Canada’s financial institution regulatory framework covers Federally and Provincially-regulated institutions. While federally-regulated organizations operate Canada-wide, provincially-regulated institutions operate locally within a specific province. However, following the credit crisis of 2009 and, more recently, the household debt situation, we’re seeing a rise in Non-regulated Financial Institutions (NRFIs).
What are Regulated Financial Institutions (RFIs)?
Canadian Regulated Financial Institutions (RFIs) are regulated at two levels, either Federally or Provincially. The simplest way to understand these sets of regulations is, Federally-regulated organizations may operate Canada-wide, while the operations of provincially-regulated institutions are localized to that province.
So, what does that mean to someone that is looking for a loan or a mortgage at one of these regulated institutions? Well, as a borrower of a personal loan or a mortgage, suffice to know that RFIs are tightly overseen by federal watchdogs.
And because they are so closely monitored and controlled, RFIs have to meet a much higher standard of reporting and compliance than some of their other (less-regulated) peers. While borrowing from an RFI therefore is considered “safer” – but it could also be more challenging to qualify for an RFI-sponsored loan, and more expensive in terms of interest rates.
What are Non-Regulated Financial Institutions (NRFIs)?
The Canadian housing market has faced some trials in recent years, and Canadian consumers are saddled with higher-than-usual debt levels. There has also been a spike in joblessness, which has all made it more challenging for individuals wishing to borrow funds from RFIs.
As a result, there has been a marked increase in the number of Non-Regulated Financial Intermediaries (NRFI) who have stepped up to provide personal loans and mortgages to Canadians in need. These lenders usually comprise of private entities that lend money to Canadians who might not otherwise have access to credit. For instance, while an RFI might not easily lend to unemployed or self-employed borrowers, a non-regulated lender might do so.
Their lending operations aren’t as stringently regulated as RFIs (both Federal and Provincial), and they aren’t allowed to accept deposits from the general public. However, while loans/mortgages from NRFIs are (technically speaking) “unregulated”, they aren’t as risky as one might think.
That’s because the government requires that all NRFIs protect their loans through a form of insurance that’s offered by a government-sponsored program – called the Government of Canada’s National Housing Act Mortgage-Backed Securities (NHA MBS) program.
What this means to you?
As a borrower, either of a personal loan or a mortgage, the status of the lender – either RFI or NRFI – could impact your borrowing decision. And here’s why:
- RFIs are required to maintain higher capital reserves – which is a sort of “rainy day fund” in case things go bad for the lender. While this requirement ensures that depositors receive a higher degree of protection in the event that an RFI goes bankrupt or faces financial collapse, it means borrowers pay higher interest rates on mortgages and loans provided by RFIs
- Federally RFIs offer deposit insurance covered by the Canada Deposit Insurance Corporation (CDIC). As a deposit holder in a federally RFI, your deposits are (currently) only protected to an amount of $100,000.
- Provincially RFI also offer local versions of similar deposit insurance. However, while some provincial institutions protect your deposits to the same amount as the CDIC, others have higher protection ($250K, $500K). In some cases, provincially RFIs offer unlimited deposit protection, which means you never have to worry about the institution going bankrupt, because your savings are 100% protected
These two features of RFIs should serve to provide some peace of mind to borrowers, that the institution they are dealing with is financially sound. However, there is another, more realistic, aspect to choosing your lender. And that’s the reality that effects how much you’ll pay for your house loan or mortgage.
The cost of borrowing from RFIs
Recently, Canada introduced new mortgage rules that mandate RFIs to apply something called a “stress test”. Under the new rules, borrowers will have to be tested for mortgage affordability at either of two levels:
- The prevailing 5-year interest rate published by the Bank of Canada (BoC); or
- The contracted rate offered by your lending RFI, plus 2%
So, what does this mean to someone who is already pre-approved by their current lender – say, for a 3% interest rate? Well, the new OSFI rules will test whether you can now afford that same mortgage at 5% (3% pre-approved rate plus the additional stress of 2%). If you pass that test, you’ll be able to receive or renew your mortgage.
But how will these new rules impact you if you are not pre-approved, or if you are a first-time buyer? And what will it do for your hopes of getting a mortgage if you are an uninsured borrower[i]?
Well, you’ll be tested against the BoC rate which, as of earlier in May[ii], stood at 5.34%. This rate stood at 4.64% in May 2017, and it has been hiked five times by the BoC since then.
So, why has the Federal government implemented these new rules? It’s because they (Federal government) felt that mortgage holders (as well as lenders) have over extended themselves in terms of borrowing (lending). As a result, they feel that once nominal rates do start to rise, most borrowers may not be able to honour their mortgage terms.
Eyes Wide Open
Previously, only mortgage borrowers putting less than 20% down payment against their loans were stress-tested. The recent changes to mortgage rules mean that ALL borrowers, seeking loans and mortgages from RFIs, will need to undergo a stress-test that’s much higher than those conducted by NRFIs.
You can easily use an online mortgage calculator to see how the recent changes might impact you if you work through an RFI. In the example calculated above, while a NRFI might approve your $300,000 mortgage at a bi-weekly payment of $638.46, a RFI will now test you at $780.23 for that same mortgage.
The only reason that NRFIs are not bound by the stress-test rules, is because they don’t come under the jurisdiction of federal watchdogs. And that means that more borrowers, including those that find their mortgages up for renewal shortly, might not qualify for favourable rates offered by RFIs. As a result, NRFIs, such as Credit Unions – who are largely unencumbered by the new stress-test rules, are likely to attract many of these borrowers away from RFIs.
So, even though one of the Big Six Canadian banks might turn down your application for a loan or a mortgage, you’ll likely find a NRFI that would be willing to consider your request favourably. If you are a homeowner whose mortgage is up for renewal, or if are in the market to buy your first home, you need to go into the transaction with eyes wide open. And knowing that you have options available to you, will help you make an informed decision when choosing the right lender.