(Bloomberg) -- US officials will seek to limit access to Federal Home Loan Banks after failing lenders turned to the $1.3 trillion system in desperate bids to survive March’s banking crisis.

The Federal Housing Finance Agency will try to push FHLBs back to their roots in housing finance, and away from serving as lenders of last resort to troubled banks, according to a report published Tuesday. The plans would ratchet up federal oversight, and seek to direct banks toward the Federal Reserve’s discount window in times of extreme stress.

Banks borrow hundreds of billions of dollars from the government-chartered FHLBs each year to fulfill short-term funding needs. The practice came under scrutiny after the FHLBs, which have implied backing from the government, lent heavily to Silicon Valley Bank, Signature Bank and First Republic Bank as they careened toward failure.

Among the major changes, the FHFA, which oversees FHLBs, will propose a rule to force many banks to hold 10% of their assets in mortgage loans to maintain access to the system. The regulator is also exploring new guardrails for lending money to troubled institutions and tougher stress tests.

“The overwhelming sentiment from FHFA’s review was that stakeholders want more, not less, from the FHLBank System,” said Ryan Donovan, who heads the Council of Federal Home Loan Banks, a trade group. “We will continue to work with our members, primary regulators, and other stakeholders to ensure that any changes in policy will not negatively impact our clear mission of providing essential liquidity and critical affordable housing and community development funding where it is needed.”

However, a big structural overhaul may also be in the offing: The FHFA is looking at consolidating some of the 11 FHLBs scattered across the country, according to the report. The regulator didn’t say which of the institutions could be targeted. Sandra Thompson, who runs the agency, could slash the number to eight without any involvement from Congress.

Elevated Compensation

“The FHLBs have always had as a part of their mission providing general liquidity, and that’s not going to change,” Joshua Stallings, the FHFA deputy director who oversees the FHLB system, said in an interview. “But the fact of the matter is that we have to ensure the Federal Home Loan Banks are operating in a safe and sound manner. They have to do a better job.”

Some changes would require congressional action. Officials will ask lawmakers to help curtail pay for some FHLB executives and to at least double the amount of profit that the FHLB system must spend on affordable housing. 

The report criticized the FHLBs’ practice of setting salaries by comparing them with similar positions at similarly sized commercial banks. Unlike those lenders, “the FHLBanks have lower risk profiles than commercial banks” and aren’t comparable in many regards, the authors wrote.

 

The FHLBs were set up in the Great Depression to boost mortgage lending, but have since morphed into a backstop for banks and credit unions. At the same time, their importance in housing finance has declined as nonbank mortgage firms grew to dominate home lending. 

FHFA Review

Senator Catherine Cortez Masto, a Nevada Democrat who had asked for the review of the system, said in a statement that she was “glad the administration is prioritizing my recommendations to reform the Federal Home Loan Bank system to ensure they’re helping us lower housing costs for Nevadans and for families across the country.” Her office is working on a bill that would implement some of FHFA’s plans. 

The chief executives of FHLBs typically earn well over $1 million annually, and average pay per employee can rival that of Wall Street banks. Last year, the average compensation and benefit expense per employee at the FHLB in San Francisco was in line with Goldman Sachs Group Inc. at more than $310,000 per year, according to regulatory filings.  

“There’s a culture shift that’s going to be needed in the banks,” said Stallings, the FHFA official. “That’s going to need to change from being passive liquidity providers to being active supporters of housing and community development.”

Although the FHFA began its review of the system more than a year ago, the effort became part of the regulatory response to the regional banking turmoil.

The FHFA found that in March some large, troubled institutions had become so reliant on borrowing from the FHLBs that they hadn’t set up the ability to borrow from the Fed’s discount window. In one week in March, the FHLBs funded $676 billion in loans, a record, the report found. 

Going forward, “there are going to be times when a Federal Home Loan Bank will need to work with the appropriate Federal Reserve Bank to ensure borrowing can be moved over,” Stallings said.

--With assistance from Heather Perlberg and Stephanie Stoughton.

(Updates with FHLB trade group reaction in fifth paragraph and senator’s comment in 11th paragraph.)

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