[Federal Register Volume 65, Number 84 (Monday, May 1, 2000)]
[Rules and Regulations]
[Pages 25267-25278]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-10427]


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FEDERAL HOUSING FINANCE BOARD

12 CFR Parts 900, 917 and 940

[No. 2000-14]
RIN 3069-AA90


Powers and Responsibilities of Federal Home Loan Bank Boards of 
Directors and Senior Management

AGENCY: Federal Housing Finance Board.

ACTION: Final rule.

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SUMMARY: The Federal Housing Finance Board (Finance Board) is 
promulgating new regulations to set forth the responsibilities of the 
boards of directors and senior management of the Federal Home Loan 
Banks (Banks) as a means of ensuring that they fulfill their duties to 
operate the Banks in a safe and sound manner and in furtherance of the 
Banks' housing finance and community lending mission.

EFFECTIVE DATE: This final rule is effective on May 31, 2000.

FOR FURTHER INFORMATION CONTACT: James L. Bothwell, Director and Chief 
Economist, (202) 408-2821; Scott L. Smith, Deputy Director, (202) 408-
2991; Julie Paller, Senior Financial Analyst (202) 408-2842; Office of 
Policy, Research and Analysis; Eric M. Raudenbush, Senior Attorney-
Advisor, (202) 408-2932; Office of General Counsel, Federal Housing 
Finance Board, 1777 F Street, NW., Washington, DC 20006.

SUPPLEMENTARY INFORMATION:

I. The Proposed Rule

    On January 3, 2000, the Finance Board published for comment a 
proposed rule to add to its regulations a new part 917, setting forth a 
state-of-the-art corporate governance framework for the Banks' boards 
of directors and senior management. See 65 FR 81 (2000). The 30-day 
public comment period closed on February 2, 2000. The Finance Board 
received a total of sixteen comment letters: eleven from Banks, three 
from trade associations and one from a Bank director.

II. Comments on the Proposed Rule and Analysis of Changes Made in 
the Final Rule

A. General

    While all commenters suggested modifications to the proposed rule, 
six expressed general support for the overall purpose of the rule. No 
commenters expressed general opposition to the rule, but two commenters 
believed that the rule as a whole was too detailed. Specifically, one 
commenter (a Bank) opposed the proposed rule's detailed allocation of 
responsibilities between Banks' boards of directors and senior 
management and recommended that each Bank's board of directors be 
permitted to determine the appropriate allocation of responsibilities 
between itself and the Bank's senior management. Another commenter (a 
trade association) stated that the rule would create unnecessary 
administrative burdens and operational complexities.
    It is the opinion of the Finance Board that an active and informed 
board of directors is one of the cornerstones of safe and sound Bank 
operation. The agency understands that, as is the case with any bank or 
corporation, most of a Bank's day-to-day operational functions will be 
undertaken by management and other Bank personnel. However, while a

[[Page 25268]]

Bank's board of directors may the delegate the execution of managerial 
functions to Bank employees, the responsibility for seeing that these 
functions are properly executed may not be delegated. Part of the 
reason for the detailed nature of the rule is to make these 
responsibilities clear.
    Now that the Banks have been given full responsibility for their 
own corporate governance, the ability of the Finance Board to ensure 
the safety and soundness of the Banks lies primarily in its ability to 
examine the Banks and to take action pursuant to Bank examinations. The 
material set forth in part 917 also is intended in part to make clear 
the standards against which Banks will be examined. Although the rule 
is detailed in some respects, the Finance Board believes that it is 
preferable to state explicitly the standards to which the Bank's boards 
of directors and management will be held than to promulgate a more 
general governance rule the application of which would remain ambiguous 
until specific examination concerns arise.

B. Renumbering of Certain Provisions

    As part of a proposed rule to amend its advances regulation, 12 CFR 
part 950, the Finance Board will be proposing to add to part 917 a 
requirement that each Bank have in place at all times a member products 
policy to address various aspects of the financial products that the 
Bank provides to its members and associates. In this final rule, the 
Finance Board has reserved Sec. 917.4 for the member products policy 
provision.
    In addition, the strategic planning provision, which appeared in 
the proposed rule as Sec. 917.9, has been moved to Sec. 917.5 in the 
final rule. This was done in order to give part 917 a more logical 
structure by placing the provisions requiring Banks' board of directors 
to adopt major written policies or plans (i.e., the risk management 
policy, the member products policy and the strategic plan) in 
consecutive sections. Consequently, the sections numbered as 917.4 
through 917.8 in the proposed rule have been redesignated as 
Secs. 917.6 through 917.10 in the final rule.

C. Definitions--Secs. 900.1 and 917.1

    As reflected in the proposed rule, the Finance Board has begun the 
process of revising its regulations to refer to nonmember mortgagees 
who are eligible under section 10b of the Federal Home Loan Bank Act 
(Bank Act), 12 U.S.C. 1430b, to obtain advances from the Banks as 
``associates.'' In addition to a desire to use less cumbersome 
terminology, this change arises from the Finance Board's concern that, 
to those not familiar with the nuances of the Bank System, the use of 
the term ``nonmember mortgagee'' could imply that the Banks are 
transacting business with entities beyond those authorized by statute. 
The term ``associate'' more accurately reflects the fact that these 
entities have a Congressionally-sanctioned relationship with the Banks, 
albeit one that falls short of full Bank membership.
    In its recent regulatory reorganization rulemaking, the Finance 
Board established in its regulations a new part 900, to contain 
definitions of terms that are used often throughout the Finance Board's 
regulations. See 65 FR 8253 (2000). By creating this part, the Finance 
Board intended both to standardize common terms used in the regulations 
and to eliminate repetitive definitions and excessive definitional 
cross-references throughout the regulations. Although this is the first 
rulemaking in which the term ``associate'' has been used, the Finance 
Board intends eventually to use the term throughout its regulations. 
Accordingly, the term, which appeared in Sec. 917.1 of the proposed 
rule, has been moved to part 900 (Sec. 900.1) in the final rule.
    Section 917.1 of the rule continues to contain definitions of terms 
that are used in the substantive provisions of part 917, but that are 
not used frequently enough throughout the Finance Board's regulations 
to warrant inclusion in part 900. Changes made to, and comments 
regarding, these definitions are discussed below in the context of the 
substantive provisions to which the definitions relate.

