FHLB Dividends: Low-Hanging Fruit for Reconfiguring FHLB Lending

In the United States, the lender-of-last-resort tool is the Federal Reserve's discount window. Despite countervailing policy efforts, substantial market stigma remains associated with borrowing from the discount window. It is in this context that market participants have come to view the Federal Home Loan Banks (FHLBs) as an alternative to the Fed's discount window for backstop liquidity needs--despite the FHLBs' relatively constrained abilities to play this role. Notably, however, the FHLBs don't just benefit from discount window stigma; the FHLBs reinforce discount window stigma with their subsidized pricing. The FHLBs are government-sponsored enterprises--and as such can fund themselves at government rates--but they operate as cooperatives that are privately owned by the banks and other financial institutions eligible to borrow from them. Under this setup, the FHLBs partially reimburse their borrowing members by distributing the bulk of their dividends based on the amount a member borrowed in a given quarter. This dividend structure reduces the "all-in" cost for FHLB borrowers--changing the cost of borrowing relative to the discount window and incentivizing banks to rely more on the FHLB System structurally than is optimal from a financial stability perspective (which favors using the Fed). Given the Federal Housing Finance Agency's (FHFA's) recently expressed desire to focus on realigning the FHLB System toward its housing mission, the FHFA should redirect the FHLB's favorable advance rates and dividends toward members that are most serving the FHFA's housing goals. Redirecting FHLB dividends away from simply subsidizing FHLB borrowing could support housing finance (and the banks providing housing finance) while also directionally getting the FHLB System out of the way of the Fed's financial stability mandate to be an effective lender of last resort.