Will scrutiny of the Federal Home Loan Bank System lead to change?

At least 100 community banks claim they could face a liquidity crisis in the future because of a rule that essentially prohibits banks with negative tangible capital from tapping the Federal Home Loan Bank system for low-cost funding. If the rule is not changed, banks with negative tangible capital would have to pay far more for deposits and funding would not be instantaneous. 


Banks that report negative tangible capital are required to get a waiver in writing from their prudential regulator in order to access low-cost advances from the FHLB system. The FHFA's tangible capital rule restricts banks with negative tangible capital from tapping both new FHLB advances and from renewing existing advances beyond 30 days unless the bank's prudential regulator agrees to a waiver. 


Community bankers have urged the FHFA to consider issuing an interim final rule to waive the requirements in the short-term of the tangible capital rule while the agency considers a more permanent fix. The FHFA's tangible capital rule dates back to 1994 — put in place after the last savings and loan crisis. Still, bankers argue that prudential regulators finalized Basel III capital rules in 2013 that changed the regulatory framework for how tangible capital is calculated resulting in FHFA's rule being out of sync with prudential regulators.  



The American Bankers Association, Independent Community Bankers of America and nearly 75 state bank trade groups want FHFA Director Sandra Thompson to align the FHFA's rule with the Tier 1 capital rules used by prudential regulators. The FHFA has not yet indicated whether it will adopt those changes. 

A key bone of contention in the review of the Home Loan banks is why the system's membership excludes nonbank mortgage lenders that currently dominate the housing market. 


Bob Broeksmit, president and CEO of the Mortgage Bankers Association, has called for independent mortgage bankers to be allowed into the FHLB system as members since nonbanks have supplanted banks in the past decade and now originate the vast majority of home loans.  


"New classes of members would increase FHLB advances and earnings," Broeksmit said in September at a listening session hosted by the FHFA.  



Bankers generally oppose allowing nonbanks into the system. Because Congress would have to approve any change to FHLB membership, many think this aspect of the debate is unlikely to lead to any change going forward.



Yet critics have argued that the Home Loan Bank system has become irrelevant in the housing markets. The secondary mortgage market is dominated by Fannie Mae and Freddie Mac, the two other, better-known government-sponsored enterprises. Some suggest the Home Loan banks are unnecessary due to the creation of the Federal Deposit Insurance Corp. 



The Home Loan banks essentially operate as a "banker's bank," with its members pledging mortgages as collateral to obtain funding in the form of "advances," or loans with variable rates and terms. The Home Loan banks issue securities that come with a government guarantee, which has also become an issue since taxpayers are essentially subsidizing the system's bonds with an implicit government guarantee in the event of a default. Like Fannie Mae and Freddie Mac, they are government-sponsored enterprises regulated by the Federal Housing Finance Agency.

Some critics have argued that the FHLB system is a form of corporate welfare because the largest users of the system are big banks and insurers with ample funding through the capital markets. Critics also claim the Home Loan Bank system has an inherent conflict between its public goals and private incentives. 


Some critics have questioned whether the Home Loan banks are fulfilling their mission of supporting the housing markets when they largely provide large institutions, which have ready access to capital markets and cheap funding. Though community bankers claim they need the FHLB system for low-cost funding and balance sheet management, the top 10 banks accounted for 70% or more of advances last year at five of the 11 Home Loan banks, according to the FHFA's annual report to Congress. 



Moreover, the top borrowers are not community or small banks, but rather giant, well-capitalized firms. New York insurance giant MetLife, with $760 billion of assets, was the largest user of FHLB advances in 2021, followed by the $59 billion-asset New York Community Bancorp in Hicksville, New York. Other top borrowers include JPMorgan Chase, with $3.8 trillion of assets; the New York pension giant TIAA, with $346 billion of assets; and Midland Financial, the holding company for the $32.1 billion-asset MidFirst Bank in Oklahoma City, Oklahoma. At least one former FHLB director, Cornelius Hurley, an adjunct professor at Boston University School of Law and a former independent director of the Federal Home Loan Bank of Boston, dropped a bombshell in November by estimating the system's members receive $5 billion a year in public subsidies in the form of a government guarantee on agency bonds. Hurley based the estimate on the Home Loan banks' current $1 trillion in outstanding debt with a 50-basis-point "benefit" attributed to the government guarantee. No one has yet disputed the $5 billion figure. 



"The mission was never" for the Home Loan banks "to be a central bank for privately owned banks," Hurley has said. "It's nice to have a taxpayer-subsidized low-cost funding facility. But if we're going to have that, we need a substantial reward for our investment. Acting as a source of liquidity for private banks is a private benefit, it's not a public benefit."