in the early 1960s to over 20% now.

So what's happened with the removal of the reserve requirements is that the Bank of Canada has essentially boxed itself into a situation where to run its monetary policy seriously affects its ability to control the money management side of it and increases the cost of servicing the debt.

I have a table in here, which is a fairly arbitrary table in the sense that I start in 1992—I could have started much sooner. I assumed the T-bill rate, 91-day rate, for an interest rate, just as an exercise. It's a fairly conservative table in that sense. What it shows is that because the Bank of Canada has not been keeping up with its 20% holding of the government's debt, over that 12-year period there have been an additional roughly $53 billion in interest paid out because of this policy. What I'm suggesting to you in this brief, then, is that the Bank of Canada has been negligent with respect to its money management responsibility, its debt management responsibilities, because it has, in effect, incurred a huge interest cost on the debt by having gone to these reduced reserve requirements.

The second thing about the reduced reserve requirement is that it makes it harder for the Bank of Canada to control the money supply, because now with 1% reserves, if the banks shift that reserve around a bit—if you use the same percentages as when there was a 10% reserve requirement—the money multiplier will change between 91 and 105. So that means you've got a big gap of 14—bigger than the original money multiplier—where the money supply can be affected simply by the banks deciding they want to push their reserves in one way or another.

The point I'm making here is simply that it becomes more difficult for the Bank of Canada to know what to do in its own policies because of that huge range of effect due to the size of the money multiplier. So the gist of the paper is that because the reserve requirement helps the bank, both in terms of monetary control and debt management, what we ought to do is take the example of this bill—of the 5% reserve requirement on foreign banks—and reintroduce requirements on the schedule I banks. And since the schedule I banks were relieved of the requirements to put them in the same position as other financial intermediaries, it should be extended to those other financial intermediaries.

Thank you.

The Chairman: Thank you, Mr. Bradfield.

We'll go to Mr. Epp.

Mr. Ken Epp: Well, thank you.

I'm glad your credentials say that you're an economist and a professor, because I have some serious questions here that we need enlightenment on. I'm not an economist, so this is tough for me to get hold of. Are you telling me that Canadian chartered banks can lend out more money than they have?

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Mr. Mike Bradfield: You have to be careful on this one. Any individual bank, if it gets a deposit of $100, can and will right now lend out $99 and keep $1 in the bank or as a deposit with the Bank of Canada. The whole system, however, can lend out to multiples, because if you deposit $100 and I walk in and I borrow $99, and I buy something with it, that $99 is going to go back into the banks as a new deposit and then they will lend out 99% of that, and the process just keeps going. As long as the money keeps recycling through the banking system, the system as a whole creates a money multiplier, even though any individual bank will say it doesn't do that, that they lend out only 99%.

Mr. Ken Epp: So actually it could multiply without limit then?

Mr. Mike Bradfield: Well, no. If the banks went down to a zero reserve, held no money in the banks, then yes, the money multiplier would be infinite. But in fact, because they hold roughly 1% reserves, the value of the money multiplier is 100. It's strictly a function of the amount of reserves they hold right now either because that's what they desire for operating purposes or because they're required to by the Bank Act, as in the case of the foreign banks.

Mr. Ken Epp: Would it be your recommendation... I know you talk about both of these things here. You're talking about equality between the foreign banks and the domestic banks. First of all, I think your foreign banks are not your regular schedule I banks, so you're talking about banking in a different sphere, if I can use that word, from the ordinary guy just going in and borrowing money. But obviously the schedule II banks lend money to big businesses, big corporations, right? This is what they do.

Mr. Mike Bradfield: That's how all banks make their money.

Mr. Ken Epp: Yes, but I mean the schedule II banks are fairly limited. They can't take a guy like me off the street.

Mr. Mike Bradfield: But they are still in the same position—taking deposits and lending them out. This bill puts them in the position of having to keep 5% reserves, and all I'm saying—

Mr. Ken Epp: So is it your contention that if a foreign bank wants to make a loan of say $1 million to a big corporation in Canada, they would have to bring in from say the United States $1,100,000—deposit $100,000 of it? Is that your understanding—so that they can lend out $1 million?

