October 18, 2017

### The Increased Role of the Federal Home Loan Bank System in Funding Markets, Part 2: Recent Trends and Potential Drivers1

The FHLB system's balance sheet: 2000 to the present
Figure 1 shows the evolution of the combined FHLB system's assets; the left panel shows dollar amounts and the right panel shows percentage shares. About two thirds of FHLBs' assets are advances to members, shown in dark purple. In addition to advances, FHLBs' assets include securities, shown in light purple, which are mainly mortgage-related and, on average, make up about one-fifth of their assets.1 They also hold some liquid assets, including about 7.5 percent of their assets in federal funds, to meet regulatory required contingent liquidity buffer.

The left panel shows that during the first part of the last financial crisis, the FHLB system acted as a lender of next-to-last resort by providing significant funding to FHLB members at a time of severe market stress. FHLBs' advances increased by 50 percent between 2007 and fall 2008, as FHLB members encountered severe difficulties accessing other sources of wholesale funding upon which they had become heavily reliant. FHLB system assets started to contract in the fall of 2008 as members started to use funding provided by the Treasury and the Federal Reserve System. Advances have grown fairly steadily since about 2012 and recently surpassed their pre-crisis level.

##### Figure 4: Money funds and FHLB debt

The money fund reform seems to have given FHLBs a further advantage in their funding costs relative to financial institutions that relied on funding from prime money funds. As shown by the red line in Figure 5, the weighted average rate on FHLB debt held by money funds as of the end of February 2017 was about 10 basis points below that of prime money funds, denoted by the dashed black line.7 As a result, for financial institutions it might have become cheaper to receive funding intermediated by FHLBs than funding from money funds.

##### Figure 5: Weighted average yield on instruments held by money funds

In this part we highlighted some of the recent developments in the FHLB system. Part 3 discusses the implications of these developments for financial stability

1. Authors: Stefan Gissler and Borghan Narajabad (R&S). We would like to thank Alice Moore and Erin Hart for their research assistance, and Celso Brunetti, Mark Carlson, Burcu Duygan-Bump, Joshua Gallin, Diana Hancock, Lyle Kumasaka, Andreas Lehnert, Laura Lipscomb, Patrick McCabe, Michael Palumbo, John Schindler, and Lane Teller for useful comments and insightful discussions. The views expressed in this paper are solely those of the authors and do not necessarily reflect the views of the Board of Governors of the Federal Reserve System or its staff. Return to text

2. The composition of the balance sheet differs across FHLBs and therefore the share of the securities portfolio may be rather small (such as for FHLB New York) or more than one third of the balance sheet (such as for FHLB Chicago). Return to text

3. Borrowing money from an FHLB will increase the bank's net cash outflow by a negligible amount because of the favorable run-off rates applied to FHLB advances due within 30 days. FHLB advances secured by Treasury securities do not count toward outflows. For advances backed by Agency securities, 15 percent of the amount is treated as a cash outflow. The assumed run-off rate for other advances is 25 percent. It is worth noting that the LCR assumptions might be at odds with FHFA's liquidity assumptions. FHFA requires FHLBs to maintain sufficient liquidity to meet the following scenarios: (i) an inability to access debt markets for five days, with all maturing advances renewed except those for very large, highly rated members; and (ii) inability to access debt markets for 15 days, with no maturing advances renewed. (See FHLB 10K filings under "Liquidity Requirement.") However, the LCR gives favorable treatment to the net cash outflow of FHLB advances. That is, the LCR assumes that the big banks will be able to renew most of their FHLB advances even as FHFA seems to assume they might decide not to. Return to text

4. This type of lending by FHLBs is different from the original intended role of FHLBs as credit enhancers for their members. While FHLBs continue to provide critical funding for their smaller members, it is a relatively volatile business. In contrast, lending to LCR members appears to generate more stable interest income. This results in more stable dividends for all FHLBs' members. For this reason even (non-borrowing) small members of FHLBs are interested in increasing advances to large LCR members. Note that FHLB charters provide each member with a single vote, independent of their equity share. Thus, the incentives of small members are essential for understanding FHLBs' decisions. Return to text

5. Almost all of the FHLB debt held by money funds belong to government money funds. About 30 percent of government money funds' two trillion dollar portfolios is invested in FHLB debt. Return to text

6. The share of FHLB discount notes held by money funds is not much higher than its historical levels. However, the share of FHLB bonds held by money funds has more than doubled in the past two years. Return to text

7. Money funds must keep the WAM of their entire portfolio, the black line in the right panel of Figure 6, below the SEC's regulatory limit of 60 days. When money funds held smaller amount of FHLB debt, their FHLB debt holding had a long WAM. As the share of FHLB debt in money funds' portfolio has risen, money funds have shortened the WAM of their FHLB debt holding, to keep the WAM of their entire portfolio low. Return to text

8. As a reference, the black line shows the weighted average yield of government money funds. Return to text