How Banks Move Your Money
Every day, customers’ money gets loaned out or invested by banks
Many Canadians keep their money in checking or savings accounts without understanding what happens to it after it’s deposited.
As soon as money gets into the hands of the banks, they take a portion and lend it out as loans or mortgages to individuals who need to borrow it.
“The [bank] doesn’t even allow the funds to sit idle overnight, so a bank is going to do one of two things. It will either purchase security with most of the check deposit you made or it will lend the funds to someone who wants to borrow money,” says Robert Ironside, a KPU Accounting instructor who studied corporate finance.
Banks usually only keep a fraction of the client’s money, in case it needs to be withdrawn.
“A small portion, say about one to two [per cent], will be retained as vault cash or as a deposit at the Bank of Canada. This is so that when a customer walks into the bank and wants to withdraw cash, the bank can meet the withdrawal request,” wrote Ironside in an email to The Runner.
Canadian banks are not required by law to hold any reserves, however.
“Banks know that they can’t send out all of the money that flows in, so they keep some in vault cash or some that are on deposit with The Bank of Canada. These [are] what is available to give back to you … on a moment’s notice,” says Ironside.
With whatever money hasn’t been used to fund loans, banks invest in “high-quality securities” such as the Government of Canada Bonds and Treasury Bills. These are investments that allow banks to own assets without physically holding onto them.
“These high-quality securities give the bank a liquidity reserve that can be quickly sold off to meet rising demand for loans or deposit withdrawals. For example, if you want your $100 back and nobody else is making any deposits, then the bank can sell a Treasury Bill and meet your withdrawal request,” Ironside wrote in an email to The Runner.
If a lot of withdrawals are being made, banks can start selling their securities. And if they still need more money to give back, they might ask The Bank of Canada to lend them the funds.
“If you have ever watched the classic 1946 Christmas movie It’s a Wonderful Life starring Jimmy Stewart, you know what happens when depositors no longer trust the bank’s ability to pay back their deposits. It is called a “run on the bank,” as everybody tries to withdraw their funds at once,” wrote Ironside.
“As George Bailey (Jimmy Stewart) explains in the movie, the bank doesn’t keep all of the money deposited in the vault.”
