THE BANK RATE IS closely related to the Target for the Overnight Rate, which is the main tool the Bank of Canada uses to conduct monetary policy. The Bank Rate — which is the rate of interest that the Bank of Canada charges on one-day loans to financial institutions — is part of a range called the Operating Band for the overnight rate. The overnight rate is the rate at which major financial institutions borrow and lend one-day funds among themselves.
The Bank Rate is always at the top end of the operating band, which is half a percentage point wide. For example, if the operating band is 4.25 to 4.75 per cent, the Bank rate would be 4.75 per cent. The Overnight Rate Target is always at the middle of the band.
The upper and lower limits of the operating band are the rates at which the Bank of Canada will, respectively, loan one-day funds to financial institutions that operate in the Large Value Transfer System (LVTS), or pay interest on one-day funds deposited at the Bank by financial institutions.
For example, if a commercial bank that is a member of the LVTS needs funds to cover its transactions during the day, it can borrow from the Bank of Canada at the Bank Rate, or it can borrow from another financial institution that has excess funds.
Over the years, the Bank of Canada has refined the way it conducts monetary policy. Under previous systems, the Bank Rate was defined differently and played a more prominent role in monetary policy.
From March 1980 to February 1996, for example, the Bank Rate was defined as the average yield at the Bank's weekly auction of 3-month treasury bills, plus one quarter of a percentage point. This rate changed with every auction. Sometimes, these weekly changes in the Bank Rate were mistakenly thought to be shifts in the Bank's policy.
But under the Bank's current system, policy shifts are clearly signalled by changes in the Overnight Rate Target. The Bank Rate and Operating Band are correspondingly adjusted at the same time. The Bank of Canada has set a calendar of eight fixed days every year when it announces whether or not these rates will be changed.