Mr. Mike Bradfield: If they have a 5% reserve requirement, it means if they have a deposit of $1 million, they can only lend out 95% of that.

Mr. Ken Epp: Yes.

Mr. Mike Bradfield: Okay.

Now, if they bring in their own capital funds, then I assume this reserve requirement is only against their deposit liabilities, not against the equity side of their statements. It's only on their deposits.

Mr. Ken Epp: That means Canadian deposits.

Mr. Mike Bradfield: Yes.

Mr. Ken Epp: But it doesn't say that in the act, does it?

Mr. Mike Bradfield: The act, I think, says they require a reserve on their Canadian liabilities, which I assume means deposit liabilities.

Mr. Ken Epp: No, it doesn't say that. It says “an authorized foreign bank shall maintain on deposit in Canada with a Canadian financial institution”, presumably one of our local banks, “unencumbered assets of a type approved by the superintendent, the total value of which, determined in accordance with the accounting principles... shall equal...” and then they go into these numbers, a minimum of $100,000 or the greater of $10 million or 5%.

I don't really understand what you're driving at here. I think the bill is talking about capital of the bank. It doesn't talk specifically about deposits, does it? It's in lieu of capital.

Mr. Mike Bradfield: As I read the bill, it's talking about keeping reserves against... Well, it says in subparagraph 582(1)(b)(ii): “five per cent of the liabilities of the authorized foreign bank in respect of its business in Canada.” And normally the chief liabilities of banks are their deposit liabilities. So that suggests to me they're talking about deposits made in Canada.

The point I'm making is that the reserve requirement that's specified here should be returned, reinstituted, for all banks.

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Mr. Ken Epp: In other words, your thesis is null and void, because these guys can come in with totally foreign capital, not taking any Canadian deposits, and then what you're saying here doesn't apply to them. Therefore, they're competitive.

Mr. Mike Bradfield: If they're operating strictly off their capital, yes. But if you look at bank statements, banks don't operate off their capital. Banks operate off their deposits.

Mr. Ken Epp: Okay, but if they bring in their deposits, not taken from Canadians, this wouldn't apply.

Mr. Mike Bradfield: I'm not sure how that would be interpreted.

Mr. Ken Epp: I'm not sure either.

Mr. Mike Bradfield: I suspect you're correct on that, but what I'm doing is saying there's a still larger point, and that is that reserve requirements play two very crucial roles in Canada, both in monetary control and in debt management. Therefore, we should be reintroducing them for all banks and all financial intermediaries.

Mr. Ken Epp: So your suggestion, just so that I'm clear, is that instead of saying that foreign banks also should have a zero-reserve requirement, like Canadian banks, you would prefer that this thing in the act apply also to Canadian banks. That's what you would like to see.

Mr. Mike Bradfield: Exactly. When the Bank of Canada removed the reserve requirements, they said it was a tax on the banks that other financial intermediaries, such as trust companies, didn't have to pay because they didn't have a reserve requirement. Well, the $52 billion in extra interest payments because of that suggest to me that there's a huge tax on the Canadian taxpayer, much larger than what the banks were implicitly paying through having to carry reserve requirements.

The function of the Bank of Canada is not to remove taxes from the private banks. The function of the Bank of Canada is to manage the economy and to be the fiduciary agent of the Government of Canada, managing its debt. What I'm suggesting with my numbers is that in fact the bank, by paying inattention to this so-called tax on the banks and not getting rid of it by expanding the reserve requirements to all financial intermediaries, has effectively protected the banks from what they call a tax at great cost to the Canadian taxpayer.

Mr. Ken Epp: Okay, I think I understand that. I taught for 31 years—in a different field. I was teaching engineering math, which makes a little more sense than economics.

Mr. Mike Bradfield: Anything makes more sense than economics.

Mr. Ken Epp: I used to tell my students that there's no such thing as a dumb question, that if you don't understand something, you're asking it because you don't understand it; therefore, I will treat it with respect. Please put me into that category right now. Where does money come from?

