Banks primarily raise the money they need to fund mortgages through two main channels: retail and commercial deposits and wholesale funding (borrowing from financial markets).

Let's take a look at both of these.   

1.  Everyday Deposits

The most fundamental way banks raise money is through their customers and is the method you and most people are familiar with.   In a nutshell, the cash that individuals and businesses hold in their chequing, savings, and term deposit accounts serves as a core, stable source of funding that banks use directly to finance personal lending, including your mortgage.

2.  The Bond Market

When banks need to raise larger amounts of capital, particularly to fund fixed-rate mortgages, they turn to the bond market to borrow directly from institutional investors. A bond is essentially a loan from an investor to the bank; the investor provides the capital, and the bank pays them a fixed interest rate in return.

To make this process more efficient and cheaper, banks use specific strategies to essentially recycle the mortgages they have already issued into fresh cash:

• Mortgage Securitization and Canada Mortgage Bonds (CMBs): Banks can package large pools of individual, insured mortgages into tradeable assets known as National Housing Act mortgage-backed securities (NHA MBS). They sell these pooled mortgages to the Canada Housing Trust (CHT), a special entity created by the Canada Mortgage and Housing Corporation (CMHC). To pay the banks for these mortgages, the CHT issues Canada Mortgage Bonds to domestic and global investors. Because these bonds are fully guaranteed by the Canadian government, investors are eager to buy them, which injects a massive, continuous supply of cash back into the banks so they can issue new mortgages.
• Covered Bonds: For mortgages that are uninsured, banks use a slightly different tool called covered bonds. The bank issues a debt instrument that is strictly secured by a dedicated pool of its high-quality, uninsured mortgages. Because the underlying mortgages act as collateral, these bonds are highly rated and allow the bank to secure cheaper funding. Canadian banks frequently sell these covered bonds to international investors in the US and Europe to diversify their funding sources.

By combining everyday deposits with the bond market, banks are able to ensure they have the massive amounts of capital required to keep the residential mortgage market liquid and functioning.  What it also means is that the bond market something that people should really be keeping an eye on as it is a major determiner of mortgage rates.   

To learn more about how the bond market affects mortgage rates, click on the link below.

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