Federal Home Loan banks must offer market-rate replacement refinancing when recalling "putable" advances, according to rules approved Tuesday by the Federal Housing Finance Board.
Putable advances are low-interest loans that can be terminated before the maturity date. Several of the system's 12 banks began offering the advances in 1993, but Finance Board rules did not cover them.
The new rules will be effective 30 days after being published in the Federal Register.
By passing on interest rate risk to members, putable advances allow Federal Home Loan banks to charge rates well below the market. If interest rates rise, the loans are likely to be recalled.
The new rules also require a Federal Home Loan bank to disclose in writing that a borrower's liquidity could be damaged by a recall. In addition, the bank must spell out interest rate conditions most likely to spur a recall.
Federal Housing Finance Board Chairman Bruce Morrison praised putable advances as a useful tool for cutting the cost of funds for members, but warned of inherent risks.
"We don't want a liquidity squeeze with member banks," he said. "We felt we needed some clarity as to the rules of the game."
To protect borrowers from market risk, the rules would allow a member to choose at the time of origination whether replacement financing will be offered at a pre-determined rate or at the prevailing rate when a loan is recalled.
The maturity date for replacement financing will also be negotiated when a loan is recalled.
"This enhances members' flexibility," Mr. Morrison said.