The Federal Home Loan Banks and Commercial Bank Risk Taking: An Overstated Moral Hazard?

Abstract

Recent attention has been focused on how Federal Home Loan Bank lending to commercial banks may create a new significant risk exposure to the Federal Deposit Insurance Corporation. This concern is prompted by the potential moral hazard created by the FHLBank policy of lending at one rate, its government sponsored enterprise status, and its preferential rights as a secured creditor in receiverships, often referred to as the super-lien. We argue, however, that this moral hazard is overstated because the Federal Home Loan Banks have an incentive to carefully monitor their borrowers based on their rights as a secured lender under the Uniform Commercial Code - that are not mitigated by the super lien. Consequently, the FHLBanks carefully underwrite advances and make adjustments to pricing based on risk - often through collateral valuation that effectively prices credit risk for FHLBank borrowers. We provide empirical evidence to support the claim that ex-ante and ex-post members are no riskier than non-members.