A. Introduction

• Author: M.H. Ogilvie
• Profession: LSM, B.A., LL.B., M.A., D.Phil., D.D., F.R.S.C. Of the Bars of Ontario and Nova Scotia Chancellor's Professor and Professor of Law, Carleton University
• Pages: 1-6

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Banking is a method of financial intermediation whereby surplus funds are transmitted from savers to borrowers, and banks are the institutions which effect that transmission.¹

The funds that banks lend are funds deposited by customers whose reward, if any, is the amount of interest promised to them by the bank for their deposits. Historically, the primary economic function of banks in any economy is to hold funds deposited with them, to manage those funds on behalf of the depositors, and to make the funds available at a cost to borrowers, that is, to be the primary source for money in an economy. Lending at a profit provides banks with the incentive to engage in deposit taking in the first place and compensates for the cost of safekeeping savers’ deposits and permitting access to them through payment instructions such as cheques or electronic funds transfers.

Although banks are the oldest financial intermediaries in the West,²in the past two centuries, other financial institutions, such as

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trust and loan companies, cooperatives, and credit unions, have offered this same financial service to savers, in addition to their respective and unique roles in the economy. Many consumers commonly refer to these institutions as "banks" and, broadly speaking, when they are carrying on deposit-taking activities, they are subject to a legal and regulatory framework similar to that of banks, as well as to the laws and regulations relating to their distinctive activities. But as discussed later,³they are not, legally speaking, banks, and therefore they are largely excluded from the scope of this text, which is about banks and banking law.

Deposit taking and lending, together with payment instruction facilities to effect fund transmission, are at the heart of banking, and their interrelationship is the reason for the economic efficiencies in banking. Banks retain only adequate reserves to meet reasonable customer cash withdrawal requirements and they lend the rest, thereby reducing safekeeping costs for customers and increasing profits from borrowers. By developing interbank transfer facilities with other banks, it becomes possible to transfer funds throughout the economy by transferring credit, thereby reducing the need for interbank cash deliveries. Multilateral clearing and settlement among banks is made more efficient through final settlement among bank accounts kept by each bank at a central bank, such as the Bank of Canada, so that the physical transfer of money is unnecessary; both bank notes and deposits held at the central bank are of equal value and are obligations of the central bank. These features are found in the early modern precursors of the

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contemporary Canadian banking system, so stable, practical, and efficient have these key ingredients been over the centuries.

In the West, banking evolved from early medieval money changing. Money changers specialized in transmitting funds between parties at a distance, first by physically transporting coinage to geographical locations at which fairs were held and later by developing the early bill of exchange, because of the notorious dangers of transporting money about. By the...