One of the takeaways from the spring 2023 bank failures was a more concerted, and more public, effort to limit the lending activities of the Federal Home Loan banks, unnecessarily so in our view. There are different "flavors" of the
The list goes on. But there are two overarching, albeit understated, rationales for restricting Home Loan bank lending.
The first has to do with the banks' role as a liquidity provider. The Home Loan banks' primary business is to provide liquidity to members through secured loans, known as advances. To fund these advances, the banks issue consolidated debt in the public markets, generally at below-market rates. The Home Loan banks enjoy these favorable rates because investors perceive that their obligations are backed by the federal government and because all the banks are jointly and severally liable for the debt that any one of them incurs. Critics point to the so-called risks of this model: Inadequately overseen and operated, the banks, armed with large amounts of debt that implicitly carries the full faith and credit of the United States, can act fast and loose with extending credit and ultimately may destabilize the financial system as a whole.
The second relates to the Home Loan banks serving as the de facto lender of last resort to troubled institutions. Although the Federal Reserve wants the discount window to officially serve as such, financial institutions often turn to Home Loan banks first for liquidity during market turmoil, as demonstrated by the preference for advances during the early years of the 2008 financial crisis and throughout the spring 2023 bank failures. This frustrates some who believe the Home Loan banks are competing for the role that the Federal Reserve was expressly established to fulfill.
We do not want to suggest that these criticisms carry no merit. We acknowledge that the Home Loan banks have a tremendous amount of borrowing power. And, as illustrated by Silicon Valley Bank's struggles with obtaining additional advances on its final day, there are real structural limitations to the Home Loan banks acting as a lender of last resort. It makes sense to ensure that they are using this lending authority prudently and to advance the goals of the Federal Home Loan Bank System. Indeed, just last year, the Federal Housing Finance Agency, which supervises the system, proposed initiatives to make some improvements, like strengthening its oversight of the banks' credit risk management and capital management practices.
The finalized rule adds flexibility to the capital rules applied to the Federal Home Loan banks to help them extend credit to their members.
While there certainly are enhancements that can be made, as there are everywhere, it would be foolish to curtail the Home Loan banks' major lending activities just because the oversight of the system can be improved. The banks provide a valuable service for their approximately 6,500 members — many of whom are smaller regional or community banks. Home Loan banks support member banks' routine operations and lending activities, particularly in the areas of housing finance and community investment. That matters for our nation's economy and Main Street.
With any other funding source, the regulators may ask a bank to justify their reliance on the Home Loan banks with "experiential data." Experience shows the Home Loan banks have been a reliable source of low-cost funding for their members for nearly 100 years. The ability of members to benefit from the system's favorable debt issuance costs should be preserved, not discouraged.
During times of stress, the discount window simply is not ready to replace Home Loan bank advances for banks' emergency liquidity needs. There are real challenges with accessing the discount window, including a stigma that may exacerbate investor or depositor fears, its operational limitations and its history of providing only short-term funding.
Until these challenges are addressed, Home Loan bank advances are a viable option. And, we are not saying the system should replace the Federal Reserve as the lender of last resort. Rather, both entities should improve existing mechanisms so they can better work together. The Home Loan banks can (and do) support discount window operations by enabling members to repledge excess collateral to the Federal Reserve to secure funding from the discount window. The prudential regulators also can (and do) communicate with the Home Loan banks about institutions undergoing severe stress and when further advances to the institutions would be inappropriate.
Diversity of reliable funding sources is the priority for any financial institution seeking to define a sound liquidity plan. Let's not try to frustrate this goal by taking one off the table.
