What it means
The law was passed during the Great Depression, when thousands of lenders were short of cash and mortgage credit was drying up. Savings institutions had lent long-term to homebuyers but funded themselves with deposits that could be withdrawn on demand.
The Act set up regional reserve banks that could lend to them against collateral, so they could meet withdrawals without selling loans at a loss. The structure is cooperative.
Banks, savings institutions, credit unions and insurers become members and buy stock in their regional bank, and the regional banks raise money by issuing debt in the capital markets. The debt is sold at rates close to government agency levels, and the banks pass that advantage on to members as lower-cost loans.
For members, an advance is a flexible funding tool with terms from overnight to many years. Advances are secured by high-quality collateral such as mortgages, and the borrower pays interest at a rate based on the system's own funding costs plus a margin.
A bank with a long-term fixed-rate loan book can match it with a long-term advance, which reduces interest rate risk. The Act has been amended several times, and later laws widened membership, added affordable housing programmes and changed oversight.
Regulation was moved to a separate federal housing finance agency after the financial crisis of 2008. The core idea, a wholesale funding source for lenders that support housing, has remained.
For a finance professional, the Act explains why many community banks have access to funding that does not depend on deposits alone, a point that comes up whenever housing finance is reformed. It also shows how the government has supported housing credit without lending to homebuyers directly.
Some critics argue that the system's low-cost funding encourages members to borrow more than they need.
In practice
Real-world examples.
Example
A savings bank with $400,000,000 of deposits sees withdrawals jump after a local factory closes. It takes a 90-day advance of $15,000,000 secured by its mortgage portfolio. The advance gives it time to raise deposits without selling loans at a loss. When deposits recover, the bank repays the advance and the pledged loans are released.
Example
A small insurer joins a regional Federal Home Loan Bank to access low-cost long-term funding. It pledges eligible mortgage securities and borrows $8,000,000 for 5 years to match a portfolio of long-dated liabilities. The finance director records the advance as secured debt on the balance sheet.
Example
A credit union wants to offer 15-year fixed-rate mortgages without funding them with short-term deposits. It takes a matching 15-year advance for each pool of new loans. The match protects its margin if deposit rates rise. The credit union's board reviews the amount of advances against its policy limits each quarter.
Formula
Calculation
Net spread earned = (yield on loans funded - cost of advance) x amount funded
Suppose a community bank borrows a $10,000,000 advance at a cost of 4.5% and uses it to fund fixed-rate mortgages that earn 6.5%. Interest cost = 10,000,000 x 0.045 = $450,000 a year. Interest income = 10,000,000 x 0.065 = $650,000. The bank's gross spread = 650,000 - 450,000 = $200,000 a year, or 2.0% of the amount funded, before credit losses and operating costs.Case study
Seen in the real world.
Cedar Hollow Savings is an illustrative, fictional community lender with $250,000,000 in assets. Most of its loans are 30-year mortgages, but most of its funding is savings deposits that customers can withdraw at any time.
When market rates rise, depositors move money to higher-paying products, and the bank's funding cost climbs faster than its mortgage income. The chief financial officer arranges a $20,000,000 advance for 7 years at a fixed cost to match part of the mortgage book.
The advance locks in the funding cost on 8% of assets, since 20,000,000 / 250,000,000 = 8%, and steadies the bank's earnings in this illustrative case. The lesson is that the system's purpose, as set out in the original law, is to help lenders match long-term assets with stable funding. The board also sets a limit on how much of the balance sheet can be funded this way, so the bank does not depend on a single source.
Watch out
Common mistakes.
- Thinking the Act created a lender to homebuyers, when it created banks that lend to financial institutions.
- Assuming the system is paid for by taxpayers, when the regional banks raise their own funds in the debt markets.
- Treating the 1932 law as unchanged, when later laws have widened membership and changed oversight.
Questions
People also ask.
When was the Act passed?
It became law in 1932, in the middle of the Great Depression.
Who can borrow from a Federal Home Loan Bank?
Eligible members, including banks, savings institutions, credit unions and insurance companies.
What is an advance?
It is a secured loan from a regional Federal Home Loan Bank to a member institution.
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