What it means
Each of the eleven regional banks is owned by its members, which must buy stock in the bank they belong to. The banks raise money in the capital markets by issuing debt that investors treat as having an implied link to the government, so they can borrow cheaply and pass part of the benefit on to members.
The central product is the advance, a loan with terms ranging from overnight to many years. A community bank might take a short advance to cover a temporary shortfall in deposits, or a long fixed-rate advance to match the term of mortgages it has just made.
Members pledge collateral, usually residential mortgages, and borrow a percentage of its value. Advances matter most when money is tight.
During banking stress, FHLB advances have often acted as a backstop for institutions that could not easily borrow elsewhere. This role means the system's lending tends to rise when other funding sources become expensive or hard to reach.
The system also runs programmes that fund affordable housing and community development, using part of its earnings. Members can apply for grants and subsidised funding on behalf of local projects.
Because these programmes depend on the system's profits, they are one reason the banks hold large capital buffers. Supervision comes from the Federal Housing Finance Agency, which examines the banks for safety and soundness.
For an outside observer, the FHLB's financial reports offer a useful gauge of how much funding stress is in the banking system at a given moment. Because members must buy stock in proportion to their borrowing and assets, the banks hold a capital base that grows with demand for advances.
Dividends on that stock are a source of income for members, which gives them a reason to keep using the system. The structure aligns the interests of the borrowers with the strength of the lender, much like a cooperative owned by its customers.
In practice
Real-world examples.
Example
A regional bank sees deposits fall after a competitor launches a high-rate savings account. It takes a 90-day advance of $25,000,000 from its FHLB, which gives it time to adjust its own deposit pricing and rebuild its funding base without selling any loans.
Example
A credit union originates 30-year fixed-rate mortgages and worries about the mismatch with its short-term funding. It borrows a long-dated advance to match the loan terms, which locks in its margin and removes the need to refinance its funding every few months.
Example
An insurance company that is a member of its regional bank uses advances as a secondary source of liquidity. It pledges high-quality securities as collateral rather than selling them in a falling market.
Formula
Calculation
Maximum borrowing against collateral is found by applying a haircut (a discount that protects the lender):
Borrowing capacity = Collateral value x (1 - Haircut)
A community bank pledges $80,000,000 of residential mortgages to its regional FHLB, which applies a 25% haircut. Borrowing capacity is $80,000,000 x (1 - 0.25) = $80,000,000 x 0.75 = $60,000,000. If the bank borrows $45,000,000 now, it still has $60,000,000 - $45,000,000 = $15,000,000 of unused capacity.Case study
Seen in the real world.
Cedarline Savings is an illustrative, fictional community bank that wrote a large volume of fixed-rate mortgages during a period of low interest rates. When rates rose, its deposit costs climbed quickly while its mortgage income stayed fixed, and its margin shrank.
The treasurer arranged a series of longer-term advances from the regional FHLB to reduce its dependence on volatile deposits. She pledged mortgages as collateral and matched the maturities of the advances to the expected life of the loans.
In this illustrative story, margin stabilised and the bank avoided selling assets at a loss. The treasurer also noted that advances were not free money: the collateral was tied up, and the bank had to monitor the haircut, which could change.
Watch out
Common mistakes.
- Thinking the FHLB lends directly to homebuyers, when its customers are member institutions, not the public.
- Assuming FHLB debt is guaranteed by the government, when it has an implied link rather than an explicit guarantee.
- Treating advances as unlimited funding, when capacity depends on collateral quality, haircuts and the member's financial health.
Questions
People also ask.
How many Federal Home Loan Banks are there?
There are eleven regional banks, each serving members in a defined group of states.
Who can join the system?
Banks, thrifts, credit unions, insurance companies and certain community development financial institutions that meet membership rules, provided they buy the required stock in their regional bank.
Why are advances cheaper than other borrowing?
The banks can raise money cheaply in the bond market because investors see the system as very safe, and that saving is passed to members.
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