EcoTV Week

Federal Home Loan Banks: their support for bank liquidity called into question


The FHFA recently proposed reforming the Federal Home Loan Banks, which are accused of having taken on the role of lender of next-to-last resort, a role that was much too big for them.


In the US, there is still an ongoing debate about the bankruptcy of the Silicon Valley Bank.

Besides the issues about banking regulation and supervision, the role played by the Federal Home Loan Banks is a subject of fierce debate.

The Federal Home Loan Banks are private credit cooperatives commissioned by the Federal State to support residential housing finance via secured loans to banks of their network. They shared the same status as Fannie Mae and Freddie Mac the two main mortgage refinancing agencies.

So, they benefit from an effective guarantee of the US Treasury. Because of this guarantee, they can seek financing from a wide base of investors at very good rates.

However, their regulator, the FHFA, considers that they are playing too large a role being 'lender of next-to-last resort'. They are criticized for having, prior to the bank run last Spring, kept afloat banks which had big financial issues; for preventing the Federal Reserve

from playing its role of lender of last resort and for having increased the cost of banks' bankruptcies.

The secured loans provided by the Federal Home Loan Banks to their members come with repayment priority superior to any other debt.

The resultant moral hazard may discourage them to ensure that their borrowers are financially healthy because if one of them goes bankrupt, they are fully reimbursed.

The FHFA intends to rectify these distortions, to refocus the Federal Home Loan Banks on their primary mission.

But interfering with their ability to support banks' liquidity may present risks.

First, the stigmatisation associated with the discount window of the Federal Reserve discourage major banks to use this service. An existing alternative, even imperfect, might seem appropriate.

Then, it could drain the market of federal funds on to which Federal Home Loan Banks are very active. And it could structurally increase banks' central bank money needs.

The availability of secured loans provided by Federal Home Loan Banks has become a determining factor of the demand for reserves at the central bank.