Enough about China, let’s talk about us. Turns out Canadians thirst for credit far exceeds what our traditional banks can offer. This has resulted in a massive shadow banking sector, that’s more than half the size of our traditional banking sector. While it’s being monitored by the Bank of Canada (BoC), there’s not a lot they can, or want to do about it. Shadow banking has transformed into a modern part of finance, even though it amplifies economic shock factors.
Shadow Banking In Canada
Shadow banking is system of financial intermediaries (a.k.a. middlemen), that help ensure the demand for credit is fulfilled. They’re kind of like banks, without that whole regulatory oversight. According to the BoC, Canadian shadow bankers primarily engage in certain types of investment funds, repurchase agreements, mortgage and consumer finance, private-label securitization, and investment deals not owned by traditional banks. Covering that much ground, it’s not surprising that they often have strong relationships with large banks.
Despite the close relationship, shadow banks and regular banks aren’t really bros. BoC explains in their annual report that they have the “potential to increase financial sector vulnerabilities, since the sector is not prudentially regulated.” When things started to go sideways during the Great Recession, a significant amount of blame was placed on US shadow bankers.
More Than Half The Size Of The Regular Banking Industry
While BoC researchers caution there are “significant gaps” in data and knowledge, what they could find was massive. They estimated that the industry has liabilities of $1.1 trillion dollars, just a little more than half of the $2.1 trillion in liabilities Canadian banks have. It’s also going to get a lot bigger soon, as BoC researchers noted further regulation of traditional banks will “lead to migration of activity from the traditional banking sector to the shadow.” China gets a lot of heat for its shadow banking sector, but Canada’s number is almost 5x larger per capita. With ‘cooling measures’ on the horizon for Canada, that number is about to get a hell of a lot larger.
China gets a lot of heat for its shadow banking sector, but Canada’s number is almost 5x larger per capita.
As big as the number for shadow banks is, it’s actually a little low due to the way the BoC compiled their estimates. Mortgage finance companies (MFCs), mortgage lenders that underwrite and service 12% of residential mortgages ($165 billion) as of 2015, only accounted for $10 billion of the estimate. Since MFCs sell the mortgages to third parties such as banks, or fund them with government-backed securitizations, only the amount being warehoused prior to sale or securitization was included in the estimate. So there’s little need to worry about the loans, since they’re now at regular banks or the government is responsible for them. Cool.
Risks Of Shadow Banks
Sure, shadow banks keep banks competitive, and provide forms of finance innovation regulated banks don’t have the freedom to do – but there’s also risks. While the BoC maintains that we’re “not at immediate risk,” they also go on to say there is one thing we should watch out for. Remember that whole sticky housing situation in the US that caused the great recession? Well, it’s been pretty well researched now, and the Federal Reserve Board published a few of their findings.
While the report is dry if you’re not a finance nerd, the takeaway is shadow banking is fine when it works – and is even a good thing sometimes. However, they “amplify” external negative shocks, like oh, I don’t know…a housing correction. They also found that during a recession, substantial shadow banking can cause slower recoveries, and are vulnerable to runs. A run is bankster for when markets decline, and people scramble to withdraw their money. This results in lenders liquidating assets in a firesale, which reduces asset prices further. It’s a perfect storm that happens with very little warning.
Canada’s shocking dependence on shadow banking brings up some interesting questions. Are traditional lending rules too tough for the average family? Have Canadians become so greedy they need loans in excess of typical qualifications? Or have stagnated wages forced Canadians to borrow the difference to make a living? Leave your comments below.
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