CRO Outlook

The FHFA's New Vision: A Wonderful Life for the Federal Home Loan Banks?

FHLBanks have moved away from their intended mission as community-oriented mortgage lenders and are therefore in need of a revamp. The Federal Housing Finance Agency recently mapped out its plan for reforming FHLBanks, but while the regulator’s recommendations should move the needle, more revisions are needed.

Friday, December 15, 2023

By Clifford Rossi


Earlier this year, during the regional banking crisis, the banks in the Federal Home Loan Bank system (FHLBanks) suddenly found themselves at the center of controversy.

When several unstable commercial banks, including SVB, needed emergency liquidity, FHLBanks provided it. But in doing so, these government sponsored enterprises (GSEs) strayed far from their original mission, established roughly 90 years ago: to provide liquidity for residential mortgage lending, particularly for community-oriented lenders.

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FHLBanks are a collection of 11 GSEs that work in the shadows of their larger housing finance agency counterparts: Fannie Mae and Freddie Mac. Importantly, FHLBanks have a lucrative implied federal guarantee on their debt, which allows them to borrow at extremely cheap rates.

However, that guarantee is intended to help FHLBanks in their expected role as community-oriented residential mortgage lenders, rather than to provide liquidity (as we saw during the 2023 crisis) to desperate, flailing banks like SVB, Signature Bank and Silvergate Bank. Today, the “lender of last resort” job in the U.S. effectively belongs to the Federal Reserve, but FHLBanks co-opted that role earlier this year, even though its neither suitable nor appropriate under their current structure.

Recognizing this problem, the Federal Housing Finance Agency (FHFA) – the regulator of FHLBanks – recently laid out a set of reform recommendations. The FHFA’s proposed revisions would improve some of what ails FHLBanks, but only if they return to their original mission.

Before we explore suggested reforms for FHLBanks and recommend some additional enhancements, let’s quickly examine the evolution of these GSEs and the reason they are in this current predicament.

Identity Crisis

FHLBanks’ mission was initially established during the Great Depression, but they have been in search of a purpose for years in a housing finance system that has been transformed.

Mortgage securitization, which began its ascension in the 1970s, relegated FHLBanks to a lesser status in the housing finance system – and ever since they have been trying to find ways to elevate their relevancy. Dissimilar to their much larger GSE cousins, Freddie Mac and Fannie Mae, FHLBanks do not have the authority to securitize mortgages. Rather, they provide their 6,500 members (including banks, credit unions, insurers and community development financial institutions) with funding via advances – or secure loans largely collateralized by residential mortgages.

The muddling of FHLBanks’ mission may have reached its high-water mark during the 2023 banking crisis, when advances were doled out to the likes of SVB. But other factors – including the rise of nonbank lenders in the mortgage market and the broadening of activities permissible to FHLBanks’ member institutions – have also contributed.

Through their lending program to member institutions, FHLBanks provide a low-cost source of funding for activities. Originally, this funding was focused on supporting community-oriented mortgage lending – but, over the years, it has become increasingly more fungible for financing nonmortgage activities of member institutions.

Indeed, FHLBanks’ looser standards on member-eligible collateral and mortgage retention have led to more nonmortgage activities, funded at better terms than what otherwise would have been possible in capital markets for members.

This all leads to the major question about FHLBanks today: what exactly should be their mission, considering the very lucrative implied federal guarantee on their debt?

Six Suggestions to Revitalize FHLBanks

If there is a role going forward for FHLBanks, it must be worthy of their implied federal guarantee. Their original mission on financing community-oriented mortgage lending was an appropriate use of such a guarantee. In fact, it helped build the world’s leading housing finance system.

It therefore makes sense for FHLBanks to revert to their original objective – i.e., to focus on providing smaller community-oriented lenders with low-cost financing to promote homeownership opportunities for low- and moderate-income households.

What would need to be in place to make that a reality?

The FHFA’s report raised as considerations several of the recommendations I made in an earlier CRO Outlook column on restructuring and revitalizing the FHLBanks. That is heartening, but there is still much more work to do. FHLBanks could take a significant leap forward by adopting the following (expanded) recommendations:

  1. Provide low-cost financing to smaller depositories for low- and moderate-income residential and multifamily mortgage lending. One of the goals of FHLBanks should be to help those members better manage their risks. Advance rates, for example, could be set to benefit smaller member institutions (e.g., <$10B in total assets) in a tiered pricing structure based on asset size.

  2. Eliminate regional differences by consolidating the 11 FHLBanks into two or three. The FHFA report recommends that FHLBanks should be trimmed from 11 to eight, but a larger consolidation would be more beneficial. The cost structure of the current FHLBanks puts the system at a competitive disadvantage and reduces the potential for efficiency gains and innovation in their activities. The regional focus of the 11 FHLBanks is an anachronism that doesn’t work in today’s more integrated financial system.

  3. Prevent FHLBanks from providing emergency liquidity to members. It is important to remember that the FHLBanks have lobbied the FDIC to allow them to act as a de facto lender of last resort for failed banks, even though that runs counter to their original mission as community-driven mortgage lenders. In its report, the FHFA took a step in the right direction to address this problem by recommending that FHLBanks work with their members to develop mechanisms for accessing the Federal Reserve discount window.

  4. Strengthen FHLBank governance and risk management practices and infrastructure. The spring banking crisis put on display some of the concerns about the level of maturity of FHLBanks’ risk management practices. An emphasis should be placed on improving risk management reviews of each member’s financial strength and collateral requirements. Likewise, board eligibility and expertise must be reexamined. Enhanced governance and risk management practices would naturally evolve under a system consolidation plan.
  1. Abolish multi-district memberships. This would eliminate the potential for members to arbitrage FHLBanks. Disallowing membership in multiple FHLBanks would also reduce advantages of large members over smaller ones in the system.

  2. Restrict access to FHLBank membership to depositories or holding companies with depository subsidiaries. Eligibility requirements for membership should place a heavy emphasis on businesses that specialize in residential and multifamily lending.

Parting Thoughts

Before and during the 2023 banking crisis, FHLBanks provided much-needed liquidity to struggling institutions like SVB. In the process, they garnered more attention than they bargained for, and, importantly, strayed far away from their original purpose as community-based lenders of affordable residential mortgages.

That’s unacceptable for a group of 11 GSEs that benefit from an implied federal guarantee.

If the FHFA wants inspiration for how to remodel the FHLBanks, it needs to look no further than the “Bailey Brothers Building and Loan” company from Frank Capra’s It’s a Wonderful Life. That fictional lender went to great lengths to provide affordable mortgages to members of the local community, even at times when the business was struggling.

FHLBanks, in short, are in dire need of reform. To its credit, the FHFA realizes this, and has taken steps in the right direction with the recommendations it offered in its recent report. But more work is necessary.


Clifford Rossi (PhD) is the Director of the Smith Enterprise Risk Consortium at the University of Maryland (UMD) and a Professor-of-the-Practice and Executive-in-Residence at UMD’s Robert H. Smith School of Business. Before joining academia, he spent 25-plus years in the financial sector, as both a C-level risk executive at several top financial institutions and a federal banking regulator. He is the former managing director and CRO of Citigroup’s Consumer Lending Group.


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