D. General Authorities and Duties of Bank Boards of Directors--
Sec. 917.2

    Section 917.2(b)(1) of the rule requires that each director carry 
out his or her duties in good faith, in a manner such director believes 
to be in the best interests of the Bank, and with such care, including 
reasonable inquiry, as an ordinarily prudent person in a like position 
would use under similar circumstances. One commenter (a Bank), while 
supporting this regulatory statement of the standard of care, suggested 
that the Finance Board state explicitly in the final rule that Bank 
directors and management are subject to the same standard of care as 
directors of ordinary corporations are under state law.
    Overall, part 917 charges Bank directors and management with many 
specific duties and responsibilities in connection with the operation 
of the Banks. In addition, Sec. 917.2(b)(1) sets forth a general 
standard of care with which the specific duties are to be executed. 
While the Finance Board believes that this regulatory standard of care 
is equivalent to the legal standard that normally applies to officers 
and directors of state-chartered corporations under state law, the 
Finance Board declines to make explicit reference to state law in the 
regulation. Part 917 specifically enumerates both the specific and 
general standards that the Finance Board has determined are 
appropriate, and it is by these express standards--and not by any 
ambiguous reference to state law--that the actions of Bank directors 
and management will be measured by the Finance Board.
    In addition, several commenters expressed their opinion that, while 
Sec. 917.2(b)(1) sets forth a standard of care identical to that which 
exists under the law of most states, various specific provisions in 
proposed part 917 appeared to impose a greater duty upon directors and 
management by essentially requiring them to guarantee the outcome of 
actions taken by other parties. The Finance Board has reviewed the 
provisions in question and has made amendments to several of them 
(specifically, final rule Secs. 917.3(a)(2)(iv), 917.3(c), 917.6(b)(2) 
and 917.7(e)(2), all discussed in greater detail below) in order to 
make clear that, while a Bank's board of directors and senior 
management are required to adopt certain policies and order certain 
actions that are ``reasonably designed'' to achieve a particular 
result, the officers and directors do not have the responsibility to 
guarantee that, in executing these policies or orders, Bank employees 
will achieve the precise result specified. However, by requiring that 
policies and orders be ``reasonably'' designed to achieve the desired 
result, the Finance Board does intend to require that officers and 
directors take all objectively reasonable measures necessary to design 
the policy or order, and oversee its implementation, in such a way as 
to maximize the chances of the desired result being achieved.
    Section 917.2(b)(3) of the proposed rule would have required that 
every Bank director ``be financially literate, or become financially 
literate within a reasonable time after appointment or election.'' One 
commenter (a Bank) suggested that the Finance Board explicitly define 
the term ``financially literate'' in the final rule, using the 
explanation of the term set forth in the preamble to the proposed rule. 
The Finance Board agrees that the meaning of the term ``financially 
literate'' was unclear in the proposed rule. However, instead of 
defining the term, the Finance

[[Page 25269]]

Board has opted in the final rule to eliminate its use altogether and 
to require, more plainly, that at the time of his or her election, or 
within a reasonable time thereafter, each director have a working 
familiarity with basic finance and accounting practices, including the 
ability to read and understand the Bank's balance sheet and income 
statement and to ask substantive questions of management and the 
internal and external auditors.
    Three commenters (two Banks and one trade association) opposed this 
requirement on the grounds that elected directors--who are primarily 
chief executives or senior officers of financial institutions--are 
likely to meet the standard, while appointed directors are chosen by 
the Finance Board, thereby giving the agency plenary power to select 
only those individuals who have a working familiarity with basic 
finance and accounting practices. Similarly, two other Banks questioned 
the requirement, given that the Banks have no power to lobby for the 
appointment or election of any director.
    The Finance Board agrees that elected directors, as representatives 
of member financial institutions, would presumably meet the requirement 
of Sec. 917.2(b)(3) with ease. The agency does not agree that this fact 
logically leads to the conclusion that the requirement should not be 
included in the rule.
    The Finance Board also agrees that, because it is responsible for 
the appointment of each Bank's public interest directors, it has the 
power to use financial literacy as a criterion in the appointment 
process. However, the intent of the requirement set forth in 
Sec. 917.2(b)(3) is not to eliminate from consideration for Bank 
directorships individuals who do not currently possess a working 
familiarity with basic finance and accounting practices, regardless of 
any other relevant qualifications they may possess. Instead, the 
purpose of Sec. 917.2(b)(3) is to require that those who do not possess 
such familiarity become so educated to the extent that they can 
effectively carry out their duties as directors. The Finance Board 
trusts that any individual who merits consideration as either an 
elected or appointed Bank director would be capable of learning in a 
very short period of time how to read the Bank's income statement and 
balance sheet and how the data set forth therein relate to the general 
operations of the Bank. The Finance Board also believes that this 
requirement will impose little burden on the Banks, especially if the 
option of such education is made a part of existing director 
orientation programs.

