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Press Release

Core deposits as a hedge for loan commitments; FHA lending: Cleveland Fed researchers

Increase in core deposits only slightly mitigated the demand for liquidity at large banks during the financial crisis, say Cleveland Fed researchers

During a financial crisis, banks might experience an unusually large drawdown on unused loan commitments, as individuals and firms face unemployment, slower sales, or unexpected expenses. Some researchers claim that banks should be able to meet these demands because funds should simultaneously be flowing in, as investors, scared by the market turmoil, seek the safe haven of bank deposits. Looking at aggregate bank data from the most recent crisis, Federal Reserve Bank of Cleveland researchers Mahmoud Elamin and Caitlin Treanor say the increase in core deposits appears to hedge to some degree the decline in unused commitments. But they also note that the aggregate picture is different from one that considers banks of different sizes.

The top ten bank holding companies (BHCs) in the US hold the vast majority of unused loan commitments. Core deposits at the top 10 BHCs increased during the crisis period by 35 percent, or $445 billion, say Elamin and Treanor. But unused loan commitments fell by $1.29 trillion, leaving a potential shortfall of $845 billion.

Looking at banks below the top ten, the researchers say they seem to have experienced a significant increase in core deposits during the crisis, with little change in their unused commitments.

Read Did Core Deposits Hedge Loan-Commitment Risk during the Financial Crisis?

FHA loans: Standards have improved substantially, but the overall default rate remains high due to loans made previously, say Cleveland Fed researchers

The financial crisis was precipitated by extensions of credit to borrowers who did not have the ability to pay back the loans. During the Great Recession, lending standards tightened, making it difficult for some creditworthy borrowers to obtain mortgages. Hopefully, say Federal Reserve Bank of Cleveland researchers Yuliya Demyanyk and Daniel Kolliner, credit conditions have relaxed to the point where underserved but creditworthy borrowers are getting credit, and bad credit risks are still being excluded. The researchers investigate whether this is the case by examining the degree to which FHA lending is being extended to creditworthy borrowers. They find that, although the standards for FHA loan originations have improved substantially, the performance of the overall FHA mortgage market has not improved.

The Federal Housing Administration (FHA) is a government agency that makes mortgage loans more accessible chiefly by allowing qualified borrowers to provide lower down payments. Splitting all FHA loan originations into four groups by the borrowers’ credit (FICO) score, Demyanyk and Kolliner find that prior to the recession in November 2007, 62.8 percent of FHA borrowers were either deep subprime or subprime. However, since the end of 2007, FHA loans have been going more often to prime and near-prime borrowers. (Currently, 73.9 percent of FHA-originated loans go to prime or near-prime borrowers.)

Although the standards for FHA loan originations have improved substantially, the researchers say the default rate of all FHA loans combined is still higher than it was before the onset of the subprime boom in 2003, due to loans made previously. Despite the fact that deep subprime loans ceased to be originated after 2010, they still represent 6.2 percent of all outstanding FHA loans. Likewise, subprime loans still constitute 30.5 percent. However, say the researchers, if the FHA continues to facilitate lending to more creditworthy borrowers, the performance of the overall FHA market is poised to improve in the future.

Read FHA Lending Rebounds in Wake of Subprime Crisis

Federal Reserve Bank of Cleveland

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.

The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.

Media contact

Doug Campbell,, 513.455.4479