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Statement of Need: The proposed rule is intended primarily to establish mission achievement standards for the Banks and to establish a new capital structure and risk-management framework under which the Banks may more effectively pursue their public policy mission, while still ensuring the safety and soundness of the Bank System. The Banks currently operate in accordance with the Finance Board's Financial Management Policy (FMP), under which risk management is accomplished principally through a list of specific restrictions and limitations on the Banks' investment practices and a leverage limit which prohibits Banks from incurring liabilities in the form of consolidated obligations (COs) or unsecured senior liabilities in an amount greater than twenty times their capital stock. Though this approach has served the purpose of ensuring the safety and soundness of the Bank System, it lacks the flexibility that would enable the Banks to fulfill their mission to the maximum extent. To ensure that the risks taken by a Bank are adequately supported by capital, the proposed rule would implement, for the first time, a risk-based capital requirement for the Banks, which builds upon the risk-based capital regimes of other federal financial institution regulators. The principal source of funding for the Banks is the COs that are issued in the global capital markets and for which the twelve Banks are jointly and severally liable. Because of the Banks' GSE status, the costs to the Banks of obtaining such funding are substantially less than the borrowing costs for comparable debt issued by other entities. The Banks pass the benefit of this funding advantage to their members through wholesale loans (called advances) priced lower than the members could otherwise obtain to provide support for housing finance, including community lending, in fulfillment of the Banks' mission. The FMP does not expressly require the Banks to use a particular percentage of the funds obtained through the issuance of COs to provide advances to their members. In large part due to the financial burdens imposed on the Banks as a result of the savings and loan crisis, the Banks use a portion of the proceeds from COs to finance investments that the Finance Board does not consider to be adequately related to their statutory mission. To better link the GSE advantages in the capital markets to the mission performance of the Bank System, the proposed rule would require, by January 1, 2005, that an amount equal to 100 percent of each Bank's outstanding COs be held by the Bank in core mission activities. "Core mission activities" would be defined as those activities that assist and enhance members' and eligible nonmember borrowers' financing of housing and community lending. The proposed core mission activity requirement would be subordinate to the safe and sound financial operation of the Banks, as mandated by the Federal Home Loan Bank Act (Act). During any specified period in which a Bank's board of directors determines that the core mission activities requirement would be inconsistent with the safe and sound operation of the Bank, the Bank would be permitted to be out of compliance with the core mission activities requirement. Because it allows the Banks substantially greater authority to acquire new assets and manage their risks, and to raise member capital accordingly, the proposed rule also would articulate certain minimum responsibilities of the Banks' boards of directors and senior management with regard to operating the Banks in a safe and sound manner and ensuring that the Banks achieve their statutory mission.

Summary of the Legal Basis: Under section 10 of the Act and part 935 of the Finance Board's regulations, the Banks have broad authority to make advances in support of housing finance, which includes community lending. See 12 U.S.C. 1430(a), (i), (j); 12 CFR part 935. The Banks also are required to offer two programs - the Affordable Housing Program and the Community Investment Program - to provide subsidized or at-cost advances, respectively, in support of unmet housing finance or targeted economic development credit needs. See 12 U.S.C. 1430(i), (j); 12 CFR parts 960, 970. In addition, section 10(j)(10) of the Act, as implemented by a recently-issued Finance Board regulation, authorized the Banks to establish Community Investment Cash Advance (CICA) programs for community lending. See 12 U.S.C. 1430(j)(10); 12 CFR part 970; 63 FR 65536 (Nov. 27, 1998). The Banks' investment authority is set forth primarily in sections 11(j) and 16(a) of the Act, which govern the investment of the Banks' surplus and reserve funds, respectively. See 12 U.S.C. 1431(h), 1436(a). Under both sections, the Banks are authorized to invest in obligations of the United States, certain obligations of Fannie Mae, Ginnie Mae or Freddie Mac, and in such securities in which fiduciary and trust funds may be invested under the law of the state in which the Bank is located. Section 11(h) also authorizes investments in the securities of certain small business investment companies. In addition, the Banks are required to have liquidity reserves in an amount equal to deposits from their members invested in obligations of the United States, deposits in banks or trust companies, and certain specified short-term advances to their members. See 12 U.S.C. 1431(g). Currently, the Finance Board regulates the Banks' investments and investment practices through its regulations, as well as through the FMP. Section 934.1 of the regulations provides that the Banks may acquire or dispose of investments only with the prior approval of the Finance Board, or in conformity with authorizations of the Finance Board or "stated [Finance] Board policy." 12 CFR 934.1. By resolution, the Finance Board adopted the FMP, in part, as its "stated policy" regarding permissible Bank investments. The FMP generally provides a framework within which the Banks may implement their financial management strategies in a prudent and responsible manner. See 62 FR 13146 (Mar. 19, 1997); Finance Board Res. No. 96-45 (July 3, 1996), as amended by Finance Board Res. No. 96-90 (Dec. 6, 1996), Finance Board Res. No. 97-05 (Jan. 14, 1997), and Finance Board Res. No. 97-86 (Dec. 17, 1997). The Banks' current capital requirements are based on the asset size of, or the dollar amount of advances outstanding to, their members. Specifically, a member must maintain a minimum investment in the capital stock of a Bank in an amount equal to the greater of: (1) 1 percent of the member's mortgage assets; (2) 0.3 percent of the member's total assets; or (3) 5 percent of total advances outstanding to the member (with a somewhat higher percentage for any member that is not a "qualified thrift lender"). See 12 U.S.C. 1426(b)(1), (b)(2), (b)(4); 1430(c), (e)(1), (e)(3); 12 CFR 933.20(a). The proposed Financial Management and Mission Achievement regulation would build on the statutory provisions outlined here, and would supplement or replace current Finance Board regulations and the FMP on matters related to investments, mission and capital. Section 2B(a) of the Act authorizes the Finance Board to supervise the Banks and to promulgate such regulations as are necessary to carry out the provisions of the Act. This regulatory action is not required by statute or court order.

Alternatives: As an alternative to this rulemaking, the Finance Board could choose to continue to conduct risk management at the Banks through the list of specific restrictions and limitations on the Banks' investment practices in the FMP and the current regulatory leverage limit which prohibits Banks from incurring liabilities in the form of consolidated obligations (COs) or unsecured senior liabilities in an amount greater than twenty times their capital stock. The Finance Board could decide to amend and expand the listed restrictions and limitations in the FMP, and permit the Banks to engage in other investment activities only pursuant to a staff legal interpretation of the statute, or to decide these issues on a case-by-case basis. The Finance Board could choose not to establish a modern risk-based capital structure for the Banks, or could choose variations of the model proposed. The agency will consider all alternatives suggested by the public during the notice and comment period.

Anticipated Costs and Benefits: Although the Finance Board cannot quantify precisely the costs and benefits of this rulemaking at this time, the agency anticipates that the regulatory amendments will benefit both the Banks and their members by giving the Banks greater operational flexibility, thereby enabling the Banks to help their members compete more effectively in the housing finance and community lending marketplace, which in turn will assure that the GSE benefit will accrue more efficiently and effectively to consumers.