Shadow Banking Expected to Grow because of new mortgage rules

Shadow Banking Expected to Grow because of new mortgage rules


If you have been reading the news over the last few weeks, you’ll notice there’s a term being used that many may not have heard of before – shadow banking.

Recent articles on financial post, Canadian Business, and CBC, talk about how the recent changes to Canada’s mortgage lending rules could lead to growth in something called shadow banking.

But what exactly is shadow banking? The Bank of Canada refers to it as “…Credit intermediation that takes place at least partly outside the traditional banking system.”

Basically, it’s private, unregulated lending.

The new rules that took effect on October 17th require buyers applying for an insured mortgage to show they can afford to pay it back at the Bank of Canada’s five-year fixed rate of 4.64%. Canada’s biggest banks currently offer mortgages at rates about two percentage points below that. These stress tests have been implemented to determine whether the borrower will still be able to make their payments if interest rates rise.

Borrowers unable to secure traditional mortgages tend to look to other sources such as so-called shadow lenders, which operate outside the scope of federal banking rules and offer short-term, uninsured loans at interest rates that are typically much higher than those provided by the banks. The loans are often financed by high net worth individuals looking for returns better than those they can get in stocks, bonds, or GICs. Mortgage Investment Corporations (MIC) also fall into the description.

These private lenders and small MICs comprise just 2-4% of Canada’s mortgage market.

A report published last year by CIBC economist Benjamin Tal suggests that unregulated lenders make up less than 5% of the market – a small figure, but one that’s rapidly growing.

According to Tal’s report, non-bank lenders doubled their market share between 2012 and 2015, and tougher regulations are likely to continue to “widen those … margins.”

Pools of capital between private investors are the norm now, ready to invest in some cases up to $50 million in mortgages to borrowers that don’t pass the new tests at annual rates between 4%-6%.

The cost to the borrower will be a higher mortgage payment.

Canada’s shadow lenders perform a vital role for borrowers and they represent a tiny fraction of mortgage lending. A fraction so small, the Bank of Canada states it does “not pose systemic risk.”

As the saying goes, every action has an equal and opposite reaction.



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