The Federal Housing Finance Board's (FHFB) proposed regulation to revise the Federal Home Loan Bank (FHLB) capital regulation may do the exact opposite of what it is intended to, according to analysts at Standard & Poor's. Although the regulation is meant to strengthen the composition of the FHLBs, S&P believes it would instead present capital management problems for the 12 FHLBs it regulates.
"The new proposed capital regulation does not appear to significantly enhance or improve the current regulatory capital framework now in place for the FHLBs under the GLB (Gramm-Leach-Bliley) Act of 1999 and the August 2003 Retained Earnings Advisory Bulletin," S&P analysts wrote in a report called FHFB Proposed Retained Earnings Regulation Poses Challenges for FHLBs. "The introduction of this potential regulation at a minimum raises concern regarding the status of the current capital plans now in place in all but one of the FHLBs..."
The proposed regulation, Excess Stock Restrictions and Retained Earnings Requirements for the Federal Home Loan Banks, has provisions that might keep the FHLBs from serving their purpose. These provisions include the establishment of a minimum amount of retained earnings for each FHLB equal to $50 million plus 1% of an FHLB's non-advance assets. If, at any time, a bank is out of compliance with the minimum retained earnings requirement, its dividend payout would be limited to 50% of the FHLB's quarterly net income, unless the bank received regulatory approval. The new proposal also prohibits a FHLB member bank from selling excess stock to its members and limits the aggregate amount of excess stock outstanding to 1% of a FHLB's total assets. Additionally, it disallows the payment of stock dividends.
To be more specific, since every FHLB's core mission is to provide liquidity to its members by advancing funds, its balance sheet must always remain adequately capitalized. The nondifferentiation of retained earnings requirement for all nonadvance assets and the disregard for the inherent risk could reduce FHLB liquidity. Similarly, the restriction on excess stock would pose a severe limitation on the FHLBs' ability to deliver low-cost funding and offer attractive returns to its members.
"Should the proposed regulation be adopted as it is currently written, Standard & Poor's will have to closely monitor any negative impacts to the liquidity profile of the individual banks, core business growth dynamics and membership trends," concluded the report.
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