Mr. Mike Bradfield: Money right now is virtual money.

Mr. Ken Epp: Who creates it? Where does it come from?

Mr. Mike Bradfield: It depends on whether you're talking to me or Gordon Thiessen. The base for the money stock is the currency the Bank of Canada prints. That then gets into the chartered banks, and they lend and relend and relend it again. And the money multiplier takes over so that the bulk of money, by normal definitions—and there are several definitions of money—is in fact not the currency we carry in our pockets or have under the bed, but rather our chequing accounts.

Mr. Ken Epp: In fact I read that the total sum of Canadian notes and coins is about 5% of our total capital.

Mr. Mike Bradfield: It depends on which definition of money you use. There are several.

Mr. Ken Epp: Does the Bank of Canada create that money? Do the individual banks create it? Where does it come from?

Mr. Mike Bradfield: This is the business about the open market operations. When the Bank of Canada buys a bond, for instance, it is paying out a cheque, which is the equivalent of printing money. If General Motors sells $100 million worth of bonds to the Bank of Canada, it takes that $100 million cheque and it deposits that in its bank. So its deposit goes up $100 million and the bank now has a $100 million increase in reserves. It says we don't have to keep all that cash against the deposits; we can lend 99% of it out. So that gets lent out, gets deposited back, and that creates the money multiplier. But it's that base of money from the Bank of Canada that generates the process upon which the private banks build.

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Now, I think in testimony before this committee several years ago Governor Thiessen said the textbook example of the money multiplier doesn't work any more. He argued that in fact it's simply the declaration of the bank rate—i.e., the borrowing rate for private banks—if they want to build up their reserves over the short term, and that this is sufficient by setting that overnight rate. Then that determines, again, a base rate, and then the term structure of interest rates is built on that base.

I would argue that even though in the short run that's true, in the long run the Bank of Canada has to have the complementary open market operation to back up what it's doing with the discount rate or he won't get the change in the term structure that he says he has. If in fact he's right, then that changes the debt management side of it, because what he's suggesting is that the base that's applied by the Bank of Canada buying bonds is no longer relevant. Then they can buy up bonds and return to a 20% proportion of the debt and lower the cost of financing the debt tremendously. So if he really believes what he says, he should change his debt management policy, because it doesn't matter how much the Bank of Canada holds. I would argue that it does matter. That's one of the effects of reintroducing the reserve requirements. It allows the Bank of Canada to hold more debt.

Mr. Ken Epp: I'm dominating this. You can cut me off, Mr. Chairman.

The Chairman: No, go ahead. I like this.

Mr. Ken Epp: I have lots of questions.

The Chairman: I've never seen this before.

Mr. Ken Epp: You haven't? No, I'm sure you haven't. I haven't seen it either.

Here's a question. We're told that not only the governments of Canada but also individuals in Canada have record high debts. I think the average personal debt load is around $25,000 per person in this country. Add to that the debts of the municipal, provincial, and federal governments. Now, if I go out and borrow $100,000 and I repay it in 20 years, the interest rate demands that I pretty well pay back twice what I borrowed—depending on the interest rate and the length of the term, obviously. If that's true for so many Canadians, then obviously in 10 years we need to double our money supply, or else we can't pay the interest.

Mr. Mike Bradfield: I have in my files a letter from a farmer on that one. One assumes that when you borrow the $100,000 you're going to pay the interest not out of an expanded money supply, but out of either reducing your consumption of goods and services in order to repay the interest, or you're going to invest the $100,000 in something that's going to give you a greater return than the rate of interest so that you can pay it.

Mr. Ken Epp: If you built a fence around Canada, which of course we can't do... You would have to build a fence around the world, the way it is right now—

Mr. Mike Bradfield: We don't need it. Nobody has enough.

Mr. Ken Epp: As far as I know, we have no investment from Mars or Venus yet. But somewhere along the line you have a closed system, and if within that system you demand twice as much money as you currently have, then clearly in the next 20 years that additional money must come to be. Where does it come from?

Mr. Mike Bradfield: Well, to the extent that the economy is expanding, then the Bank of Canada has to accommodate that expansion and increase the money supply by increasing that currency base on which the money multiplier takes over.

