Federal home loan bank advances and systemic risk

We explore the relationship between Federal Home Loan Bank (FHLB) advances and systemic risk. In terms of theoretical framework, there exist two links which characterise this relationship. The first connection is from lagged systemic risk to subsequent advances, establishing the 'liquidity provision' effect. The second is from lagged advances to subsequent systemic risk, establishing 'the moral hazard' effect. We empirically explore which link prevails in the U.S. commercial banking sector, using a unified mixed frequency VAR econometric model. This approach is flexible enough to model quarterly advances and monthly systemic risk. We reveal robust evidence for the link from lagged systemic risk to subsequent advances, thereby supporting the liquidity effect. In addition, we show that this effect is a mechanism which alleviates any detrimental impact of systemic risk on real economic activity. The latter finding carries important policy implications, highlighting the role of FHLB advances in managing the effects of increasing systemic risk on the real economy.