Sanders, Jeff, Independent Banker
The merits of FHLB advances as a source of liquidity
Over the past decade, commercial banks have become frequent users of the low-cost funding available from the Federal Home Loan Banks. Attractive pricing and ease of access brought many banks to the advance window and continuing demand for mortgages led many community banks to use FHLB advances to fill the funding void caused by slow deposit growth.
In fact, 19 percent of FDIC insured FHLB members now fund over 10 percent of their assets with FHLB advances. While community bankers have enjoyed the benefits of an added wholesale funding source, regulators have had questions about the trend, expressing concerns about community banks' growing reliance on FHLB advances.
In recent months, each of the national regulators has published some form of guidance relating to wholesale borrowing from the FHLBs. The common theme: Advances are acceptable as part of a well-managed funding program in which decisions are supported by analysis and documentation.
Planning and Policy
A well-managed funding program begins with a strategic plan that outlines potential uses of wholesale funds, such as liquidity management, asset growth or interest rate risk management. The uses for the funds will lead to the desired advance levels and maturity structures.
A funding policy supports the strategic plan with specific guidelines relating to advances. It might include oversight responsibilities, concentration limits, transaction procedures, and documentation and review requirements. The policy should be flexible enough to allow exceptions, provided the reasons are well supported and any new direction is consistent with the overall strategic plan.
Best practices require that the board and the asset-liability committee of the borrowing bank routinely review the advance portfolio to ensure consistency with stated purposes. When staffers prepare reports for board review, they should provide sufficient detail to show whether the portfolio is performing as planned. Having a knowledgeable funding manager is very important, but a bank also needs to provide written evidence of sound management in its plans, policies and reports.
Regulators recognize that the reliability of wholesale funds, including advances, depends on the individual bank's financial strength. If a bank's condition deteriorates, examiners fear it will lose access to liquidity sources at the time of greatest need. However, this is not necessarily true for banks using an FHLB for backup liquidity.
As long as the troubled institution can provide collateral, its liquidity needs may be met. These members will, of course, face more stringent collateral requirements, additional monitoring, and fewer advance types available.
Regulators may challenge healthy banks on liquidity issues because borrowing growth impairs traditional liquidity measures such as the loans-to-deposit and dependence ratios. Bankers can combat this challenge by explaining that borrowing FHLB funds provides liquidity just as quickly as selling investment securities. When FHLB borrowing capacity is counted in the liquidity calculation, bankers can turn liquid assets on their books into higher yielding loan products. Is the bank leaving earnings on the table by carrying too much liquidity?
Examiners expect managers to document available borrowing capacity when counting it in their liquidity measures. Most FHLBs provide borrowing capacity reports to their members that include an estimate of available capacity, subject to underwriting.
Generally, an institution's borrowing capacity is limited primarily by its collateral level. Members may be able to add capacity by changing collateral programs or by adding different assets as collateral. Members can contact their FHLB credit department for additional information about collateral programs.
A strong cash budgeting program also eases regulators' liquidity concerns. …