Late last year, the Federal Housing Finance Agency (FHFA) released a study proposing potentially harmful reforms to the Federal Home Loan Bank (FHLB). Of particular importance are measures that could dissuade larger banks from becoming members of the FHLB system, which would only undermine the system's ability to offer reliable low-cost liquidity. Despite being the FHLB's chief regulator, the FHFA fundamentally misunderstands what makes the FHLB so integral to small and local banking. In a new study published this week, the American Consumer Institute (ACI) helps set the record straight.
The FHLBs are government-sponsored enterprises (GSE) charted as cooperatives, and this is important to understand as their members are American banks, both large and small. The GSE moniker comes from its founding by President Hoover as an entity tasked with protecting the U.S. housing market as well as ensuring a vibrant banking system.
Though its membership has expanded beyond traditional Savings and Loan banks, which comprised the bulk of the housing market during the first half of the century, the FHLB's role has not changed, and for good reason. The FHLB remains focused on supporting housing and community development that the financial sector relies on. By law, each FHLBank must contribute 10 percent of its net income to its Affordable Housing Program. However, according to the Council of Federal Home Loan Banks, all 11 FHLBs have voluntarily agreed to increase their contribution amount to 15 percent, which will dedicate $1 billion to affordable housing and community development initiatives this year.
Due to its unique private debt solicitation system, the FHLB can afford generous housing programs without costing taxpayers a dime. Because FHLBanks have a statutory super-lien, preceded by a uniform commercial code, they have priority as a secured lender. Thus, their advances are highly secure, making their debt securities extremely low-risk and attractive for investors, which include states and municipalities, pension plans, and private investors.
Funds acquired through the private sale of highly secure debt go towards providing liquidity to mostly medium-sized and smaller banks. Bank call reports show that lenders with assets between $10 billion and $250 billion, or between $1 billion and $10 billion, are the first and second most consistent users of FHLB liquidity.
The quick use of advances helps stabilize the small and medium local banking sector, which otherwise may find it harder to compete against large banks with deeper coffers. For instance, a study by Moody’s and the Urban Institute found a positive relationship between FHLB advances and a bank's long-term stability, proving that the FHLB provides systemic financial stability to these institutions.
Another part of this story is the integral role of large banking members in the FHLB system. Because the system is privately funded, large banking institutions with access to large amounts of liquidity play an essential role in market stability. If the banking system were only made up of small-to-medium-sized banks, the FHLB system would neglect a massive part of the market, making acquiring liquidity far more tenuous. This is because large banks have large pools of liquidity, which the FHLB would otherwise lack without access to this liquidity. The FHLB creates cohesion between the interests of both large and small banking institutions.
Essentially, the bigger institutions borrow more, which allows the debt issuers, the Office of Finance, to obtain the right price, and since all members are treated equally in the FHLBank system, that creates scale for the community-based lenders who would otherwise not have access to the global debt markets. Therefore, proposals to limit FHLB membership and utilization could unnecessarily undermine this cohesion, divide the banking sector, and further drive up the cost of housing for the average consumer.
The FHLB already provides disproportionate assistance to small-to-medium-sized banks when comparing the everyday use of advances. Removing large banks or limiting their involvement as members is unnecessary. The FHLB can help smaller banks and assist large ones if regulators and policymakers allow it.
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