The Federal Home Loan Banks are facing heightened scrutiny since a series of bank failures brought attention to their expansive role in the US financial system. These government-sponsored lenders have morphed from their Depression-era roots in home lending to a general liquidity backstop for banks of all sizes. FHLB loans hit a record $1 trillion in 2023, and a federal regulator is preparing to release recommendations for changes.
The US Congress set up the FHLB system in 1932 to make it easier for savings and loan associations and insurance companies to get cash so they could finance more mortgages. Although they were created by the US government, FHLBs are actually owned by their members, which now include small-town community lenders and giants like JPMorgan Chase & Co. A bank can use FHLB loans, which are known as an advances, for pretty much any purpose, and their role in housing finance has greatly diminished. Because the system has the implicit backing of the US Treasury Department, advances are cheaper than financing on the open market. They also lack the stigma of borrowing from the Federal Reserve.
2. How do the FHLBs work?
To use the system, a bank must buy into its local FHLB. There are 11 scattered across the country in places like Boston, San Francisco and Topeka, Kansas. Once a bank buys in, it can ask for loans with a range of terms, from an overnight advance due in 24 hours to longer-term financing. As long as the financial firm is in good standing with its regulator, an FHLB generally grants requests quickly — a perk of the system. The borrower bank must put up collateral from a pre-approved list of assets, like Treasuries or mortgage-backed securities. For every dollar FHLBs lend out, the borrowing firm must set aside at least a dollar’s worth of collateral. In the event of a bankruptcy, the FHLB gets paid before the Federal Deposit Insurance Corp., the agency that insures bank deposits. That arrangement, which is dubbed a super lien, is controversial because it gives FHLBs first dibs on collecting.
3. Why are regulators reviewing the FHLBs?
In 2022, the Federal Housing Finance Agency, which oversees the FHLBs, announced a review of the system titled “FHLBank System at 100: Focusing on the Future” in advance of the system’s centennial. FHFA chief Sandra Thompson said the study was needed to “ensure they remain positioned to meet the needs of today and tomorrow.” The stakes were supercharged by revelations that Silvergate Capital, Silicon Valley Bank, Signature Bank and First Republic Bank had billions of dollars in FHLB loans when they collapsed earlier this year. Critics have seized on the extent that FHLB lending often has little to do directly with mortgages as a reason to fundamentally change in the system.
The circle of FHLB critics has expanded and longstanding critiques have been amplified since the regional banking crisis. Last year, former Federal Reserve Governor Daniel Tarullo called the FHLBs “largely irrelevant” to the housing finance market and suggested that the system posed risks to financial stability. More recently, in August, a group of New York University and Brandeis University professors wrote in the Financial Times that the system keeps “dying institutions artificially alive and increasing the ultimate costs of their failures.” Other critics have zeroed in on the system’s lending to crypto-aligned banks, among other complaints.
FHLBs argue that they help financial institutions weather storms and avoid tumbling into failure. Ryan Donovan, the head of Council of Federal Home Loan Banks, a trade group for the FHLBs, has cast the system as a reliable and cost-effective source of funding. Defenders of the system, including two housing-policy experts closely followed by the Biden administration, Jim Parrott and Mark Zandi, have also said the FHLBs are vital sources of liquidity and should be expanded. Backers also point out that the collateral requirements mean the lending is secured, and they point out that FHLBs haven’t lost any money on advances.
6. What’s expected in the FHFA’s report?
FHFA’s report on the FHLB system is expected by the end of September and will include both recommendations for Congress and changes the regulator can make on its own. In its deliberations, FHFA has discussed limiting big banks’ use of the system and possibly extending access to FHLBs to additional types of firms such as nonbank mortgage lenders, Bloomberg News has reported. Additionally, FHFA has discussed requiring banks that want to borrow from the FHLBs to hold a minimum percentage of their assets in mortgages, which would create a greater link between the FHLBs and the mortgage market.
More stories like this are available on bloomberg.com