E. Risk Management--Sec. 917.3

    Section 917.3(a)(1) of the rule requires that, within 90 days of 
the effective date of the final rule, each Bank have in effect at all 
times a risk management policy. Section 917.3(b) of the rule sets forth 
the requirements for this policy. As it appeared in the proposed rule, 
Sec. 917.3(b)(1) required that the risk management policy ``describe 
how the Bank will comply with its capital structure plan, after such 
plan is approved by the Finance Board.''
    Four commenters (two Banks and two trade associations) stated that 
the proposed rule was unclear as to whether the risk management policy 
must immediately state how the Bank will comply with capital 
requirements that will not be known until after the 90-day 
implementation period, or whether the policy is to be amended after the 
Finance Board issues a final rule on capital and subsequently approves 
that Bank's capital structure plan. Three of these commenters (one Bank 
and two trade associations) stated that the Finance Board should not 
require a Bank to adopt its risk management plan until 90 days after 
that Bank's capital structure plan has been approved by the Finance 
Board. The remaining Bank stated that the Finance Board should allow 
the Banks 180 days after the publication of the final rule to adopt 
their risk management policies.
    Of course, the Finance Board does not intend to require that the 
Banks describe how they will comply with a capital regulation or a 
capital structure plan that will not yet exist at the end of the 90-day 
implementation period. In the final rule, Sec. 917.3(b)(1) has been 
revised to more clearly state that this risk management policy 
requirement will apply only after the Finance Board has adopted its new 
capital regulations and has approved the Bank's capital structure plan. 
At that time, a Bank will need to amend its existing policy to add the 
material required under this provision.
    The Finance Board declines to extend the risk management policy 
implementation period beyond 90 days after the effective date of the 
final rule. It is the agency's view that, pursuant to the Federal Home 
Loan Bank System Financial Management Policy (FMP) (which is the 
Finance Board policy that currently addresses Bank risk management), 
Banks should already have in place policies that largely conform to the 
requirements of Sec. 917.3(b). The rule does not require that a Bank 
adopt a new risk management policy if one is already in place that 
meets the requirements of Sec. 917.3(b), but requires merely that the 
Bank have such a policy ``in effect at all times'' after the end of the 
90-day period.
    Even if a Bank must amend its existing policy, or adopt an entirely 
new risk management policy, in order to conform to new Sec. 917.3(b), 
the necessary changes should be easily accomplished by the close of the 
90-day implementation period given that, under the FMP, the Banks have 
very little discretion regarding the management of the risk components 
that must be addressed in the risk management policy. As the 
substantive requirements of the FMP are gradually superceded in the 
coming year by new regulations that are likely to give the Banks more 
discretion in the area of risk management and capital structure, each 
Bank will need to make appropriate amendments to its risk management 
policy.
    Proposed Sec. 917.3(a)(2)(iv) would have required each Bank's board 
of directors to ensure that policies and procedures are in place to 
achieve Bank compliance at all times with its risk management policy. 
Four commenters (all Banks) opposed this language on the ground that it 
would be unreasonable to require the Bank's board of directors to act 
as a guarantor that the Bank would always be in compliance with the 
risk management policy. The Finance Board recognizes that a Bank's 
board of directors typically is not involved in the day-to-day 
operations of the Bank and, therefore, would not be in a position 
constantly to monitor and enforce employee compliance with Bank 
policies and procedures. Accordingly, the Finance Board has revised the 
language of Sec. 917.3(a)(2)(iv) to require only that the board ensure 
that policies and procedures are in place ``that are reasonably 
designed'' to achieve ``continuing'' Bank compliance with its risk 
management policy.
    Sections 917.3(b)(3)(i) and (ii) require that each Bank's risk 
management policy set forth standards for the Bank's management of 
credit risk and market risk, respectively. One commenter (a Bank) 
suggested that the Finance Board amend the definitions of both market 
risk and credit risk, which in proposed Sec. 917.1 referred to the 
``market value'' of a Bank's portfolio and of a particular obligation, 
respectively, to refer also to the ``estimated fair value'' of assets. 
In the final rule, these two definitions have been revised to add 
references to ``estimated fair value if market value is not 
available.''
    The same Bank also suggested that the Finance Board define the 
terms ``market value'' and ``estimated fair value'' in the final rule. 
Because these terms are

[[Page 25270]]

standard accounting terms, see, e.g., Financial Accounting Standards 
Board (FASB) Statement of Financial Accounting Standards No. 133, App. 
D, para. 534(j), the Finance Board has determined that they need not be 
defined in the final rule.
    The same Bank also suggested that the definition of ``market risk'' 
be amended to include changes in interest rate volatility as an 
underlying causal factor. Because the Finance Board believes that the 
concept of changes in interest rate volatility are subsumed within the 
general term ``changes in interest rates,'' which is included in the 
definition of market risk, it finds the suggested revision to be 
unnecessary.
    Section 917.3(b)(3)(iii) of the rule requires that each Bank's risk 
management policy set forth standards for the Bank's management of day-
to-day operational liquidity needs and contingency liquidity needs. One 
commenter (a Bank) recommended that the definition of ``contingency 
liquidity,'' set forth in Sec. 917.1, include both maturing advances 
and off-balance sheet sources of funds that a Bank can use to help meet 
liquidity needs if access to capital markets is impeded. Because the 
Finance Board considers maturing advances to be included within 
paragraph (2) of the definition of ``contingency liquidity'' (self-
liquidating assets with a maturity of seven days or less), it has 
chosen not to list maturing advances separately in the definition.
    Regarding off-balance sheet items, during a funding crisis, a Bank 
may be expected to lose access to normal sources of unsecured 
borrowings such as deposits or federal funds. However, even if, due to 
a funding crisis, a Bank were to lose access to its normal sources of 
unsecured borrowing, it is expected that the Bank would continue to 
have access to previously-established irrevocable lines of credit from 
AAA- or AA-rated financial institutions, through either deposits or the 
federal funds market. Accordingly, the Finance Board has amended the 
definition of ``contingency liquidity'' in the final rule to include 
these sources of funds.
    One commenter (a Bank), noting that the proposed rule contained a 
definition of ``contingency liquidity,'' but did not define 
``operational liquidity,'' requested that a definition of ``operational 
liquidity'' be added to the final rule. In response, the Finance Board 
has, in final Sec. 917.1, defined ``operational liquidity'' as 
including sources of cash from both a Bank's ongoing access to the 
capital markets and its holding of liquid assets to meet operational 
requirements in a Bank's normal course of business.
    Section 917.3(c) of the rule requires that each Bank's senior 
management perform an annual risk assessment to identify and evaluate 
all material risks that could adversely affect the achievement of the 
Bank's performance objectives and compliance requirements. One 
commenter (a Bank) requested that the Finance Board include in the 
final rule a definition of the word ``material.'' The same Bank opposed 
the requirement that a Bank identify and evaluate ``all'' material 
risks, stating that the ``innocent failure'' to identify a risk that is 
deemed by a Finance Board examiner to be ``material'' could expose the 
Bank's board and management to criticism.
    Because ``material risk'' is a standard accounting concept, see, 
e.g., FASB Statement of Financial Accounting Concepts No. 2; SEC Staff 
Accounting Bulletin No. 99, the Finance Board finds it unnecessary to 
define the term in the final rule. Additionally, because the Finance 
Board would consider the failure of a Bank's management to identify any 
material risk--whether innocent or intentional--to be a matter of 
supervisory concern, the agency declines to eliminate the word ``all'' 
from Sec. 917.3(c). However, so as not to set an unreasonable 
regulatory standard, the Finance Board has amended Sec. 917.3(c) in the 
final rule to require only that the risk assessment be ``reasonably 
designed'' to identify and evaluate all material risks.

