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Asset/Liability Portfolio Risk & CECL

FHLB reform: Implications for financial institutions

Susan Sharbel
August 30, 2024
Read Time: 0 min

Prepare now for potential changes to FHLBs

Capital rules and membership criteria are among the areas where banks could see changes in how the Federal Home Loan Bank system operates. 

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Takeaway 1

The FHLB system faces potential changes in its structure, operations, and mission that could affect financial institutions.

Takeaway 2

Reform moves are stemming from actions of the FHFA against the San Francisco and New York FHLBs.

 

Takeaway 3

Banks should respond to the reform efforts to ensure contingent liquidity options will remain.

Wake of 2023 bank failures

Federal Housing Finance Agency review prompts reform

The Federal Home Loan Bank (FHLB) system faces potential changes in its structure, operations, and mission that could affect financial institutions. Capital rules and membership criteria are among the areas where banks could see changes.

The FHLB system reform is precipitated primarily by its regulator, the Federal Housing Finance Agency (FHFA), which is performing a deep dive into all aspects of the FHLB in the wake of some disturbing actions, specifically with four of the five failed banks just weeks or days before failure.

Other changes that could be on the horizon relate to the membership criteria. These could include potentially tightening or broadening access to FHLB advances, which could certainly affect the diversity and risk profile of the FHLB’s member base. Additionally, the conditions under which FHLBs provide advances to member institutions might be modified to better support the FHLB’s mission and respond to economic changes. This could involve changes in the types of collateral accepted, terms of advances, or “haircuts” on the value of collateral.

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Mission scrutinized too

FHLB changes focus on risk management

Initially, FHFA took action against the San Francisco and New York FHLBs based on their lending actions with four of the five failed banks in 2023 prior to closure. These FHLBs continued to lend to the member banks despite clear deterioration of their financial status. One failed bank received $5 billion on the last day it was open and another was rated high until the day before closure. This lack of communication between the FHLB and the Federal Reserve will clearly be a focus point in reform measures.

The FHFA’s review also assesses whether the FHLB is fulfilling its mission effectively.

The FHLB was established in 1932 during the Great Depression as a way to prop up a problematic housing market. However, there is a growing debate about whether the FHLB’s mission should be updated to better align with the current housing landscape and liquidity needs. Some stakeholders are advocating for a focus on affordable housing, community development, and supporting underserved communities.

Capital rules are also being reassessed for members and the FHLB themselves in an effort to ensure greater financial stability and risk management. Liquidity management policies of the FHLBs and members are under scrutiny to allow for better management of risks associated with market volatility and changing interest rates.

Currently, the FHFA has a “tangible capital rule” that restricts banks with negative tangible capital from obtaining new advances and existing advance renewals beyond 30 days without a regulatory waiver.

With investment portfolios under water, community banks would be hit especially hard if the waiver is eliminated altogether.

 

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Ensure contingent liquidity

How financial institutions should respond

Related to potential adjustments to the FHLB membership and mission, the move is toward having the Fed discount window be the first lender considered. Banks should investigate and establish credit lines with the Fed discount window now in case modifications in the FHLB's structure and operations adversely affect their contingent liquidity position.

Finally, we may see a consolidation of the 11 regional FHLBs to increase efficiency. These potential changes reflect the current dynamic environment; the FHLB system is being re-evaluated to ensure it remains relevant, efficient, and aligned with its mission. A bulletin from the FHFA is expected to be released soon.

This piece was created with the monitored assistance of generative AI.

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About the Author

Susan Sharbel

Senior Consultant
Susan Sharbel brings over 35 years of expertise in the banking industry, with a focus on asset/liability management and regulatory compliance. Prior to joining Abrigo, she was an ALM consultant leading ALM model implementations and managing the quarterly ALM process, support, and analysis for nearly 40 banking clients. As a

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Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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