092117 WP MMFs and FHLB 1

The Real Story Behind the Surge in FHLB Advances: Macroprudential Policy Changed How Banks Borrow

Sep 21, 2017

In the wake of the 2008 global financial crisis and ensuing regulatory reforms, U.S. banks dramatically altered their sources of funding. Funding from non-deposit sources now accounts for only 13 percent of bank liabilities, compared with more than 30 percent 10 years ago. However, bank funding from Federal Home Loan Banks (FHLBs) has not followed suit. As government-sponsored enterprises (GSEs) charged with supporting housing and community investments, FHLBs are financed mainly by issuing notes and bonds implicitly guaranteed by the U.S. Government. Financial institutions (e.g., savings and loans and commercial banks) that are members of the FHLB system are eligible for FHLB loans (“advances”). Although FHLB advances to banks fell for a time following the crisis, they began to rise rapidly beginning in 2012, roughly doubling in the five years leading up to 2017.

Banks have doubled their borrowings from FHLBs in the past five years. FHLBs are now the source for roughly one-quarter of all bank non-deposit liabilities.

Money market fund reforms designed to strengthen financial stability may have unintentionally exposed taxpayers to potential banking system losses. The reforms have allowed large banks to obtain safer funding with advances from FHLBs instead of relying on other non-deposit instruments such as repurchase agreements. However, taxpayers could be required to bail out FHLBs in the event of a liquidity crisis.

The increase in banks’ FHLB borrowing is part of a broader transition to be less reliant on short-term (non-deposit) sources of financing. This change in funding structure has made the banking system safer. However, FHLBs now incur more refinancing risk.

In this paper, we show that the use of FHLB advances accelerated following regulatory changes to money market funds. These regulatory changes lowered the cost of FHLB advances, and also had the effect of shortening the maturity of FHLBs’ obligations to satisfy the needs of MMFs. We conclude with some policy considerations.