F. Strategic Planning Requirement and Mission--Sec. 917.5 and Part 940

    Section 917.5 of the final rule (Sec. 917.9 in the proposed rule) 
requires that, beginning 90 days after the effective date of the final 
rule, each Bank's board of directors have in effect at all times a 
strategic business plan that describes how the Bank's business 
activities will achieve the mission of the Bank. In the proposed rule, 
the ``mission of the Banks'' was defined in paragraph (a) of the 
strategic business plan section. In the final rule, this mission 
provision remains substantively unchanged, but is moved from part 917 
and to a new part 940, entitled ``Mission of the Banks.''
    The mission provision describes the mission of the Banks as 
providing to their members and associates financial products and 
services, including but not limited to advances, that assist and 
enhance their members' and associates' financing of housing and 
community lending. Three commenters (all Banks) stated their belief 
that individual Banks should have the responsibility for establishing 
their own mission statements. One Bank stated that each Bank's mission 
statement should be a reflection of how the Bank, its board, its 
management and shareholders construe the authority granted under the 
Federal Home Loan Bank Act (Bank Act). The Bank further stated that the 
Bank Act does not explicitly define the mission of the Banks and does 
not require that the Finance Board do so. Another Bank commented that 
the drafting of a mission statement is fundamentally a management 
responsibility that should be exercised by the entity's board of 
directors and not by the entity's regulator.
    The Bank Act authorizes the Finance Board to supervise the Banks 
and to promulgate and enforce such regulations and orders as are 
necessary from time to time to carry out the provisions of the Bank 
Act. See 12 U.S.C. 1422b(a)(1). Among the provisions of the Bank Act 
are those outlining the duties of the Finance Board, which include the 
duty to ``ensure'' that the Banks carry out their housing finance 
mission. See id. at 1422a(a)(3)(B)(ii). Many of the comment letters 
received in response to the proposed rule criticized the Finance Board 
for using the word ``ensure'' in some of the provisions setting forth 
specific duties of Bank directors, noting that the word implies that 
the directors would have a duty to ``guarantee'' that Bank employees 
would carry out the board's directives with precision. The Finance 
Board agrees that the word ``ensure'' connotes an affirmative 
obligation that carries a high degree of responsibility. Thus, the use 
of the word ``ensure'' in section 2A(a)(3)(B)(ii) of the Bank Act makes 
clear that, consistent with the safe and sound operation of the Banks, 
the Finance Board has the duty to take active measures, using all 
available avenues, to see to it that the Banks carry out their housing 
finance mission.
    Because Congress has not expressly defined the term ``housing 
finance mission,'' it is the responsibility and the privilege of the 
Finance Board--as the body charged with the duty to ensure that the 
Banks fulfill that mission and, more generally, as the supervisory 
regulator of the Banks and the agency charged with the administration 
of the Bank Act--to construe the term reasonably in light of the 
totality of the Act. It is the position of the Finance Board that, when 
Congress amended the Bank Act in 1989 to require the Banks to offer 
Affordable Housing Programs (AHP) and Community Investment Programs 
(CIP) and authorized the Banks to offer Community Investment Cash 
Advance Programs (CICA), the Banks' ``housing finance mission,'' as 
referenced in section 2A(a)(3)(B)(ii),

[[Page 25271]]

came to include support not only for the financing of traditional 
housing-related activities, but also for those types of community 
lending that the Banks are authorized by statute to support and that 
indirectly enhance traditional housing finance by helping to create and 
sustain thriving and livable communities. See 12 U.S.C. 1430(i), (j).
    Section 940.2 of the final rule implements in regulation this 
description of the Banks' ``housing finance mission.'' Although, as 
discussed, the Finance Board believes that support of community lending 
is an integral part of the Banks' statutory housing finance mission, it 
has used the terms ``housing'' and ``community lending'' separately in 
Sec. 940.2 and in other parts of the regulations in order to make clear 
that the Banks' housing finance mission goes beyond the parameters that 
the term ``housing finance'' would traditionally connote.
    Regarding the substance of the mission provision, seven commenters 
(five Banks and two trade associations) stated that the scope of the 
provision was too narrow. Specifically, several commenters noted that 
the mission provision does not reference the Banks' new authority to 
extend advances to CFIs for the purpose of funding loans to small 
businesses, small farms and small agri-businesses. One of the Banks 
stated that, if the Finance Board must enact a mission provision, the 
agency should draft the provision broadly enough to support all 
activities explicitly allowed by the Bank Act. Similarly, two of the 
Banks opined that the mission provision does not include sufficient 
reference to other types of investments, products and services that may 
directly contribute to mission achievement. Yet another Bank stated 
that the mission provision should recognize the need to use member's 
capital prudently and effectively, particularly in light of the recent 
statutory change to an all-voluntary membership base.
    As drafted, the mission provision does not appear to consider as 
mission-related activities related to those purposes addressed by the 
Modernization Act-namely facilitating the funding of loans by CFIs to 
small businesses, small farms and small agri-businesses. However, the 
Finance Board has recently approved for publication a proposed rule to 
amend its advances regulation to incorporate the new CFI-related 
advance authorities. As part of this rule, the Finance Board is 
proposing to amend the term ``community lending,'' as defined in part 
952 of the regulations, to include these authorities. Because the 
mission provision incorporates the term ``community lending,'' it will 
also encompass the new CFI-related authorities once the Finance Board 
promulgates a final rule amending its advances regulation, most likely 
in the third quarter of 2000. Presently, the Finance Board is in the 
midst of an ambitious regulatory agenda intended to implement in a 
timely manner the statutory changes brought about by the Modernization 
Act. In order to accomplish these changes effectively, the agency must 
necessarily proceed one step at a time. With many interrelated 
regulations, it will in some cases take two or more rulemakings before 
a change can be fully integrated into all relevant aspects of the 
Finance Board's regulatory scheme. In order to make clear immediately 
that the CFI-related authorities, as well as support for the financing 
of multi-family housing, are considered to be part of each Bank's 
mission, the Finance Board has added to Sec. 917.5(a) a requirement 
that performance goals for these areas be included in each Bank's 
strategic plan.
    It should also be noted that the mission provision is not intended 
to be an all-encompassing description of every function that a Bank is 
authorized to undertake. As mentioned in several of the comment 
letters, there are many ways in which a Bank may serve its members and 
associates that do not fall within the parameters of the mission 
provision. The point of the mission provision, in combination with the 
strategic planning requirement, is to require the Banks to focus 
primarily upon carrying out their housing finance mission and to do so 
in a profitable manner.
    Finally one commenter (a trade association) expressed concern that 
the Finance Board's promulgation of the mission provision, in 
combination with the strategic planning requirement, is inconsistent 
with the content of an October 18, 1999 letter from Finance Board 
Chairman Bruce Morrison to Senator Phil Gramm and Congressman Jim 
Leach. In that letter, Chairman Morrison stated that, upon the 
enactment of the Modernization Act, the Finance Board would withdraw 
its Financial Management and Mission Achievement (FMMA) proposed 
rulemaking, see 64 FR 52163 (1999), and would take no action to 
promulgate proposed or final regulations limiting Bank assets or 
advances beyond those regulations currently in effect, except to the 
extent necessary to protect the safety and soundness of the Banks. As 
discussed, this rule does nothing to limit Bank assets or advances of 
any kind, but merely requires the Banks to adopt a strategic plan 
setting forth how their assets, advances and other products and 
services will contribute to fulfillment of the Banks' mission.
    The requirements regarding the content of the Banks' strategic 
plans remain in part 917, at Sec. 917.5. Regarding the actual strategic 
plan requirement, one commenter (a Bank) expressly opposed specific 
strategic planning requirements, stating that each Bank should be 
permitted to determine the strategic planning methodology most 
appropriate for the Bank to pursue its mission. As mentioned above, it 
is the duty of the Finance Board to ensure that the Banks carry out 
their statutory mission. The Finance Board has determined that, in 
order to fulfill this duty, it must require the Banks to focus upon the 
development of profitable products and services that enhance the 
carrying out of this mission. This is the intent behind the strategic 
planning requirement.
    One commenter (a Bank) asked whether the strategic business plan 
may consist of multiple documents generated and approved by a Bank's 
board of directors in a sequential manner. Nothing in the rule 
prohibits the Banks from drafting and approving elements of the 
strategic business in a sequential fashion, so long as: (1) It is clear 
which documents comprise the strategic business plan; and (2) these 
documents, as a whole, meet the requirements set forth in Sec. 917.5.
    Five commenters (three Banks and two trade associations) opposed 
the 90-day time limit the Banks have been given to adopt their 
strategic business plans. Two of the Banks suggested that the rule be 
revised to permit the Banks to adopt the plan during their next 
scheduled annual planning process. Another of the Banks requested that 
the Banks be given one year to adopt their plans. The trade 
associations suggested that the Finance Board delay imposition of the 
strategic planning requirement until the implementation of each Bank's 
new capital structure. The Finance Board believes that, under current 
requirements, the Banks should already have most elements of the 
strategic plan in place and that, therefore, the adoption of the full 
plan under Sec. 917.5 within 90 days should not be overly burdensome. 
Accordingly, the 90-day requirement remains unchanged in the final 
rule.

