How Money Is Created in Canada, and Why a Household Cannot Do It

Ask most people where money comes from and the answer is a building. Ask again and the answer is a printing press. In Canada both answers are wrong, and the true answer is more interesting than either: most of the money Canadians use every day is not issued by the state at all. It is issued in the ordinary course of business by private institutions, and the Bank of Canada sets the arithmetic of it out in public for anybody willing to read three pages. This article does that, from the Bank of Canada and from nowhere else, and then says what any of it has to do with a family that owns a life insurance contract, a registered plan and a segregated fund. The honest answer to that second question contains a boundary, and the boundary has a section of its own rather than a line at the bottom.

A note on the words, before a single one of them is used

This article is a comparison, and a comparison only works if the reader knows from the start which side each word belongs to. So the rule is stated before the first section rather than assumed.

The words bank, banker and banking appear below a great many times. Every one of them describes an actual chartered institution operating under the Bank Act: a real company, with a charter, supervised by the Office of the Superintendent of Financial Institutions and reporting to the Bank of Canada. Not one of them describes this practice, the services it offers, the way to reach it, or any contract it places. It is not one of those institutions, it does not claim to be, and the law reserves the word for the institutions that are. That reservation is section 983 of the Bank Act and it has stood for thirty four years.

The other side of the comparison is named differently on purpose, and the difference is not decoration. What a family holds is a contract. The person who holds it is a policyowner. What is paid into it is a premium. What accumulates inside it is capital, or in the registered world a plan and its property. Those words are used because they are the accurate ones, and they are never swapped for the institutional set, in either language.

A reader who finishes this article believing that an insurance contract is a deposit account with better manners has been failed by it, and the section on where the comparison breaks exists so that nobody finishes it believing that.

There are two kinds of money, and most people only ever hold one

The Governor of the Bank of Canada set the division out plainly in a public address. Central bank money is bank notes and settlement balances. Private sector money is the deposits held at financial institutions, together with the infrastructure that moves them between accounts. Central bank money, he said, is the foundation of the financial system because the central bank stands behind it.

Notes are the part everybody has held. They are a liability of the Bank of Canada, they are designed and distributed by it, and the Bank inspects them in circulation so that the ones in use are not worn or damaged. For most households they are also, by value, a rounding error in the year.

Settlement balances are the part almost nobody has held, because only the members of the high value payment system can. They are deposits held at the Bank of Canada by those members, and the Bank of Canada Review describes what makes them different from anything else: they carry neither default risk nor bankruptcy risk, because the institution behind them can create Canadian dollar liquidity as required and can therefore always meet its Canadian dollar obligations.

Everything else is the third thing, and the third thing is what a household actually has. A balance in an account is not central bank money. It is a promise made by a private company to pay, and the whole apparatus of deposit insurance exists because a promise made by a private company is a promise that can fail.

What the central bank creates, and how it says it does it

The Bank of Canada published a staff analytical note on what its own balance sheet does to the banking system, and it is the plainest description of money creation available from a Canadian authority. When the Bank buys a Government of Canada bond, it pays for it by depositing funds electronically into the seller’s settlement account at the Bank of Canada. That deposit, the note says, creates a unique type of liability called settlement balances, also called reserves.

Read that sentence twice, because it is doing something unusual. The Bank did not move money from somewhere to somewhere else. It wrote an entry. The bond arrived on the asset side and the settlement balance appeared on the liability side, and the note states the identity without embarrassment: for every dollar of securities purchased, both the Bank’s assets and its liabilities increase by a dollar.

What happens next depends entirely on who sold the bond, and this is the part that decides whether the quantity of money in the country changes. If the seller was a commercial bank, the note says the overall balance sheet of the banking system remains the same size and only its composition shifts: the system’s holdings of government bonds fall and its reserves at the Bank of Canada rise by the same amount. The bank swapped one asset for another.

If the seller was not a bank, the arithmetic is different. The commercial bank acts as the intermediary, and the note says the size of the overall balance sheet of the banking system also grows, because the commercial bank now holds more reserves at the Bank of Canada and owes the non-bank entity the equivalent amount in its deposit account. A deposit appeared that did not exist before. Nobody saved it first.

What a chartered institution is, and what it is doing when it lends

The Bank of Canada defines the term it uses in its own statistics. A chartered bank is a privately owned institution chartered by Parliament, or holding letters patent by order in council as provided for in the Bank Act. It operates under the terms and provisions of that Act, which defines the range of its activities and regulates parts of its internal operations, and it reports on those operations to the Office of the Superintendent of Financial Institutions and to the Bank of Canada.

That is the whole legal content of the word, and it is worth noticing how little of it is about vaults. What makes such an institution powerful is not the building; it is that its own promise to pay circulates as money.

That is the mechanism the staff note describes from the other end. When a borrower signs a loan, the institution records a claim on the borrower as an asset, and records a deposit in the borrower’s name as a liability. The borrower now has money to spend. Nobody handed over a shoebox. The two entries were written at the same moment, and the deposit is money because everybody treats the institution’s promise as money.