Mr. Ken Epp: But the money supply in Canada is controlled by the interest rates.

Mr. Mike Bradfield: It's the reverse: the money supply determines the interest rate. It's the supply of money and the demand for money that then determines the interest rate. The interest rate determines the level of investment, consumer expenditures, and so on, and that then affects the economy.

Mr. Ken Epp: Okay. Well, Mr. Chairman, I'm going to quit, because I—

The Chairman: Is this a formal announcement you're making?

Some hon. members: Hear, hear.

An hon. member: Can you put it in writing?

Mr. Ken Epp: No, it doesn't mean I'm resigning my seat. You misinterpreted it.

The Chairman: Oh, okay.

Mr. Ken Epp: I'm just going to quit for now. I've got to get my head around this.

I think our witness has brought an interesting idea here in terms of equality of the banks. I think I understand what he's saying there, but I don't think he's answered the question. It seems to me that foreign banks bringing foreign capital in don't necessarily, because they're not taking deposits from Canadians... It's a different ball game, I would think.

I'm going to have to get some help on this from our researchers. The act here talks about “with respect to business in Canada”, and it doesn't specify whether that's deposits taken in or money lent out. It's not clear. I think we need to fix that part up. I think he has a point. But exactly how to fix it, I have no idea at this stage.

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The Chairman: Thank you, Mr. Epp.

Mr. Pillitteri.

Mr. Gary Pillitteri (Niagara Falls, Lib.): Thank you, Mr. Chairman.

Thank you very much for making your presentation. Maybe I'm a little older than some of the others on this committee and I've heard more. I've heard a lot of presentations. It dates back to the Social Credit west. It dates back to Paul Hellyer. Of course he's made a more eloquent... I mean no offence to you. Don't forget he was running for the leadership. He made more eloquent remarks on how we should be controlling our money supply in Canada.

Many a time I've personally asked the Governor of the Bank of Canada about the money supply. As a matter of fact, I've asked him many times about the deposits held by the domestic banks. I recall one time back when they had 10% and then went down to 5%. Now they no longer have any deposits. But I do understand the branch banking had a 5% deposit, and this is what they've been wanting to be treated differently. This is why this legislation is coming about with different treatment. Why should we have 5% on deposit when your domestic banks don't have that? So we want to be treated equally.

Let me just clarify one thing here. You did say that for every dollar that depositors put into a bank, they can only lend out a dollar. But with the multiplier effect, my understanding is that if they receive a dollar in deposit and they lend out 95 cents, as long as they deposit some of it back, eventually for every dollar they receive they'll lend out $20, sir.

Mr. Mike Bradfield: For every dollar received, they lend out $20.

Mr. Gary Pillitteri: Yes, for every dollar they get in deposits, they lend out $20.

Mr. Mike Bradfield: The system would lend out $20 if there is a 5% effective reserve ratio.

Mr. Gary Pillitteri: Regardless.

Mr. Mike Bradfield: Well, it's not regardless. It's a function of their capacity.

Mr. Gary Pillitteri: They're doing it now, sir. Our domestic banks are doing it now.

Mr. Mike Bradfield: Well, if you look up the data, they are in fact lending out closer to $100. If you look at the amount of cash reserves the banks hold, either in their own banks or with the Bank of Canada—

Mr. Gary Pillitteri: Excuse me. I don't want to be argumentative. I'm saying that for every dollar that they receive in deposits, they're able to lend out $20. I didn't use the $100 multiplier.

Mr. Mike Bradfield: No, you're using the $20 multiplier. But I'm saying that if you look at the data, in fact it's closer to $100.

Mr. Gary Pillitteri: Is it?

Mr. Mike Bradfield: Yes. It was about $78 back in 1994, and it's gone up since then.

Mr. Gary Pillitteri: So what you're saying then is that the banks are printing money?

