Lenders of Next-to-Last and Last Resort: In Competition?
INSIGHTi
Lenders of Next-to-Last and Last Resort: In
Competition?
May 8, 2023
A solvent bank may seek a cash advance from the lender of last resort, meaning a district Federal Reserve
bank’s discount window, when it needs immediate liquidity. However, there is a certain stigma associated
with such borrowing, so banks often prefer to borrow from a lender of next-to-last resort, a district
Federal Home Loan Bank (FHLB), although this option is less immediate. Recently, the Federal Reserve
announced another option for banks to obtain cash advances, the Bank Term Funding Program (BTFP),
which may potentially divert revenues away from the FHLB system.
Background
The Federal Home Loan Bank Act of 1932 (P.L. 72-304; 47 Stat. 128) created the Federal Home Loan
Bank system, consisting of 11 regional institutions and the system’s Office of Finance, that collectively
constitute one government-sponsored enterprise. The FHLBs are federally chartered cooperative financial
institutions, meaning that each FHLB is privately owned and capitalized by its members. Four types of
financial institutions may become FHLB members: (1) federally insured depository institutions (i.e.,
banks and credit unions), (2) insurance companies, (3) community development financial institutions, and
(4) non-federally insured credit unions that meet certain criteria.
The FHLBs, sometimes referred to as lenders of next-to-last resort, make cash loans to member lending
institutions in their regional districts. Members may obtain FHLB cash advances if they hold assets that
can be used as collateral for the loans. Eligible assets include government-backed securities, such as U.S.
Treasuries, and mortgage-backed securities (MBS) issued by Ginnie Mae, Fannie Mae, and Freddie Mac.
By obtaining liquidity from an FHLB, a bank can avoid the stigma associated with going to the lender-of-
last resort—a Federal Reserve bank’s discount window. When solvent banks go to the discount window,
rather than borrow cash from other private financial institutions or the FHLBs, they may not have ample
amounts of liquid assets, which are easily convertible to cash, such as government-backed securities.
Given that the Federal Reserve discourages excessive use of the discount window for cash advances,
banks typically go to the FHLBs first for liquidity.
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Recent Developments
Following the Federal Reserve’s recent interest rate increases, the market value of existing government-
backed securities declined. Specifically, the yields on existing securities already held in bank portfolios
were relatively low compared to new issuances with higher interest rates. In addition, the use of
government-backed securities to obtain FHLB cash advances did not preclude bank insolvencies during
March 2023.
• In response to a sudden outflow of deposits from its digital asset customers, Silvergate
Bank turned to its lender of next-to-last resort, the FHLB of San Francisco, to obtain $4.3
billion of cash advances. Silvergate pledged government-backed securities as collateral.
The news that Silvergate experienced losses on loans held in portfolio—despite those
losses stemming from sales of government-backed securities—triggered more concerns
that arguably contributed to its decision to voluntarily liquidate and wind down
operations.
• The FHLB of San Francisco reported providing $13.5 billion in cash advances to Silicon
Valley Bank (SVB). Following a $1.8 billion loss on a sale of $21 billion of available-for-
sale securities consisting predominantly of fixed-income government-backed securities,
SVB announced a plan to issue common equity along with other strategies to improve its
liquidity position. SVB’s depositors and venture capital customers, however, used social
media to express concerns and still moved their deposits out of the bank. Bank regulators
closed SVB on March 10, 2023.
• The FHLB of New York provided cash advances to Signature Bank, which reportedly
pledged $23.5 billion of highly liquid government agency securities as collateral. The
bank regulators closed Signature Bank two days after SVB’s failure to reduce contagion
risk—that is, the risk of adverse news about one financial institution spreading and
adversely affecting other institutions with some similarities in business models, although
they may not have any obvious business relationships.
The typical practice of using high-quality liquid assets to obtain cash did not avert these insolvencies.
Although FHLB borrowing lacks the stigma associated with the discount window and is considered a
routine practice for obtaining liquidity, some stakeholders arguably formed unfavorable perceptions that
still led to panic runs by some depositors.
On March 12, 2023, the Federal Reserve announced the BTFP. In contrast to a Federal Reserve Bank’s
discount window, which charges above-market rates for loans, eligible depositories will receive cash
loans based upon above-market values (e.g., the initial par values) of their government-backed securities
used as collateral. The FHLBs, however, must still offer cash loans based upon current market as opposed
to initial par values of eligible collateral. (Unlike the Federal Reserve, the FHLBs must issue debt to raise
the funds that they in turn lend to member financial institutions.) The FHLB of Dallas subsequently
disclosed to investors (on its updated 10-K form for the fiscal year ended December 31, 2022) that the
Federal Reserve’s BTFP could reduce the demand for its advances over the term of the program. Stated
differently, the BTFP could potentially become a more attractive liquidity source, possibly causing
declines in the FHLB system’s earnings and, consequently, the amount of funding collected for the FHLB
districts’ affordable housing programs. For this reason, the BTFP’s purpose to mitigate market panic may
inadvertently bring about competition between the Federal Reserve and the FHLBs.
Congressional Research Service
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Author Information
Darryl E. Getter
Specialist in Financial Economics
Disclaimer
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