Commercial Banks' Borrowing from the Federal Home Loan Banks

Article excerpt

Enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 was a watershed event in the financial system policy of the federal government. It represented the first concrete effort to resolve the 1980s thrift debacle and to make meaningful financial system and regulatory reforms. It also changed the role of the Federal Home Loan Banks by opening them up to commercial banks.

The Federal Home Loan Banks (FHLBs) function as special lending facilities for the housing finance industry. These government-sponsored enterprises increase the liquidity of mortgage markets by making advances (loans) against member institutions' mortgage portfolios. For the better part of six decades, membership in the FHLBs was limited to institutions specializing in housing finance-largely savings associations. This limitation established a strong connection between FHLB lending and housing finance. The wider range of assets commercial banks can hold and the fungibility (interchangeability) of advances weakens the connection between housing finance and FHLB lending to banks. So, while it reaffirmed the FHLBs' housing finance mission, the Financial Institutions Reform, Recovery, and Enforcement Act widened the scope of lending that was supported, albeit indirectly, by FHLB advances. A decade later, the Gramm-- Leach-Bliley Act of 1999 contained a provision that formally extended FHLB advances to support the small business and small agricultural loan portfolios of community financial institutions (then defined as those with assets of $500 million or less). In this provision of Gramm-Leach-Bliley, Congress amended the FHLBs' mission to include providing broader liquidity support for community banks and thrifts.

Today, commercial banks are an important constituency of the FHLBs. Starting from zero at the beginning of 1990, commercial bank membership had grown to 5,786 (73 percent of all FHLB members) by December 3 1, 2001. Moreover, at the end of 2001, three-fourths of all FHLB advances went to commercial banks, which collectively borrowed $198 billion (nearly 42 percent of the total dollar volume of FHLB advances).

Commercial banks' prominence as members of the FHLB system and their increased use of FHLB advances for funding is not surprising. After all, throughout the 1990s the attractive returns offered by the stock market and competition from other financial institutions made it difficult for banks to attract and retain deposits. Moreover, the stability of FHLB advances as a funding source and the below-market lending rate make borrowing from them attractive.

Given the cost and funding advantages that FHLBs enjoy as governmentsponsored enterprises (see the Congressional Budget Office studies in the recommended reading list) and the increasing share of FHLB assets represented by advances to banks, I am interested in the effects on the financial system of changes in access to FHLB funding. Is the borrowing pattern consistent with the FHLBs' traditional housing finance mission? With the FHLBs' providing liquidity support for community banks? With some other objective? I shed light on these questions by examining the characteristics of banks' borrowing from FHLBs, including the distribution of borrowing across different sizes of banks. I find evidence of a positive relationship between a bank's reliance on FHLB advances for funding and the share of assets invested in housing-related credits. Although community banks are less likely than their larger brethren to have outstanding FHLB advances, the data suggest that the FHLBs are an important backup liquidity source for community banks. Support of Housing Finance In opening up the FHLBs to commercial banks, Congress recognized that the thrift industry's post-debacle role in financial markets would be permanently reduced. Failures during the 1980s and early 1990s, combined with ongoing industry consolidation over the last decade, brought the number of savings institutions down from a peak of 3,677 in 1986 to 1,533 at the end of 2001. …