G. Internal Control System--Sec. 917.6

    Section 917.6 of the final rule (Sec. 917.4 of the proposed rule) 
sets forth requirements pertaining to the establishment and maintenance 
of a Bank's internal control system. Section 917.6(a)(1) enumerates the 
areas of

[[Page 25272]]

concern that each Bank's internal control system should be designed to 
address. Section 917.6(a)(2) sets forth several of the ongoing internal 
control activities that the Finance Board has determined are necessary 
in order to adequately address the concerns referred to in paragraph 
(a)(1). One commenter (a Bank) opposed the non-exclusive listing of 
required ongoing internal control activities in Sec. 917.6(a)(2), 
stating that the list added little, if anything, to the regulation.
    In determining whether a Bank's internal control system adequately 
addresses the areas of concern set forth in paragraph (a)(1), Finance 
Board examiners will be looking to determine whether the Bank is 
effectively carrying out the ongoing internal control activities listed 
in paragraph (a)(2). Accordingly, the Finance Board finds it preferable 
to list explicitly some of the internal control activities on which 
examiners will focus so that each Bank will be aware in advance of the 
standards that will be applied in the examination of its internal 
control system.
    Section 917.6(b) of the rule lists the internal control 
responsibilities of each Bank's board of directors. In the proposed 
rule, paragraph (b)(2) would have required that each Bank's board 
ensure that an effective and comprehensive internal audit of the 
internal control system is performed annually. Four commenters (three 
Banks and one Bank director) objected to the proposed rule language on 
the ground that it appeared to require Bank boards of directors to 
``guarantee'' that employees carrying out an internal control audit 
would do so effectively and comprehensively. The commenters argued that 
this regulatory standard would exceed the legal standard that normally 
applies to corporate directors under state law. In response to these 
concerns, and to emphasize that the regulatory standard of care 
applicable to Bank directors is equivalent to the legal standard that 
normally applies to corporate directors under state law, the Finance 
Board has revised Sec. 917.6(b)(2) in the final rule to require only 
that: (1) The board require an annual internal audit of the Bank's 
internal control system; and (2) the audit plan is reasonably designed 
to be effective and comprehensive.
    Two commenters (one Bank and one trade association) suggested that 
the Finance Board modify Sec. 917.6(b)(2) to enable Banks to 
distinguish between high- and low-risk internal control areas and that 
audits of low-risk areas be required less frequently than annually. The 
Federal Deposit Insurance Act (FDIA) requires that each insured 
depository institution prepare annually, among other things, a report 
signed by the chief executive officer and the chief accounting or 
financial officer of the institution that contains: (A) A statement of 
the management's responsibilities for (i) preparing financial 
statements; (ii) establishing and maintaining an adequate internal 
control structure and procedures for financial reporting; and (iii) 
complying with the laws and regulations relating to safety and 
soundness; and (B) an assessment, as of the end of the institution's 
most recent fiscal year, of (i) the effectiveness of such internal 
control structure and procedures; and (ii) the institution's compliance 
with the laws and regulations relating to safety and soundness. See 12 
U.S.C. 1831m(b)(2); see also 12 CFR part 363 (FDIC implementing 
regulations). These FDIA provisions essentially require that each FDIC-
insured financial institution perform an annual comprehensive audit of 
its internal control system. Section 917.6(b)(2) of the rule is 
intended to apply a similar requirement to the Banks and therefore 
remains unchanged in the final rule.
    One commenter (a Bank) also objected to the requirement, set forth 
in Sec. 917.6(b)(6), that a Bank's board of directors report to the 
Finance Board in a timely manner any internal control deficiencies 
found and the corrective action taken. The commenter suggested that the 
Banks be required to report only significant internal control 
deficiencies that have the potential to impact a Bank's safety and 
soundness. As the entity charged by statute with ensuring the safety 
and soundness of the Banks, see 12 U.S.C. 1422a(a)(3)(A), it is 
ultimately the statutory responsibility of the Finance Board to 
determine which deficiencies may impact upon the safety and soundness 
of a Bank. As such, final Sec. 917.6(b)(6) continues to hold each 
Bank's board of directors responsible for reporting all known internal 
control deficiencies to the Finance Board.
    Section 917.6(b)(8) of the rule requires that each Bank's board of 
directors review all delegations of authority to specific personnel or 
committees and require that such delegations state the extent of the 
authority and responsibilities delegated. One commenter (a Bank) 
requested clarification as to whether, under this provision, it would 
be permissible for a Bank's management to make particular delegation 
decisions, so long as the Bank's board of directors reviews the 
delegations. The Finance Board understands that decisions regarding 
delegations of authority among specific Bank personnel will most likely 
be made by a Bank's management as part of its responsibility for the 
day-to-day operations of the Bank. Such management decisions are 
permissible under Sec. 917.6(b)(8), provided that the Bank's board of 
directors reviews the delegations and requires that the delegations 
state the extent of the power delegated.
    Section 917.6(c) of the rule addresses the responsibilities of each 
Bank's senior management for the establishment, implementation and 
maintenance of the Bank's internal control system. As it appeared in 
the proposed rule, this provision would have required that senior 
management ensure that Bank personnel fully understand and comply with 
all policies, procedures and legal requirements. One commenter (a trade 
association) requested that the Finance Board amend this provision to 
require only that management ensure that Bank personnel understand and 
comply with policies, procedures and requirements applicable to their 
positions and responsibilities. Although this was implicit in the 
proposed rule, the Finance Board agrees that the provision may have 
appeared to be overly-burdensome as written. Therefore, the agency has 
revised Sec. 917.6(c)(2) to add the requested clarification.
    In addition, one commenter (a Bank) objected to the use of the word 
``ensure'' in Sec. 917.6(c)(2), and also to its use in 
Sec. 917.6(c)(6), which requires that senior management ensure 
adherence to the lines of authority and responsibility established by 
the Bank's board of directors. Contrary to the role of the Bank's board 
of directors, which sets overall policy and oversees the operations of 
the Bank in a general sense, the management of the Bank is responsible 
for day-to-day operations, including the direct supervision of Bank 
employees. As such, Bank management should be in a position: (1) To 
educate employees regarding policies, procedures and legal requirements 
related to their positions and regarding lines of authority and 
responsibility relevant to their positions; (2) to determine on a 
regular basis whether employees are complying with these policies, 
procedures and requirements and lines of authority and responsibility; 
and (3) to take prompt corrective action when it is discovered that 
they are not so complying. Accordingly, the Finance Board has 
determined that use of the word ``ensure'' in Secs. 917.6(c)(2) and (6) 
is appropriate.

