Recently passed legislation increased the powers available to banks,
but many of these new activities appear geared to larger institutions.
In contrast, policymakers aimed a series of the reforms in the legislation
directly toward smaller, agriculturally focused banks. Specifically,
the Gramm-Leach-Bliley (GLB) Act increased the access that such
banks have to lower-cost funds from a government-sponsored entity
(GSE) called the Federal Home Loan Bank (FHLB) system. Although
these changes could be important to a particular bank, initial estimates
suggest that the overall effect of the reforms could be small.
FHLB membership pre-GLB
As a GSE, the FHLB makes loans, called advances, to its member
financial institutions. GSEs are privately owned, federally chartered
corporations with specialized lending powers. GSEs are supposed
to correct deficiencies in the functioning of financial markets,
such as the mortgage market. To help carry out this public purpose,
the charters of GSEs give them special benefits, such as exemption
from registering their securities with the Securities and Exchange
Commission or exemption from state and local taxation. More importantly,
these special powers suggest to those who own debt issued by GSEs
that the federal government will protect them for loss if the GSE
cannot pay them back. This implicit credit support of the federal
government allows the GSE to borrow at rates slightly above those
available to the U.S. Treasury. Thus a GSE like the FHLB can provide
funds to its borrowers at relatively low cost.
FHLB membership was originally restricted to savings and loans.
Commercial banks were first allowed to join the FHLB with passage
of the Financial Institutions Reform, Recovery and Enforcement Act
in 1989. To join the FHLB, banks had to be in sound financial condition
(usually a regulatory safety and soundness rating of 1 or 2) and
have at least 10 percent of their assets in residential mortgage
loans. To receive an advance, a member has to purchase FHLB stock
and pledge high-quality assets as collateral. Acceptable collateral
includes first mortgages and other real estate-related assets, Treasury
and GSE securities, and deposits held at the FHLB.
GLB makes membership and borrowing easier
For a number of years, rural, agriculturally focused banks (those
with a ratio of agricultural loans to total loans of greater than
25 percent) have been seeking new low-cost sources of funds. While
core deposits remain the primary source of funds for agricultural
banks, their share of total liabilities has fallen steadily from
90 percent to 81 percent over the last 10 years (see graph).
Agricultural banks have been replacing these core deposits with
other sources of funds, such as large certificates of deposits.
Some agricultural banks have begun borrowing from the FHLB system.
But the requirement that banks hold a certain percent of their assets
in mortgage-related assets to join the system and the limited types
of collateral they could pledge were viewed as a barrier to full
access to this source of low-cost funding.
These concerns were addressed in the financial modernization legislation
that passed in 1999. (The legislation is discussed in more detail
in "Is financial modernization
anything new?" in the April 2000 fedgazette.
GLB took steps to increase the number of commercial banks that
can join the FHLB and the types of assets these banks can offer
as collateral. (GLB made other changes to the FHLB and the financial
system that we do not explore.) Eligibility is increased under GLB
by allowing a bank with assets under $500 million to join the FHLB
"without regard to the percent of its total assets that is represented
by residential mortgage loans." GLB also allowed commercial banks
with assets under $500 million to offer small business and farm
loans as collateral for FHLB advances. As a result, virtually all
of the nation's nearly 2,300 agricultural banks are eligible for
GLB may have small effect
We have made rough estimates as to the number of agricultural banks
that will be able to join the FHLB system after GLB and the number
that were eligible to join the system prior to GLB but did not (in
addition to current members). We find that as of the end of 1999
when GLB passed, roughly 50 percent of agricultural banks were already
members, and roughly 30 percent of agricultural banks could have
joined but had not. Newly eligible agricultural banks under GLB
approximate 20 percent. This distribution is roughly the same in
the Ninth District where about 30 percent of agricultural banks
will become newly eligible to join the system. (The methodology
is available from the authors by request.)
Moreover, we find that some important characteristics of the newly
eligible banks for membership are similar to those that were previously
eligible but did not join. For example, both the newly and currently
eligible agricultural banks have asset growth rates of around 5
percent, in contrast to the nearly 9 percent growth rate for agricultural
banks that are members. Likewise, the newly and currently eligible
agricultural banks used core deposits at roughly the same rate,
which was higher than agricultural banks that had joined the system
(86 percent of liabilities vs. 81 percent of liabilities). This
type of data suggests that the newly eligible agricultural banks
may decide, like the currently eligible banks that they resemble,
not to join the FHLB system.
We estimate that the total amount of collateral that agricultural
banks can pledge for FHLB advances could increase by roughly 50
percent under the GLB rules. We find that under existing rules,
eligible collateral for agricultural banks equaled $36.4 billion.
Using the new GLB collateral and eligibility rules, agricultural
banks will have eligible collateral equaling $55.2 billion. However,
the total amount of advances made against the new collateral could
very well be smaller. The FHLB of Des Moines has suggested that
advances made against newly pledged farm loans will likely be much
less than the typical 80 cents on the dollar for mortgages.
Additionally, the need to pledge the new collateral and increase
FHLB borrowings is unlikely to be the same for all current and potential
FHLB members that are agricultural banks. We measure the potential
propensity to borrow by examining the ratio of deposits to loans
at individual banks. Higher ratios could indicate that a bank has
not fully deployed its deposits to fund loan growth. As might be
expected, agricultural banks that are actively borrowing from the
FHLB have the lowest deposit-to-loan ratios, indicating more full
deployment of deposits and the potential need to find other sources.
The newly eligible agricultural banks have significantly higher
median ratios, implying a lower need to borrow from the FHLB. This
could limit the growth in advances, since roughly 38 percent of
the $18 billion projected increase in eligible collateral results
from the newly eligible agricultural banks.
|Agricultural Bank Group
|| Deposit-Loan Ratio
Agricultural banks naturally want access to as many low-cost sources
of funds as they can find. GLB includes reforms that were designed
to add a new source, the FHLB system. However, the bill may not
have a significant effect. In part, this reflects the success the
FHLB already has in signing up agricultural bank members. In part,
it reflects the fact that not all banks see it as advantageous to
join the system currently.