FRM Exam Part II · Managing Nondeposit Liabilities

Secured Funding: FHLB Advances and Central Bank Facilities

Updated 11 October 2026 · Fact-checked

Secured funding is borrowing backed by pledged collateral. Banks get it from Federal Home Loan Banks (FHLB advances) and from central bank facilities such as the discount window. Lend value equals collateral market value times (1 − haircut). Advances are often a stable source; the discount window is a contingent backstop.

Understand Secured Funding: FHLB Advances and Central Bank Facilities

Secured funding means the lender holds a claim on specific assets of the borrower. If the borrower defaults, the lender takes the collateral. Because the lender's loss risk is lower, secured funding usually costs less than unsecured funding and stays available when markets are stressed. The trade-off is that the borrower must give up assets.

FHLB advances are loans made by the Federal Home Loan Banks, a US government-sponsored system, to its members. Members are mainly banks, thrifts, credit unions and insurers. Advances are secured by eligible collateral such as residential mortgage loans, mortgage-backed securities and some other loans. Maturities range from overnight to many years, and rates can be fixed or floating. Because of this, banks use advances as a term funding source and to match the maturity of mortgage assets.

Central bank facilities such as the US Federal Reserve discount window lend to eligible depository institutions against collateral. They are meant mainly as a contingent or backstop source, not routine funding. The central bank values collateral at market value and applies a haircut, so the bank borrows less than the collateral is worth. Using the window has historically carried stigma, because a bank that borrows may be seen as weak. For this reason, banks may avoid it until stress is severe.

Collateral and liquidity management is the key risk lesson. Pledged assets become encumbered, which means they are not free to sell or pledge elsewhere. Heavy secured borrowing reduces unencumbered assets and leaves unsecured creditors with less protection. Haircuts can rise in stress, which cuts borrowing capacity just when it is needed. A good contingency funding plan pre-positions collateral at the FHLB and the central bank and tests operational access.

In short: secured funding is cheaper and more reliable than unsecured funding, but it consumes collateral. FHLB advances lean toward stable funding. Central bank facilities lean toward contingent funding.

Key formulas to remember

Lendable value of collateral: Lendable value = Market value × (1 − haircut); Haircut is the percentage discount applied by the lender. A higher haircut means less borrowing capacity.
Borrowing capacity: Capacity = Σ [Market value of each collateral pool × (1 − its haircut)]; Add lendable values across pools. Each asset type has its own haircut.
Unencumbered assets: Unencumbered assets = Total assets − Pledged (encumbered) assets; Tracks the free collateral available for contingent funding.
Collateral required for a loan: Required market value = Loan amount ÷ (1 − haircut); Use it to find how much collateral you must pledge for a target advance.
Encumbrance ratio: Encumbrance ratio = Encumbered assets ÷ Total assets; A higher ratio means less protection for unsecured creditors and less spare collateral.

How to solve Secured Funding: FHLB Advances and Central Bank Facilities questions

Use this method for numerical and conceptual questions on secured funding.

1Identify the funding type: FHLB advance, discount window or another secured source. Decide if the question asks about stable or contingent funding.
2List the collateral pledged and its market value. Check whether the asset type is eligible.
3Apply the haircut to each collateral pool: market value × (1 − haircut).
4Sum the lendable values to get borrowing capacity, then compare it with the funding need.
5If the question asks for required collateral, divide the loan by (1 − haircut).
6Check the effect on unencumbered assets and the encumbrance ratio.
7Consider stress: haircuts may rise, eligibility may tighten and stigma may delay use of the central bank window.
8Choose the answer that matches the correct use: advances for term funding, discount window as a backstop.

Quickest way: Haircut shortcut

When to use it: Use when the question gives collateral values and haircuts and asks for capacity, shortfall or required collateral.

Convert each haircut to a factor, such as 8% to 0.92.
Multiply each collateral value by its factor and add up.
Subtract the loan need to find surplus or shortfall.
For required collateral, divide by the factor instead of multiplying.
Eliminate options that confuse the direction: a larger haircut must reduce capacity.