[[Page 25273]]

H. Audit Committees--Sec. 917.7

    Section 917.7 of the final rule (Sec. 917.5 in the proposed rule) 
addresses the powers and responsibilities of Bank audit committees. One 
commenter (a Bank) stated generally that the language of the rule 
suggests that audit committees will interact directly with Bank 
management as an independent source of authority, while, under 
traditional notions of corporate governance, the audit committee acts 
as an agent of the full board. Nothing in the audit committee 
provisions of the rule is intended to suggest that the authority of a 
Bank's audit committee derives other than from its status as agent of 
the full board of directors. References in the rule to direct audit 
committee supervision of, or authority over, the internal auditor or 
other Bank employees are to powers that the Finance Board has 
determined a Bank audit committee must possess in order to be 
effective. These powers would be delegated by the full board of 
directors to the audit committee as part of the audit committee 
charter.
    Section 917.7(b) of the rule addresses the required composition of 
Bank audit committees. Specifically, Sec. 917.7(b)(1) requires that the 
audit committee comprise at least five persons drawn from the Bank's 
board of directors. One commenter (a trade association) opposed this 
requirement, stating that the rule contradicts Report and 
Recommendations of the Blue Ribbon Committee on Improving the 
Effectiveness of Corporate Audit Committees (Feb. 8, 1999) (Blue Ribbon 
Committee Report), which establishes a minimum of three directors.
    Section 917.7(b)(2) requires that each Bank's audit committee 
include a balance of representatives of: (i) community financial 
institutions (CFIs) and other members; and (ii) appointive and elective 
directors of the Bank. One commenter (a Bank) opposed the diversity 
requirement, stating that the safety and soundness issues that face the 
Banks are straightforward and that the requirement adds to the 
complexity of the audit committee without adding to its ability to deal 
with issues of safety and soundness. Another commenter (a trade 
association) opposed the diversity requirement, stating that it has no 
basis in the Blue Ribbon Committee Report. Two commenters (both Banks) 
suggested that the Finance Board remove the provision requiring a 
balance between representatives of CFIs and other members, stating that 
there can be no assurance that a particular Bank's board of directors 
will have any elected directors representing a CFI. Finally, one 
commenter (a trade association) opposed the diversity requirement as 
written, suggesting that large borrowers be precluded from serving on 
the audit committee.
    As stated in the proposed rule, the Finance Board included the 
diversity requirement in the rule in order to prevent dominance of the 
audit committee by any particular interest. Section 917.7(a)(1) sets 
the minimum audit committee membership at five (instead of the three 
established by the Blue Ribbon Committee Report) because the Finance 
Board has determined that this is the minimum number required to 
achieve adequately diverse representation on a Bank's audit committee. 
The Finance Board rejects suggestions that it eliminate the requirement 
that there be a balance of representation between CFIs and other 
members. If there are no CFI representatives on a Bank's board of 
directors, there will obviously be no one to serve on the audit 
committee in that capacity and the Bank would not be in violation of 
the regulation for failure to appoint a non-existent CFI director to 
the board. Section 917.7(b)(4) requires that at least one member of 
each Bank's audit committee have extensive accounting or related 
financial management experience. Three commenters (two Banks and one 
trade association) expressly supported this requirement. One of the 
Banks requested that the Finance Board clarify the meaning of the 
phrase ``extensive accounting or related financial management 
experience.'' The Blue Ribbon Committee Report uses the phrase 
``accounting or related financial management expertise,'' where 
``expertise'' signifies ``past employment experience in finance or 
accounting, requisite professional certification in accounting, or any 
other comparable experience or background which results in the 
individual's financial sophistication, including being or having been a 
CEO or other senior officer with financial oversight 
responsibilities.'' Although the Finance Board has chosen to use the 
word ``experience'' in order to express the standard more clearly, the 
explanation contained in the Blue Ribbon Committee Report is equally 
applicable to the standard set forth in final Sec. 917.7(b)(4).
    In the proposed rule, the Finance Board requested comment on two 
specific questions regarding the composition of a Bank's audit 
committee. First, the Finance Board asked whether, in the final rule, 
the provision requiring that at least one member of the audit committee 
have extensive accounting or related financial management experience 
should be made to apply specifically to the chair of the audit 
committee. Eight commenters (six Banks and two trade associations) 
opposed, and no commenters supported, the inclusion of this requirement 
in the final rule. The primary objection to this idea was that such a 
requirement might prevent an individual with other important 
qualifications, such as proven administrative ability, from serving as 
chair. Most commenters expressed a belief that, so long as at least one 
member of the committee has extensive financial or accounting 
experience, it would add little to the effectiveness of the audit 
committee to require that the chair specifically possess such 
experience. The Finance Board agrees with these arguments and, 
therefore, has not included this requirement in the final rule.
    Second, the Finance Board asked whether the final rule should 
require that the vice chair of the board of directors serve as chair of 
the audit committee, to enable Banks to pay the audit committee chair 
at a higher rate of compensation. Twelve commenters (nine Banks and 
three trade associations) opposed, and no commenters supported, the 
inclusion of this requirement in the final rule. Most commenters 
believed that this decision properly should be left to a Bank's board 
of directors. Others expressed concern that, far from being an 
incentive, service as vice chair would only distract the audit 
committee chair from his or her audit committee duties. The Finance 
Board also agrees with these comments and, therefore, has not included 
this requirement in the final rule.
    Section 917.7(c) of the rule prohibits any member of a Bank's board 
of directors from serving on the audit committee if he or she has a 
disqualifying relationship with the Bank or its management that would 
interfere with the exercise of that director's independent judgment. 
This section includes a non-exclusive list of relationships that would 
disqualify a board director for audit committee service regardless of 
the attendant circumstances. In the proposed rule, paragraph (4) of 
this list deemed as disqualifying ``being an immediate family member of 
an individual who is, or has been in any of the past five years, 
employed by the Bank.'' Two commenters (both Banks) suggested that the 
Finance Board amend this provision to refer only to family members who 
are employed by the Bank ``as an executive officer.'' The commenters 
pointed out that the suggested language conforms to

