519-646-2222How Banks Sell You Your Own Debt: The Hidden Loop Behind Mutual Funds, RRSPs, and 401(k)s
When people invest in mutual funds, Registered Retirement Savings Plans (RRSPs), or 401(k) retirement accounts, they typically believe they’re helping finance business growth or lending money to successful companies. What few realize, however, is that a surprising amount of these investments are actually tied to consumer debt—credit card balances, personal loans, auto loans, and mortgages—often the very debt they or their neighbors carry. In other words: you may be investing in your own debt.
This article explores how banks securitize consumer debt and sell it to retail investors under the guise of stable and profitable investment products.
Step 1: Banks Issue Consumer Credit
Banks lend money in various forms:
- Credit cards
- Auto loans
- Mortgages
- Lines of credit
- Personal loans
These debts typically carry high interest rates, especially unsecured forms like credit cards, which can range from 18–30% annually.
Banks profit from the interest spread—charging consumers more interest than they pay on deposits—but they’ve found an even more lucrative method: securitization.
Step 2: Packaging Debt into Securities
Through securitization, banks bundle consumer loans into financial instruments called Asset-Backed Securities (ABS) or Mortgage-Backed Securities (MBS).
- ABS are typically based on credit card receivables, auto loans, or student loans.
- MBS are created from residential or commercial mortgages.
These packages are sliced into “tranches” of varying risk and sold to investors. Ratings agencies assign risk grades (AAA to junk), and each tranche offers different expected returns.
Step 3: Selling Debt as Investment Products
Here’s where mutual funds and retirement accounts come in.
- Bond funds, income funds, and even target-date retirement funds commonly invest in ABS and MBS.
- Many RRSPs (Canada) and 401(k)s (USA) include these funds, especially when they seek stable yield with low volatility.
Retail investors often choose these options thinking they are conservative or balanced investments. Yet, under the hood, they are frequently exposed to pools of consumer debt.
Step 4: You Invest in Your Own Payments
Here’s the ironic twist:
- You may hold $5,000 in a mutual fund within your RRSP or 401(k).
- That fund holds ABS backed by credit card debt.
- Part of that debt might be your own—or your neighbor’s—credit card balance, carrying a 20% interest rate.
- The bank pays you a 4–6% return on your investment—while collecting 20% from your debt.
The margin between your credit card’s interest rate and your investment return becomes bank profit, minus default risk and operating costs.
Why Do Banks Do This?
Benefits to banks include:
- Liquidity: They can lend more without tying up their own capital.
- Risk transfer: They shift the default risk to investors.
- Capital relief: Selling off loans reduces the need for capital reserves.
For banks, securitization and fund-based investment is a way to double dip: earn on issuing debt and again by collecting fees for managing the funds that invest in it.