Over the course of the current U.S. economic expansion, commercial banks have prospered by significantly increasing loans to businesses and consumers. Indeed, since mid-1994, loans outstanding at District banks have risen almost 35 percent. And the growth shows little sign of tailing off: Anecdotal reports from bankers around the District indicate that loan demand remains fairly strong.
That said, bankers—especially community bankers—also report that they are having increasing difficulty obtaining deposits, traditionally the major source of loan funding. Indeed, over the last three years, deposits have risen about 19 percent—roughly half the growth of loans—at District banks. Moreover, most of the growth occurred early in the period; deposit growth has been really anemic and even negative for many banks in recent quarters. To meet loan demand in the absence of strong deposit growth, an increasing number of District banks are turning to advances from the Federal Home Loan Bank (FHLB) system.
Banks first became eligible to join this previous thrift-only, government-sponsored enterprise in 1989. In the past several years, commercial bank membership has soared: banks currently make up about two-thirds of the system's 6,000-plus members.
District banks have clearly become big fans of the system, with membership at nearly 50 percent (see table). Within the District's borders, FHLB membership ranges from 37.9 percent in Illinois to 71.9 percent in Indiana. Overall, almost two-thirds of District FHLB-member banks had outstanding FHLB advances as of June 30, 1997, and in Kentucky and Tennessee, all District member banks were borrowing at mid-year 1997.
In several District states, especially Mississippi (34.7 percent) and Indiana (25.7 percent), FHLB advances make up a significant portion of banks' total nondeposit liabilities, indicating how much banks—especially community banks that have experienced actual declines in deposits—have come to rely on other funding sources.
Most of the FHLB advances made to District banks are longer term in nature, with almost three-quarters of total District borrowings carrying maturities of a year or more. These figures, however, vary quite a bit across states. In Missouri and Indiana, for example, more than 50 percent of borrowings are for terms of less than one year, compared with the District-wide average of 27.3 percent. And in Arkansas and Mississippi, about two-thirds of borrowings are for terms of more than five years, compared with the District-wide average of 30.3 percent.
Although FHLB advances have certainly helped banks increase their loan-to-deposit ratios and post record profit levels in recent years, this strategy is not without risks. So far, loans have performed extremely well, and loan losses have been minimal. However, if credit quality deteriorates unexpectedly, and loan portfolio returns start to fall, the burden of interest payments from FHLB advances and other borrowings could pinch earnings significantly.
In a worst-case scenario, a significant downgrading of a bank by supervisors could force it to immediately pay back all FHLB advances and halt all further borrowing, potentially causing a liquidity crisis. Although the industry is exceedingly well-capitalized at this time, and liquidity is readily available, there may be more than a few District banks that will wish they hadn't made that last loan when the next economic downturn arrives.
as of June 30, 1997
|District Portion of State||FHLB Members as a Percent of Total Banks||FHLB Advances as a Percent of Nondeposit Liabilities|