Can Federal Home Loan Banks effectively self-regulate lending to influential banks?

Abstract

In principle, the threat of partial or full revocation of the Federal Home Loan Bank (FHLB) System’s charter by Congress should limit advances (collateralized loans) by FHLBs to member banks with high risks of failure that increase potential losses to the Deposit Insurance Fund. In practice, even as the risk of insolvency became apparent in the financial crisis, FHLBs renewed and in some cases increased lending to several large-bank members that eventually failed. We argue FHLBs continue to lend to large risky members both because the cooperative structure enables these banks to exert significant influence over their FHLBs, and because the risk of insolvency can be difficult to assess. Policy makers should consider regulatory or supervisory measures that limit the use of advances by large-bank members.