Smaller lenders don’t necessarily operate on the deposit and loan system associated with the larger banks
, where lending is primarily funded by money deposited in their accounts. The supply for their lending is enabled by wholesale funding, in particular through residential mortgage backed securities (RMBS)
RMBS are an investment bond backed by residential debt. Basically, a bank or mortgage originator organises your home loan, and your loan is then bundled with other home loans and sold to a trust. To raise the money required to buy these home loans, the trust issues a bond to wholesale investors. Your principal and interest payments are collected by the mortgage originator and passed on to the trust. The trust then uses these cash flows from the home loans to pay interest and return the principal to investors.
In Australia, the volume of RMBS plunged in 2009 in the wake of the GFC. RMBS are crucial for smaller non-deposit taking lenders and critical for competition in mortgage lending and, as a result, the federal government has been propping the RMBS market up since 2008 by investing in the bonds.