[[Page 25274]]

the standard set forth in the Blue Ribbon Committee Report and that a 
director's familial relationship with a low-ranking Bank employee would 
be likely to have little effect on the director's independent judgment.
    The Finance Board agrees that, on its face, a familial relationship 
with a low-ranking Bank employee should not disqualify a director from 
service on the Bank's audit committee and, therefore, has added the 
requested language to final Sec. 917.7(c)(4). However, if circumstances 
surrounding the relationship were to cast doubt upon the director's 
ability to act independently, that director would still be prohibited 
from serving on the audit committee pursuant to the general prohibition 
against disqualifying relationships set forth in the introductory 
paragraph of Sec. 917.7(c).
    In addition, one commenter (a Bank) requested clarification that 
the concept of ``independence'' does not in any way preclude elected 
directors associated with Bank members from serving on the audit 
committee. Given that, under Sec. 917.7(b)(2), a Bank is expressly 
required to have on its audit committee elective directors that 
represent both CFI and non-CFI members, Sec. 917.7(c) should not be 
read as overriding this requirement. Only if an industry representative 
were to have a direct personal or financial relationship with the Bank 
or its senior employees would that director's independence be called 
into question under Sec. 917.7(c).
    Section 917.7(e) enumerates the duties applicable to Bank audit 
committees. Under the proposed rule, paragraph (2) of this section 
would have required, among other things, that each Bank's audit 
committee ensure that policies are in place to achieve disclosure and 
transparency regarding the Bank's true financial performance and 
governance practices. One commenter (a Bank) requested that the Finance 
Board modify the language of this paragraph to refer instead to 
policies that are ``reasonably designed'' to achieve disclosure and 
transparency regarding the Bank's true financial performance and 
governance practices. The commenter argued that the language of the 
proposed rule appeared to require that audit committee members 
``guarantee'' that Bank employees would implement these policies 
without error and that the precise result intended would be achieved. 
The Finance Board agrees that, in the proposed rule, this provision 
appeared to impose upon audit committee members a regulatory 
requirement that exceeds the legal standard that normally applies to 
corporate directors under state law. Accordingly, the Finance Board has 
amended Sec. 917.7(e)(2) in the final rule to include the requested 
language.

I. Budgets, Dividends and Bylaws--Secs. 917.8, 917.9 and 917.10

    Sections 917.8, 917.9 and 917.10 of the final rule address the 
power and responsibilities of Banks' boards of directors and senior 
management regarding, respectively, budget preparation and reporting 
requirements, dividends and Bank bylaws. These provisions already 
appear in existing part 917 as Secs. 917.6, 917.7 and 917.8, 
respectively, having been redesignated from old Secs. 934.7, 934.16 and 
934.17, respectively, in the recent final rulemaking that reorganized 
and renumbered the Finance Board's regulations. See 65 FR 8253 (2000). 
Each of these provisions has also been substantively amended as part of 
the Finance Board's recent rulemaking that devolved various corporate 
governance authorities to the Banks in response to statutory changes 
made by the Federal Home Loan Bank Modernization Act of 1999 
(Modernization Act), Pub. L. No. 106-102, Title VI (1999). See 64 FR 
71275 (1999) (interim final rule); 65 FR 13663 (2000) (final rule). As 
such, no further amendments are made to these provisions in this final 
rule, other than their redesignation as Secs. 917.8, 917.9 and 917.10.

III. Regulatory Flexibility Act

    The final rule applies only to the Banks, which do not come within 
the meaning of ``small entities,'' as defined in the Regulatory 
Flexibility Act (RFA). See 5 U.S.C. 601(6). Therefore, in accordance 
with section 605(b) of the RFA, see id. at 605(b), the Finance Board 
hereby certifies that this final rule will not have a significant 
economic impact on a substantial number of small entities.

IV. Paperwork Reduction Act

    The final rule does not contain any collections of information 
pursuant to the Paperwork Reduction Act of 1995. See 44 U.S.C. 3501 et 
seq. Consequently, the Finance Board has not submitted any information 
to the Office of Management and Budget for review.

List of Subjects in 12 CFR Parts 900, 917 and 940

    Community development, Credit, Federal home loan banks, Housing.

    Accordingly, the Finance Board hereby amends title 12, chapter IX, 
Code of Federal Regulations as follows:

PART 900--GENERAL DEFINITIONS

    1. The authority citation for part 900 continues to read as 
follows:

    Authority: 12 U.S.C. 1422b(a).

    2. In Sec. 900.1, add a definition of ``associate'' to read as 
follows:


Sec. 900.1  Definitions applying to all regulations.

* * * * *
    Associate means an entity that has been approved as a nonmember 
mortgagee pursuant to subpart B of part 950 of this chapter.
* * * * *

    3. In subchapter C, revise part 917 to read as follows:

PART 917--POWERS AND RESPONSIBILITIES OF BANK BOARDS OF DIRECTORS 
AND SENIOR MANAGEMENT

Sec.
917.1   Definitions.
917.2   General authorities and duties of Bank boards of directors.
917.3   Risk management.
917.4   Bank member products policy. [Reserved]
917.5   Strategic business plan.
917.6   Internal control system.
917.7   Audit committees.
917.8   Budget preparation.
917.9   Dividends.
917.10   Bank bylaws.

    Authority: 12 U.S.C. 1422a(a)(3), 1422b(a)(1), 1427, 1432(a), 
1436(a), 1440.


Sec. 917.1  Definitions.

