Why It Matters

A recent Congressional Research Service report on the Federal Home Loan Bank system examines a longstanding tension over whether the system primarily supports housing finance or increasingly serves as a general source of wholesale funding for member institutions. Congress created the system in 1932 to address liquidity shortages experienced by mortgage lenders during the Great Depression. Today, FHLB advances can provide members with relatively low-cost funding even when those institutions are not principally engaged in residential mortgage finance.

The debate has become more significant as nonbank mortgage companies have taken a larger role in mortgage origination and servicing but generally remain ineligible for FHLB membership. The report said many nonbanks cannot join because they lack a primary federal or state prudential regulator and would generally lack a designated conservator or receiver in the event of insolvency. Mortgage servicing rights also are not eligible collateral for FHLB advances.

The issue presents Congress with competing considerations. Expanding membership could give mortgage-focused nonbanks another source of liquidity, while allowing institutions without comparable prudential supervision into the system could expose individual FHLBs and their members to additional risk. CRS says expanding membership to these firms would require congressional consideration.

The Big Picture

The system’s shift toward a broader membership base began before 1999. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 expanded FHLB eligibility to all federally insured depository institutions provided at least 10% of their assets were mortgages. The Gramm-Leach-Bliley Act of 1999 then reduced barriers that had limited commercial bank participation by removing the 10% mortgage-asset requirement and allowing certain agricultural and small-business loans to serve as collateral.

Those changes contributed to the current policy debate. The report said it is unclear whether FHLB advances specifically facilitate mortgage funding or effectively provide member institutions with general wholesale funding at below-market rates because institutions generally fund their overall asset portfolios rather than particular loans individually. FHLB advances can be used for routine funding and are generally less expensive than market repurchase agreements.

The system’s role during periods of banking stress has also drawn scrutiny. In March 2023, access to FHLB advances did not prevent member banks from becoming insolvent. The report cited Silvergate Bank, Silicon Valley Bank and Signature Bank in discussing large FHLB advances around the banking turmoil. The FHLB of San Francisco had reported $13.5 billion in advances to Silicon Valley Bank. The report noted that unlike the Federal Reserve, the FHLBs cannot provide unlimited liquidity during a crisis because they must raise money by issuing consolidated debt obligations before lending those funds to members.

Nonbank mortgage firms remain on the other side of the membership divide. Many lack the prudential supervision required of traditional FHLB members. Even if Congress expanded eligibility, some nonbanks could still face difficulty obtaining advances because mortgage servicing rights are not accepted as collateral and can experience substantial changes in value. The report noted that MSR values fell between 50% and 60% during March and April 2020.

Mortgage real estate investment trusts previously gained access to the system by establishing captive insurance companies. The Federal Housing Finance Agency ended that practice in 2016, determining that captive insurers should not be treated as eligible insurance companies for membership and requiring existing captives to leave the system by early 2021. FHFA said the arrangement allowed otherwise ineligible entities to use captive insurers as conduits for FHLB membership.

Treasury recommended in 2019 that FHFA consider whether expanded access for captive insurers and nonbanks might be warranted under certain circumstances. FHFA’s subsequent comprehensive review concluded that ineligible institutions typically lack prudential safety-and-soundness requirements, community support requirements and housing-related asset or activity requirements.

FHFA has also outlined other potential changes to the system. The agency has considered seeking congressional authority to consolidate and reorganize FHLB districts and to prescribe compensation levels or ranges for FHLB executives. Potential regulatory changes include enhanced stress-testing requirements intended to ensure that the banks maintain adequate capitalization.

The Bottom Line

The report identifies an unresolved tension between the FHLB system’s original housing mission and its modern role as a source of wholesale liquidity. The report said many eligible institutions are not principally engaged in residential mortgage finance, while some nonbank companies heavily involved in mortgage finance cannot become members because they lack comparable prudential regulation.

Congress could consider whether to broaden membership, change collateral requirements or leave the existing framework intact. The report did not recommend a particular approach. It instead identifies the trade-offs involved in expanding liquidity access while protecting the financial condition of the FHLBs and maintaining the system’s housing and community development mission.

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