Mr. Mike Bradfield: Well, the banks have always had a licence to print money. As long as chequing accounts and other types of accounts are considered acceptable money, then by setting up an account for somebody who's borrowing, they are creating money. Whether they do it physically, by taking somebody's previous deposit and lending that out, or whether they do it by setting up an account, the effect is going to be the same thing. They have created a form of money, not fiat money, not legal tender, the way the currency is created by the Bank of Canada—

Mr. Gary Pillitteri: But artificially.

Mr. Mike Bradfield: —but artificially. As long as people will accept your cheque, then your cheque is money.

Mr. Gary Pillitteri: Well, that's the theory of Mr. Hellyer and of course the old Social Credit.

I have one more question. I asked the Governor of the Bank of Canada what the role of the Bank of Canada is, and it was explained to me that it does not hold any debt; it's the Government of Canada that holds the debt, not the Bank of Canada. The Bank of Canada only has reserves in order to interject, in order to prop up the dollar or sell off dollars. It has somewhere around $25 billion at its disposal to do this.

Mr. Mike Bradfield: You're talking an entirely different part of the bank's operation.

Mr. Gary Pillitteri: I'm just saying what the role of the Bank of Canada is.

Mr. Mike Bradfield: The bank has several roles: to manage the economy, which is unemployment and inflation; keep a stable exchange rate; and operate as a fiduciary agent of the government, managing its debt.

• 1735

On the foreign exchange stability side of it, they keep a foreign exchange fund, which varies. I haven't looked at the numbers lately, but $25 billion sounds like a not unreasonable figure for it. That is strictly for the foreign exchange side of their operation.

For the domestic monetary policy side of it, they engage in what's called “open market operations”, buying or selling bonds to change that currency base I was talking about, to change the capacity of the banks to expand the money supply.

Mr. Gary Pillitteri: And derivatives.

Mr. Mike Bradfield: And for that they hold... The Bank of Canada could buy and sell anything; they could be buying and selling pins. But for a variety of good reasons, they buy and sell federal government bonds. They could be buying and selling provincial bonds. And in fact they hold a stock of bonds.

Mr. Gary Pillitteri: But they do not hold the debt.

Mr. Mike Bradfield: Well, those bonds are government debt, by definition.

Could I disassociate myself in part from Paul Hellyer and Social Credit? The argument I'm making is not a Social Credit and Paul Hellyer argument. I agree with some of the things Paul Hellyer has written about, but he gets off into the concern that was raised earlier about if you borrow money, where does the money come from to pay the interest? Then he gets into Social Credit and funny money, and they're going in an entirely different direction.

Mr. Gary Pillitteri: And also where the government should tell the banks what to lend back to government interest-free, and so on. We've heard that before.

Thank you, Mr. Chairman.

The Chairman: Dr. Bennett, any questions? Mr. Limoges?

Mr. Bradfield, on behalf of the committee, I would like to thank you very much for your intervention.

Mr. Ken Epp: Can I ask one more quick question?

The Chairman: Yes. This is from a man who was going to quit.

Mr. Ken Epp: This is really quick.

Dr. Bradfield, this is hypothetical. If we were to ask you to come here with a panel of 25 or 30 economists, how many of them... Could you get 20 or 30 economists that would agree with your document that you've...

Mr. Mike Bradfield: Yes, quite easily.

Mr. Ken Epp: You think so.

Mr. Mike Bradfield: Well, in fact I originally worked these numbers up about four or five years ago, and the alternative budget incorporated the idea in their first or second budget, which in fact has the support of something like 40 or 50 economists.

I did a seminar in our department on this when I first started looking at the numbers, and what was bothering me was the decreasing proportion of the debt held by the bank. I couldn't figure out why. Then it finally twigged with me: it was because they had lowered the reserve requirement and therefore are restricted in the amount of debt they can add.

In any case, I kicked it around with my colleagues over several luncheons, and then I finally presented a formal seminar in our department. My colleagues had gone from skepticism about the numbers—they couldn't believe the Bank of Canada had pulled out of holding the debt that much—to horror at what was actually going on. So within my own department, I can probably get strong support.

Mr. Ken Epp: Thanks.

The Chairman: Dr. Bradfield, thanks again.

The meeting is adjourned.