The Federal Home Loan Bank (FHLB) system has faced a barrage of criticisms recently, one of the most common of which has been that the FHLBs increase instability in the financial system. In this brief, we address this argument by explaining how the FHLBs stabilize the financial system in times of stress and showing how the system reduces the risk of bank failure, particularly for the nation’s smaller banks.

We model the impact of FHLB lending on a bank’s probability of failure, considering year-over-year changes in multiple measures of a bank’s financial strength, including FHLB advances, share of FHLB advances as a percent of total assets, Tier 1 capital, nonperforming assets, liquid assets. The model results show that an increase in a bank’s use of FHLB funds reduces its odds of failure by as much as a third, and for smaller banks with $50 billion or less in assets, the impact is greater.

Ultimately, the FHLBs are a critical source of stability to the financial system, not instability. The FHLBs could use some updating, but that means building on this critical, if poorly understood, network of institutions to serve more of the financial system, not handicapping them.