Canadians have had a great run of luck in getting better returns on their savings and investments by taking on more risk. The Home Capital story is a reminder that this risk is real, not just boilerplate that can safely be ignored.
By no means do you have to accept the horrible rates the big banks offer on savings accounts and guaranteed investment certificates. If we were all sheep who bought what the big banks were selling, you can be sure their rates would be even less competitive.
But in reaching for better returns, you must always ask yourself some questions. What could go wrong, and what happens to my money if it did? Also, is my money protected by the Canada Deposit Insurance Corp., which covers deposits in savings accounts and GICs (terms of five years or less) at member banks for up to $100,000?
In the past decade or so, we've seen the emergence of many new financial players offering high-rate savings accounts and guaranteed investments with rates that beat the big banks by a lot. Some of these players are offshoots of traditional banks and credit unions, while others, such as Home Capital, are set up to raise money to lend out as mortgages.
To date, using these bank alternatives has meant highly competitive interest rates, a big win in today's low-rate world, and zero stress. But a basic rule of saving and investing – as absolute as the law of gravity – is that risk increases proportionately as returns rise above supersafe government bonds and Treasury bills.
This has been demonstrated by Home Capital, which offers high-interest savings accounts and GICs through subsidiaries Home Trust, Home Bank and Oaken Financial (all three are CDIC-covered). Securities regulators allege the company did not properly disclose flaws in its mortgage underwriting process to investors. Home Capital has made changes in its executive ranks, arranged for a $2-billion loan and announced it is looking at options that could include putting itself up for sale. But its shares have plunged in value in recent months and deposit holders have been pulling money out of its high-interest accounts.
According to data provider Cannex.com, Oaken's high-interest savings account paid 1.75 per cent as of mid-day Thursday, while Home Trust paid 1 per cent. Big bank high-rate savings accounts offered about 0.5 per cent at best. Oaken's five-year GIC rate was 2.5 per cent, compared with roughly 1.5 per cent at the banks.
Consider the risk as well as the return when you see that big a spread between standard bank rates and a competitor. Lower returns mean less potential for the kind of stress that Home Capital depositors are feeling.
As for existing accounts, you can transfer your money out of a high-rate savings account to another financial institution within 48 hours without penalties. According to Home Capital's public disclosures, more than $1-billion has been taken out of Home Trust's high-interest accounts in recent weeks.
If a CDIC-member bank becomes insolvent and shuts down, your account is protected up to the limit. I notice a certain amount of skepticism about government-related institutions such as the CDIC (a Crown corporation) and the Canada Pension Plan these days. But the CDIC's annual report says it has about $3.4-billion in cash and investments, and the ability to borrow up to $20-billion with federal government approval. The agency can also help to arrange a buyer for deposits held at a sinking bank.
GICs are a more complex issue than savings accounts because only the cashable variety, with lower rates, can be easily redeemed. One mortgage broker reports that cashing GICs issued by Home Capital subsidiaries means an interest penalty and early redemption fee. This explains why there has so far been no rush to redeem Home Capital GICs.
The CDIC covers both principal and interest to the $100,000 limit, which is something to keep in mind when buying GICs from alternative banks. Always cap your deposit at less than $100,000 so deposit insurance protects your gains as well as your initial investment.
If you have savings or GICs with alternative financial institutions offering better rates than the big banks, it's time for some introspection. There's the fear of missing out on better returns, and the fear of losing money or having it tied up because you made a bad choice. Figure out which will grind on you the most and act accordingly.
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