Finance and Economics Discussion Series (FEDS)
August 2007
Federal Home Loan Bank Advances and Commercial Bank Portfolio Composition
W. Scott Frame, Diana Hancock, and Wayne Passmore
Abstract:
The primary mission of the 12 cooperatively owned Federal Home Loan Banks (FHLBs) is to provide their members financial products and services to assist and enhance member housing finance. In this paper, we consider the role of the FHLBs' traditional product--"advances," or collateralized loans to members--in stabilizing commercial bank members' residential mortgage lending activities.
Our theoretical model shows that using membership criteria (such as a minimum of 10 percent of the portfolio being in mortgage-related assets) or using mortgage-related assets as collateral does not ensure that FHLB advances will be put to use for stabilizing members' financing of housing. Indeed, our model demonstrates that advances--a relatively low cost managed liability--are most likely to influence lending only when such liabilities are used to finance "relationship" loans (i.e., loans to bank-dependent borrowers) that will be held on a bank's balance sheet and are least likely to influence lending for loans where the loan rate is heavily influenced by securitization activities, like mortgages.
Using panel vector autoregression (VAR) techniques, we estimate recent dynamic responses of U.S. bank portfolios to FHLB advance shocks, to bank lending shocks, and to macroeconomic shocks. Our empirical findings are consistent with the predictions of our theoretical model. First, recent bank portfolio responses to FHLB advance shocks are of similar magnitude for mortgages, for commercial and industrial loans, and for other real estate loans. This suggests that advances are just as likely to fund other types of bank credit as to fund single-family mortgages. Second, unexpected changes in all types of bank lending are accommodated using FHLB advances. Third, FHLB advances do not appear to reduce variability in bank residential mortgage lending resulting from macroeconomic shocks. However, some banks appear to have used FHLB advances to reduce variability in commercial and industrial lending in response to such macroeconomic shocks. Thus, relatively low cost managed liabilities may be used to finance "relationship" borrowers (which are typically business borrowers, rather than residential mortgage borrowers), although this use for advances appears to have diminished over time.
Full Paper (Screen Reader Version)Keywords: Advances, Government-Sponsored Enterprises, GSE, Portfolio shocks, Panel-VAR
PDF: Full Paper
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