In the past, I have done a few posts about the concept of  fractional reserves or closley related capital reserves.  Canadian company Home Capital is a recent shining example of what can happen when your monetary system is founded on the concept of reserves.

Simply put, in countries that allow fractional or capital reserves; as long as financial institutions retain a government/regulator specified reserve of capital or specified deposit holdings, they can lend the rest.

For Example -Home Capital

Home Capital gathers funding via savings accounts, gauranteed investment certificates and shareholder capital.  At the end of April they had about $15 billion on deposit and $17 billion in mortgages.

The deposits were used to fund the loans.  Under the capital reserve model (Canada’s model) Home Capital is able to lend more than they have on deposit as long as the capital reserves (readily available cash on hand) are enough to cover a reasonable rate of withdrawal.

The reserve amount is set by the government based on the risk weighting of capital employed.  The idea is the amount of liquid cash on hand will cover the normal volume of withdrawals.

This all goes to hell in a handbasket when there is a run of withdrawals.  Since the majority of the deposits have been lent out as mortgages, a high and rapid volume of withdrawals can cause Home Capital  to run out of cash and default on the depositors.

And this is what exactly happened – the running out of cash part, not the default part, at least not yet.

Stay Tuned

There is a lot more to tell about this story and the saga will continue tommorow with some analysis on the triggers, what’s been done about it so far and what it says about the fractional / capital reserve monetary model.