By the end of last year, 1,295 commercial banks had taken an important step to safeguard earnings, manage interest rate risk, and enhance liquidity: They had joined the Federal Home Loan Bank System.

While thrifts had long been required to belong to the system, which now has 3,643 member institutions, commercial banks became eligible to join with the enactment of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989.

Many more banks should consider applying for membership. By lengthening the duration of liabilities, members protect their fixed-rate assets against an increase in interest rates.

The primary reason for becoming a system member is to gain access to a wide range of borrowings, called advances. These provide not only liquidity but also a means to fund various asset-liability strategies that can result in improved earnings with a manageable level of interest rate risk.

In Tune with Regulation

This focus on asset-liability management is very timely given current low rates and forthcoming regulations on the interest rate risk component of capital.

The Federal Deposit Insurance Corp. Improvement Act of 1991 directs each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk.

Final regulations and transition rules implementing that section of the law must be published by June 19. This proposal will require that additional capital be set aside by those institutions that are deemed to have a level of interest rate risk that is above the regulatory threshold.

Many institutions address asset-liability management primarily by putting on variable-rate assets or short-intermediate fixed-rate assets. This "asset" approach, while better than doing nothing, fails to address the liability side of the balance sheet.

These same bankers would probably say that they would love to be able to attract longer-term certificates of deposit, but that their customer base has been unresponsive to their efforts to obtain these types of deposits. in these types of deposits.

This situation lends itself very nicely to membership in the Home Loan Bank System.

Long-Term and Fixed Rates

Advances are available to member institutions in maturities ranging from overnight (variable rate) to 10 years (fixed rate).

The opportunity to borrow, for example, five-year fixed-rate advances at approximately 30 to 40 basis points over the comparable term Treasury provides the bank with the option of making a five-year or seven-year fixed-rate balloon loan or investment.

This advance-balloon strategy can achieve a spread between 150 and 200 basis points. The ability to essentially match fund a loan or investment portfolio and lock in a spread will keep a bank's interest rate-risk profile and net interest income at levels that are acceptable to regulators.

For longer-term maturities of five to 10 years the cost of advances has historically compared quite favorably to certificates deposit with comparable maturity.

Less Expensive than CDs

However, even with shorter maturities, those of six months to three years, the cost of Home Loan Bank advances has been less expensive than certificates of deposit. This is especially so when one considers the full cost of deposits, including deposit insurance premiums, advertising, and other overhead.

The ability to access these types of fixed-rate advances provides an exceptionally stable and cost-effective source of funds. Asset-liability managers are able to improve their institution's rate-risk profile while at the same time generating additional investment opportunities.

Given the current regulatory focus on interest rate risk management and its impact on capital adequacy, chief executive officers, chief financial officers, and asset-liability managers need to identify and utilize every resource that is available to them to improve the efficiency of their institutions' balance sheets.

Membership in the Federal Home Loan Bank System is a relatively new and important resource that addresses both liquidity and funding needs. This opportunity should be pursued by every bank that wants better control over its asset-liability mix.

Mr. Kaul, a former thrift regulator, is a senior member of the client service group of Sandler O'Neil & Partners, an investment banking firm in New York.

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