Each chartered bank is allowed to issue notes in amount equal to its capital without deposit of security of any kind. Since 1908 the Canadian banks have had the right to issue during the crop-moving season, October 1 to January 1, an additional emergency circulation equal to 15 per cent of their capital and surplus or "rest" fund. This additional circulation is subject to a tax not exceeding 5 per cent assessed by the Governor in Council. The recent revision of the Canadian Bank Act, which became effective July 1, 1913, provides for a further increase of circulation by depositing gold or Dominion notes, in what is termed the "Central Gold Reserves." These reserves will be under the control of trustees appointed by the Canadian Bankers' Association and the Minister of Finance.
Note holders are protected (1) by a first lien upon the assets of the bank; (2) by the double liability of the stockholders; (3) by a 5 per cent circulation redemption fund. The note holder is further protected by the provision that the notes of failed banks shall draw 5 per cent interest from the time of default until announcement is made of readiness to redeem them. This holds them at par pending redemption as the yield of 5 per cent makes them a desirable investment for other banks. The redemption fund of 5 per cent of the circulation, which is required of each bank, is in the custody of the Minister of Finance and draws interest at 3 per cent. If the fund becomes impaired the banks may be called upon to restore it, but the rate of contribution is not to exceed 1 per cent a year. Since 1890, however, this fund has never been drawn upon. A few banks have failed, but their notes have been redeemed either out of the assets or by recourse to the double liability of the stockholders.
The law requires each bank to redeem its notes at its head office and in certain commercial centers designated by the treasury board. The redemption cities are the same for all banks and now include Montreal, Halifax, St. John, Charlottetown, Toronto, Winnipeg and Victoria. When the note of a bank is in circulation it is earning money for the bank, so each bank is anxious to keep out as large a volume of its own notes as possible. Hence every bank pays out its own notes through its branches and sends in the notes of other banks for redemption as fast as they are received. They are redeemed in the same way as checks are collected; in cities having clearing houses the notes and checks alike appear in the collections. There is, therefore, a constant process of redemption and issue and the volume of notes rises and falls with the needs of business.
This system of automatic redemption thus provides a safe and clastic currency without the danger of inflation. When a merchant deposits notes, together with his checks, drafts and like items in the local branch bank, this branch sorts out the notes of other banks and sends them to the nearest redemption agency or uses them as an offset in the local clearing house if the issuing banks have branches in that particular town. Thus each bank is constantly send ing in for redemption the notes of other banks and at the same time is paying out its own notes to depositors who want cash. In this way inflation is avoided, and the volume of currency responds automatically to the demands of business.
Though Canada, like the United States, makes use of more currency at the crop-moving season than at other times, it is singularly free from the monetary disturbances and anxiety that we formerly experienced every autumn. The bank note has practically exclusive possession of the currency field in Canada. Though the circulation of all the banks does not ordinarily exceed 50 or 60 per cent of the capital, it may be issued up to the full capital and in emergencies an additional 15 per cent is possible. No security is required against the circulation and no fixed reserve. The Canadian banks meet the need for additional currency by the issue of their own notes, but this leaves their liabilities unchanged, for their deposits decline in proportion as their notes inerease. When a depositor draws $1,000 from his bank and reeeives $1,000 of the bank's own notes, the liability of the bank has simply been changed from a deposit liability to a note liability, and since its reserve of legal tender money remains undisturbed, the transaction does not involve any reduction in its loans.1
The Canadian banks are not required to keep a specified cash reserve against notes or other liabilities. The only legal provision is that of whatever reserve a bank may keep, 40 per cent shall be in Dominion notes. Each bank is free to keep whatever reserve it deems adequate, and adequate reserves are always carried. There is a tacit understanding among the banks that in normal times the reserve should equal 15 per cent of the liabilities, and that about 8 per cent should be cash on hand, the rest being in balances due from other banks.2 The ratio varies with the season and with local conditions, but the whole matter is left to the judgment of the bank managers. The Canadian banks have not suffered from a crisis or panic for over thirty years.
1 Johnson: Canadian Banking System (Nat. Mon. Comm.), p. 62. 2 Ibid., p. 71.