Paper asserts regulations led to short-term funding reliance by FHLBs — and maybe ‘runs’

Federal Home Loan Banks became reliant on short-term funding from money market funds to finance longer-term loans and other assets in the wake of new regulations imposed after the financial crisis, which could make the financial system more vulnerable to “runs” and pose risks to financial stability, a paper released Tuesday by the Office of Financial Research (OFR) claims.

“The intersection of money market mutual fund reforms and the LCR (liquidity coverage ratio) have contributed to the FHLBanks’ increased reliance on short-term funding to finance relatively longer-term assets, primarily collateralized loans to its largest members,” the paper states.

“While a funding run seems unlikely, it is often the violation of commonly held conventions that tend to pose financial stability risks,” the paper, published jointly by OFR and the Federal Reserve Bank of Boston, states. “Indeed, runs on leveraged financial intermediaries engaged in maturity transformation have produced systemic risks issues in the past and are worthy of investigation and continuous monitoring.”

The paper, The Intersection of U.S. Money Market Mutual Fund Reforms, Bank Liquidity Requirements, and the Federal Home Loan Bank System, (Working Paper no. 17-05) claims that after the financial crisis of 2007-10, reforms of money market funds and changes to banks’ liquidity requirements had an unintended consequence of increased Federal Home Loan Banks’ reliance on short-term funding.

It points out that the reallocation of money from money market funds (“which had declined significantly”) to government funds contributed to the latter’s increased demand for debt issued by the U.S. government and government-sponsored enterprises.

“The Federal Home Loan Bank (FHLBank) System played a key role in meeting this heightened demand for U.S. government-related assets with increased issuance of short-term debt,” the paper states. “The FHLBank System uses the funding obtained from money market funds to provide general liquidity to its members, including the largest U.S. banks. Large U.S. banks’ increased borrowings from the FHLBank System are motivated, in large part, by other post-crisis regulations, specifically the liquidity coverage ratio (LCR).”

The paper notes that the Federal Housing Finance Authority (FHFA) is aware of the increased maturity mismatched and is taking steps to reduce the system’s reliance on short-term funding, including a plan to issue proposed liquidity risk management rules by year-end.

The Intersection of U.S. Money Market Mutual Fund Reforms, Bank Liquidity Requirements, and the Federal Home Loan Bank System

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