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The Big Bank Edge

Bank_AdvantageThose of us in the mortgage industry know that, at any given time, big banks can undercut virtually any other competitor. It’s not their standard operating procedure (since they prefer to maintain margins), but if they wanted to, big banks could win any mortgage rate war.

One reason for that is their funding advantage. They have a considerable edge when raising cheap capital. A recent Bank of Canada report (link) shows just how much of an edge.

Take deposits, for example. “On average, deposits are around 65 per cent of large banks’…total liabilities and equity,” the report’s authors say. That’s a huge pool of cheap funds, a pool that represents the primary source of mortgage funds for banks.

But it’s not just the sheer quantity of mortgage funds available that matters. It’s the cost. “Retail deposits continue to be one of the lowest cost funding sources,” says CMHC. Indeed, one of the best benefits of being a huge bank is that your customers are willing to accept a lower interest rate on their deposits. Compared to smaller banks, for example, “Big Six Canadian banks pay around 80 basis points less for their deposits…,” notes the report.*

It makes you wonder how small non-bank lenders (who can’t take deposits) can possibly compete against Canada’s banking giants. The fact is, if it weren’t for government-backed securitization programs (like the Canada Mortgage Bond–CMB), they couldn’t.

This chart below shows how exceptionally competitive the CMB is from a funding cost perspective, when compared to deposits.


(Click to enlarge)

Unfortunately for small lenders, CMB funding doesn’t entirely close the gap. For one thing, lenders can access only about $1 billion per year of 5-year mortgage funding via the CMB. Moreover, the CMB costs (spreads) in the above chart do not represent the full cost of mortgage funding. As CMHC notes, you also have to account for guarantee fees, other forms of credit enhancements, legal costs, underwriting fees, and so on.

That leaves retail bank deposits as practically the lowest cost mortgage funds in the market. And it helps make Big 6 banks the most powerful lenders in Canada.

* After controlling for differences in banks’ funding/maturity mix, the Big Six Canadian banks pay 20-30 basis points less on demand and fixed deposits than other domestic banks. For more, see: Funding Advantage and Market Discipline in the Canadian Banking Sector by Mehdi Beyhaghi, Chris D’Souza and Gordon S. Roberts

Chart source: Bank of Canada

Rob McLister, CMT