Wednesday, December 30, 2009

A Stronger Financial System

Ever wonder what happens behind the scenes of banks? For example, how does the bank manage its money?

Part of the system involves banks lending money to one another for short terms. The system is known as repurchase agreements, or repos for short. In order to raise money, a bank sells bonds or other collateral to another bank but agrees to buy back the collateral at a later date. Repos are part of a market that involves traders at the various banks trading with each other and shuffling the collateral back and forth.

All was well and good until the recent recession. The banks began to be leery of the solidity of other banks. The time proven system of trading began to fail, leaving even the healthiest of banks with a potential cash shortage.

Anticipating a possible major blow to the Canadian banking system, the Bank of Canada, together with the country's securities industries, began creating a plan to revamp the system and ensure crucial funding for the country's banks.

The plan involves establishing a central clearinghouse. Banks would no longer trade with each other but, rather, with the clearinghouse. This would eliminate questions of stability of other banks. Also, a central clearinghouse would be able to give a bank a clearer picture of their repos transactions, thus affording the bank a better way to manage its capital.

The Bank of Canada hopes that this new system will begin to be implemented by mid-2010 and will increase the overall safety and solidity of the Canadian banking system.

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