Common mistakes in Secured Funding: FHLB Advances and Central Bank Facilities

Calculating lendable value as market value × haircut.
The word haircut sounds like the amount lent.
Fix: The haircut is the discount. Lendable value is market value × (1 − haircut).
Treating the discount window as a routine funding source.
It is a collateralized loan, so it looks like any other secured line.
Fix: Treat it as a contingent backstop. Stigma and policy intent mean it is not meant for regular funding.
Calculating required collateral as loan × (1 + haircut).
It feels like adding a margin on top of the loan.
Fix: The correct formula is loan ÷ (1 − haircut). Check the answer by applying the haircut back.
Ignoring encumbrance when judging the bank's funding profile.
Secured funding is seen as purely good because it is cheap.
Fix: Remember that pledged assets are unavailable to others. More secured funding means less free collateral and less protection for unsecured creditors.
Assuming haircuts and eligibility stay constant in a crisis.
Textbook examples use a fixed haircut.
Fix: In stress, lenders can raise haircuts or narrow eligible collateral. Size buffers using stressed haircuts.

Worked examples

Example 1

A bank pledges ₹ equivalent collateral to an FHLB: residential mortgage loans with market value USD 400 million and haircut 20%, and agency MBS with market value USD 250 million and haircut 5%. The bank needs USD 500 million of advances. What is its borrowing capacity and is there a surplus or shortfall?

Show the solution

Mortgage loans: 400 × (1 − 0.20) = 400 × 0.80 = USD 320 million.
Agency MBS: 250 × (1 − 0.05) = 250 × 0.95 = USD 237.5 million.
Capacity = 320 + 237.5 = USD 557.5 million.
Compare with need: 557.5 − 500 = USD 57.5 million.

Answer: Borrowing capacity is USD 557.5 million, which leaves a surplus of USD 57.5 million.

Example 2

A bank wants to borrow USD 180 million from the central bank discount window. The central bank applies a 10% haircut to the bank's eligible collateral. What market value of collateral must the bank pledge, and what does the haircut mean in the stress case if the haircut rises to 25% on the same pledged collateral?

Show the solution

Required collateral = 180 ÷ (1 − 0.10) = 180 ÷ 0.90 = USD 200 million.
Check: 200 × 0.90 = 180, which matches the loan.
Stress case: lendable value = 200 × (1 − 0.25) = 200 × 0.75 = USD 150 million.
Capacity falls by 180 − 150 = USD 30 million.

Answer: The bank must pledge USD 200 million of collateral. If the haircut rises to 25%, the same collateral supports only USD 150 million, a USD 30 million drop in borrowing capacity.

Exam tips

Questions often ask which source is stable and which is contingent. Link FHLB advances to term, stable funding and the discount window to backstop use.
Always apply (1 − haircut). Check that your answer is lower than the collateral value when computing capacity.
Expect case-style questions on contingency funding plans: the best answer usually pre-positions collateral and tests access in advance.
Watch for stigma, encumbrance and rising haircuts in stress. These are the usual risk points the exam tests.
Compare secured with unsecured funding: secured is cheaper and more reliable in stress, but it encumbers assets.

Practice questions from Managing Nondeposit Liabilities

Secured Funding: FHLB Advances and Central Bank Facilities: frequently asked questions

What is an FHLB advance?

It is a collateralized loan from a Federal Home Loan Bank to a member institution. Members pledge assets such as mortgage loans or securities. Advances come in many maturities and are used for term funding and asset-liability matching.

How is the discount window different from FHLB advances?

The discount window is a central bank facility meant mainly as a contingent backstop for eligible depository institutions. FHLB advances are offered by the FHLB system to its members and often serve as an ongoing source of term funding. Both require collateral.

What is the difference between secured and unsecured funding?

Secured funding is backed by pledged collateral, so the lender can claim those assets on default. Unsecured funding has no specific collateral claim. Secured funding is usually cheaper and steadier in stress, but it encumbers assets.

Why does stigma matter for discount window borrowing?

Markets may read borrowing from the central bank as a sign of weakness. Banks may therefore delay using it, even when they have collateral. This reduces its practical value as a contingent source.