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October 31, 2017

OFR published a working paper examining the intersection of U.S. money market mutual fund (MMF) reforms, bank liquidity requirements, and the federal home loan bank (FHLBank) system. The paper examines the risks resulting from this linkage, including the potential for vulnerability of this funding model to "runs."

The paper highlights the impact of the SEC’s 2014 reforms on the money market industry and the broader money markets. It also describes the landscape for FHLBanks and examines the potential implications of money market fund industry’s increased holdings of their debt. The paper argues that intersection of MMF reforms and liquidity coverage ratio has contributed to the FHLBanks’ increased reliance on short-term funding to finance relatively longer-term assets, primarily collateralized loans to its largest members.This funding model could be vulnerable to “runs” and could impact financial markets and financial institutions in ways that are difficult to predict.

Analysis of regulatory filings by FHLBanks finds that this increased funding is largely used to subsidize regulatory liquidity requirements to the largest U.S. banks. FHLBanks are increasingly serving as a link between money market funds and the largest U.S. banks, which may generate new unintended vulnerabilities to the U.S. financial system. Although a low probability event, potential risk channels include a run on FHLBanks’ liabilities due to uncertainties about their government-sponsored enterprise, or GSE, status, operational issues that limit the FHLBanks’ ability to rollover its debt, or other events that cause a rapid shift in investor preferences. The paper concludes that prospect of such an event warrants close monitoring, as it could impact the broader financial markets in ways that are difficult to predict. The Federal Housing Finance Agency, or FHFA, is aware of this increased maturity mismatch and is taking steps to reduce the system’s reliance on short-term funding, including its plan to issue proposed liquidity risk management rules by year-end. 

 

Related Link: Working Paper (PDF)

Keywords: Americas, US, Banking, Money Market Funds, FHLBank System, Shadow Banking, Systemic Risk, Liquidity Risk, Maturity Mismatch Risk, FHFA, OFR

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