FHLBanks: The Advantages of Advances
History has shown that the use of FHLBank advances reduces risk, especially for small banks, in both times of stability and crisis. While most sources of funding proved unreliable during the financial turmoil that began in 2007, the FHLBanks demonstrated their reliability as liquidity providers notwithstanding tremendous market dysfunction and extreme stress. This is a role that the FHLBanks have performed repeatedly since they were established by Congress in 1932.
In an extensive study performed by the Federal Reserve Bank of New York, researchers found that, during the financial crisis, the Federal Home Loan Bank System was “by far, the largest lender to U.S. depository institutions while most of the Federal Reserve’s liquidity operations have been for the benefit of non-depository institutions or foreign financial institutions.”
Not only do advances serve an instrumental role in helping banks with their liquidity needs, the variety of advance products, programs, and tenors enable member banks to manage interest-rate risk.
The FHLBanks are able to grow or contract to meet member demand for advances in financial panics because of the following:
• Active and continuous market presence ensures investor awareness
• Unique funding and capital structure is designed to fulfill its legislative mandate in all economic scenarios
• Investor preference shifts from lower-quality and risky investments to higher-quality, low-risk instruments, including FHLBank debt (Consolidated Obligations) during market distress
Throughout the financial crisis, the FHLBanks accessed the debt markets continuously, and, as a result, reliably provided essential liquidity to members in the form of advances.
In a future rising interest-rate environment, FHLBank advances will continue to play an important role in helping banks control their asset-liability and liquidity exposures.