With offers of lower rates, easier terms and cash incentives, non-bank lenders (or shadow banks) are growing home loan market share at four times the rate of their mainstream banking rivals, according to Digital Financial Analytics and Canstar.
As mortgage brokers in Perth, we can vouch for that too. The most important thing for borrowers to know is that there are other finance options out there, other than the big four banks. Just as we have been saying in response to the Banking Royal Commission…healthy competition delivers better outcomes for borrowers.
All of these shadow banks have little or no branch network nor sales staff. As a consequence they don’t have the huge overhead costs which means they can deliver lower borrowing rates to customers.
What are Shadow Banks?
A shadow bank is typically a non-authorised deposit taking institution, in essence an institution whose deposits are not government guaranteed like those of the big four banks and a large number of other ‘authorised’ deposit taking institutions (ADI’s). Shadow banking acts in parallel to the banking system proper, providing loans for credit cards, car loans, business loans, housing loans and more.
Shadow banks have been gaining market share since 2016. This is when the government started imposing tighter lending standards on ADI’s in a successful bid to limit a property bubble during the east coast property boom (which appears to have finally ended).
Getting to grips with how shadow banking works can be confusing but here’s an example that should help to clarify the process.
Let’s look at the differences between the nature of these two systems.
A traditional bank:
- Does business the traditional way - i.e. people save money in the bank and the bank pays a small amount of interest on these deposits.
- The bank then takes the deposits and lends them out at a higher interest rate. The interest in between or ‘spread’ is the bank’s profit.
- Loans are kept on the books of the bank.
- Operates under a series of government regulations to provide a safety net to depositors.
A shadow bank:
- Bundles up borrowers mortgages and loans and turns them into securitised bonds (e.g AAA, AA, BBB etc).
- These are offered as investment opportunities for hedge funds, pension funds etc.
- Investors can buy a selection of bonds each with different interest rates depending on their risk profile (e.g AAA bonds might give 2% interest, AA might give 3% interest and so on).
- The money comes into the shadow bank via these bonds and flows out to borrowers.
- Operates under no, or very little, government regulation.
Shadow banks have become a key part of the economy because they are typically able to offer cheaper lending and faster loan approval than the big four banks.
While the big four banks are tightening their regulations, raising interest rates and turning away customers who don’t meet their strict criteria, shadow banks are becoming a viable alternative if you want to borrow money.
According to Canstar, a research institute which monitors rates and fees, the amount of shadow bank loans approved in 2018 increased by about 8% as borrowers sought out lower rates and more favourable terms and conditions.
If you’re in the market for a home loan, speak with an experienced finance broker to help you find the best option for you.