The limits on this are real and are not the ones most people imagine. They are capital and liquidity requirements, the willingness of creditworthy borrowers to borrow, and the price of funding set against the policy interest rate the Bank of Canada adjusts on fixed dates each year. The Bank publishes that framework and the inflation-control target it serves: the two per cent midpoint of a control range, held there because predictable inflation lets Canadians make spending and investment decisions with confidence.

Where the money is counted, and the line that should surprise you

If money is mostly a set of private promises, somebody has to decide which promises to count. The Bank of Canada does, and it publishes the answer as the monetary aggregates. The narrow ones are close to what a household would guess: currency outside banks, plus personal and non-personal chequable deposits at chartered banks, plus all chequable deposits at trust and mortgage loan companies, credit unions and caisses populaires.

Widen the definition one step and non-chequable notice deposits join it. Widen it again and the broadest published aggregates take in Canada Savings Bonds and other retail instruments and non money market mutual funds. The Bank is explicit that the non-bank part of these series includes trust and mortgage loan companies, credit unions and caisses populaires, personal deposits at government owned savings institutions, and life insurance company individual annuities.

That last item is the one worth stopping on, because it is the only place in this whole subject where the two sides of the comparison touch. The Bank of Canada counts individual annuities issued by life insurance companies inside a broad measure of the money in the Canadian economy. Not as deposits, and not at a bank. As a separate named line, from a separate kind of institution, under a separate statute.

It is a small line in a statistical table and it makes a large point. The capital a family builds inside a life insurance contract is not invisible to the national accounts and it is not eccentric. It is measured. It simply sits in a different column from the one everybody looks at.

What a household holds instead, named in its own words

Now the other side, and every word on it is the accurate one for what it describes.

A family that owns permanent life insurance owns a contract. The person who owns it is the policyowner. What is paid into it is a premium, and a premium buys a set of promises: a death benefit, and in a permanent contract a value that accumulates inside the contract and can be reached on the conditions the contract sets. Where the contract is a participating one, the policyowner shares in the experience of a separate account maintained for that purpose, and what is credited is never guaranteed in advance and is never described here as though it were.

A family that owns a segregated fund contract owns something different again: an insurance contract whose value follows a fund, carrying contractual guarantees at maturity and at death, and carrying the insurance law features that come with being a contract rather than a holding, including the ability to name a beneficiary. A family that owns a registered plan owns a wrapper defined by the Income Tax Act, and what is inside the wrapper decides almost everything about it.

None of these is a deposit. None of the people holding them is a depositor. The capital inside them was paid in by the family, dollar by dollar, out of money that already existed. That is the honest description, and it is also the beginning of the next section.

Where the comparison breaks, stated here and not at the bottom

A comparison offered as an equivalence is a misrepresentation, so here is every place this one stops working, in the body of the article rather than in small type at the foot of a page.

A household creates no money. Not a dollar, not ever. The entries described above are made by institutions licensed to make them, supervised on their capital and reporting to two federal bodies. Nothing a family signs gives it that power, and any sentence anywhere that suggests otherwise is wrong.

Where a permanent contract permits a loan against its value, the insurer is the lender. The money comes from the insurer, on the insurer’s terms, and the interest is owed to the insurer. It is not paid to the family, it is not credited back into the family’s own contract, and describing it as though it were is the commonest misrepresentation in this market.

A participating policyowner is not a shareholder. There is no share, no vote and no ownership of an institution. What exists is a contractual right to share in the experience of a separate account, and stock companies maintain such accounts as well as mutual ones, which is the proof that the right comes from the contract and not from ownership.

A premium is not a deposit and a contract is not an account, which decides which protection scheme applies. The Canada Deposit Insurance Corporation insures eligible deposits at its member institutions and lists what is not eligible, including mutual funds, stocks and bonds, exchange traded funds and digital currencies. A life insurance company is not a member institution and a contract is not a deposit, so the body that stands behind a Canadian insurance contract is Assuris: an independent, industry funded, not for profit compensation association designated by the federal Minister of Finance under the Insurance Companies Act, whose membership every authorised life and health insurer is required by the regulators to hold and cannot terminate while it has active business in Canada.

And the last one. An institution earns on a spread it can reprice, on fees it can adjust and on leverage it is permitted to run. A family has none of those levers, only the choice of where its own capital sits and on what terms it is reachable, which is a smaller power and a real one.

Where the rest of this subject lives

Readers who follow this argument to its end usually arrive at the same question, which is whether a family can organise its own capital so that it finances its own purchases rather than renting money for them. That subject has a name and a literature and it is not taught here. It is set out at ibcfinancial.com in English and at financierecbi.com in French, and nothing on this page is a summary of what those pages say.

What this site does is the placement side: the contracts, the registered plans, the segregated funds, the annuities and the protection that has to hold when somebody dies or stops earning.

Frequently Asked Questions

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If the protection side is what matters, what deposit insurance covers sets out the two Canadian schemes and where the boundary between them runs. Four ways a bank earns takes the institutional side further, and interest paid against interest earned is the household arithmetic beside it. Whole life insurance and segregated funds describe the contracts named above. Transparency and compensation sets out what this firm is paid and by whom.