The Function of Canada’s Central Bank- and How It Relates to Fintechs
When examining Fintechs and the relationships they have with the Canadian economy- it is practically impossible to ignore the presence of the Bank of Canada- Canada’s central bank- and the numerous roles it plays in everything from the overall state of Canada’s economy- right down to the cost of borrowing for small businesses and consumers at the individual level.
The Canadian government uses extensive policy to shape the direction of our economy. Fiscal policy- which primarily includes taxation/spending- is the responsibility of elected federal and provincial legislatures. Monetary policy- on the other hand- is the policy conducted by the Bank of Canada, which operates separately and autonomously from Canada’s government. (To clarify- this article will only address monetary policy and not fiscal policy.)
The main function of monetary policy is to keep Canada’s currency system stable by keeping inflation rates low. This in turn provides security and stability for Canadian citizens and businesses, and encourages international investment in Canada by promoting a secure financial system and strong dollar. This in turn has numerous spin-off benefits, as it contributes to job creation, greater economic productivity and output, and ultimately- an increase in the standard of living that we enjoy.
The Bank of Canada has a target band of keeping inflation within an annual range of 1-3%. Rates of inflation within this range are considered healthy and normal for our economy- but if it exceeds this, it can be a sign of the economy overheating- which would have an adverse impact on consumers and businesses via hyperinflation- so the Bank of Canada then acts to adjust its interest rates accordingly in order to keep the rate of inflation within the 1-3% range.
But what does this mean for lenders and financial institutions- such as Canadian Fintechs?
When the Bank of Canada adjusts its prime interest rate- all retail banks and financial institutions in Canada follow suit by adjusting their rates- which in turn has a ripple effect across the economy. An increase in interest rates will make borrowing money for businesses and consumers more expensive- and is a policy instrument that is used to slow down an overheated economy. On the contrary- an economy in recession will see the Bank of Canada slash interest rates (such as how the past few years the Bank of Canada has cut its key rate to between 0.25-0.50%- essentially the lowest it can go)- which in turn makes borrowing less expensive and is intended to stimulate economic growth by getting businesses and consumers to increase spending and economic output.
Canadian Fintechs and other financial institutions adjust their rates based on the Bank of Canada’s prime interest rate- and throughout the different phases of the economy- they keep their rates essentially in lockstep with the Bank of Canada.
Right now, as Canada’s economy has drastically slowed down- mostly due to Covid-19- economists warn a recession is looming; so Canadians can expect to see interest rates kept low for at least the next year and beyond- in order to gradually stimulate the economy and increase output and GDP. Time will tell- over the next few months- how quickly Canada’s economy is able to recover and get back on its feet.
For more information about the Bank of Canada and its principal functions- check out https://www.bankofcanada.ca/core-functions/