    As used in this part:
    Business risk means the risk of an adverse impact on a Bank's 
profitability resulting from external factors as may occur in both the 
short and long run.
    Capital structure plan means the plan establishing and implementing 
a capital structure that each Bank is required to submit to the Finance 
Board under 12 U.S.C. 1426(b).
    Community financial institution has the meaning set forth in 
Sec. 925.1 of this chapter.
    Contingency liquidity means the sources of cash a Bank may use to 
meet its operational requirements when its access to the capital 
markets is impeded, and includes:
    (1) Marketable assets with a maturity of one year or less;
    (2) Self-liquidating assets with a maturity of seven days or less;
    (3) Assets that are generally accepted as collateral in the 
repurchase agreement market; and
    (4) Irrevocable lines of credit from financial institutions rated 
not lower than the second highest credit rating category by a credit 
rating organization

[[Page 25275]]

regarded as a Nationally Recognized Statistical Rating Organization by 
the Securities and Exchange Commission.
    Credit risk means the risk that the market value, or estimated fair 
value if market value is not available, of an obligation will decline 
as a result of deterioration in creditworthiness.
    Immediate family member means a parent, sibling, spouse, child, 
dependent, or any relative sharing the same residence.
    Internal auditor means the individual responsible for the internal 
audit function at the Bank.
    Liquidity risk means the risk that a Bank will be unable to meet 
its obligations as they come due or meet the credit needs of its 
members and associates in a timely and cost-efficient manner.
    Market risk means the risk that the market value, or estimated fair 
value if market value is not available, of a Bank's portfolio will 
decline as a result of changes in interest rates, foreign exchange 
rates, equity and commodity prices.
    Operational liquidity means sources of cash from both a Bank's 
ongoing access to the capital markets and its holding of liquid assets 
to meet operational requirements in a Bank's normal course of business.
    Operations risk means the risk of an unexpected loss to a Bank 
resulting from human error, fraud, unenforceability of legal contracts, 
or deficiencies in internal controls or information systems.
    Reportable conditions means matters that represent significant 
deficiencies in the design or operation of the internal control system 
that could adversely affect a Bank's ability to record, process, 
summarize and report financial data consistent with the assertions of 
management.


Sec. 917.2  General authorities and duties of Bank boards of directors.

    (a) Management of a Bank. The management of each Bank shall be 
vested in its board of directors. While Bank boards of directors may 
delegate the execution of operational functions to Bank personnel, the 
ultimate responsibility of each Bank's board of directors for that 
Bank's management is non-delegable.
    (b) Duties of Bank directors. Each Bank director shall have the 
duty to:
    (1) Carry out his or her duties as director in good faith, in a 
manner such director believes to be in the best interests of the Bank, 
and with such care, including reasonable inquiry, as an ordinarily 
prudent person in a like position would use under similar 
circumstances;
    (2) Administer the affairs of the Bank fairly and impartially and 
without discrimination in favor of or against any member;
    (3) At the time of appointment or election, or within a reasonable 
time thereafter, have a working familiarity with basic finance and 
accounting practices, including the ability to read and understand the 
Bank's balance sheet and income statement and to ask substantive 
questions of management and the internal and external auditors; and
    (4) Direct the operations of the Bank in conformity with the 
requirements set forth in the Act and this chapter.
    (c) Authority regarding staff and outside consultants. (1) In 
carrying out its duties and responsibilities under the Act and this 
chapter, each Bank's board of directors and all committees thereof 
shall have authority to retain staff and outside counsel, independent 
accountants, or other outside consultants at the expense of the Bank.
    (2) Bank staff providing services to the board of directors or any 
committee of the board under paragraph (c)(1) of this section may be 
required by the board of directors or such committee to report directly 
to the board or such committee, as appropriate.


Sec. 917.3  Risk management.

    (a) Risk management policy. (1) Adoption. Beginning August 29, 
2000, each Bank's board of directors shall have in effect at all times 
a risk management policy that addresses the Bank's exposure to credit 
risk, market risk, liquidity risk, business risk and operations risk 
and that conforms to the requirements of paragraph (b) of this section 
and to all applicable Finance Board regulations and policies.
    (2) Review and compliance. Each Bank's board of directors shall:
    (i) Review the Bank's risk management policy at least annually;
    (ii) Amend the risk management policy as appropriate;
    (iii) Re-adopt the Bank's risk management policy, including interim 
amendments, not less often than every three years; and
    (iv) Ensure that policies and procedures are in place that are 
reasonably designed to achieve continuing Bank compliance with the risk 
management policy.
    (b) Risk management policy requirements. In addition to meeting any 
other requirements set forth in this chapter, each Bank's risk 
management policy shall:
    (1) After the Bank's capital structure plan is approved by the 
Finance Board, describe how the Bank will comply with its capital 
structure plan;
    (2) Set forth the Bank's tolerance levels for the market and credit 
risk components; and
    (3) Set forth standards for the Bank's management of each risk 
component, including but not limited to:
    (i) Regarding credit risk arising from all secured and unsecured 
transactions, standards and criteria for, and timing of, periodic 
assessment of the creditworthiness of issuers, obligors, or other 
counterparties including identifying the criteria for selecting 
dealers, brokers and other securities firms with which the Bank may 
execute transactions; and
    (ii) Regarding market risk, standards for the methods and models 
used to measure and monitor such risk;
    (iii) Regarding day-to-day operational liquidity needs and 
contingency liquidity needs:
    (A) An enumeration of specific types of investments to be held for 
such liquidity purposes; and
    (B) The methodology to be used for determining the Bank's 
operational and contingency liquidity needs;
    (iv) Regarding operations risk, standards for an effective internal 
control system, including periodic testing and reporting; and
    (v) Regarding business risk, strategies for mitigating such risk, 
including contingency plans where appropriate.
    (c) Risk assessment. The senior management of each Bank shall 
perform, at least annually, a risk assessment that is reasonably 
designed to identify and evaluate all material risks, including both 
quantitative and qualitative aspects, that could adversely affect the 
achievement of the Bank's performance objectives and compliance 
requirements. The risk assessment shall be in written form and shall be 
reviewed by the Bank's board of directors promptly upon its completion.


Sec. 917.4  Bank member products policy. [Reserved]


Sec. 917.5  Strategic business plan.

    (a) Adoption of strategic business plan. Beginning 90 days after 
the effective date of this section, each Bank's board of directors 
shall have in effect at all times a strategic business plan that 
describes how the business activities of the Bank will achieve the 
mission of the Bank consistent with part 940 of this chapter. 
Specifically, each Bank's strategic business plan shall:
    (1) Enumerate operating goals and objectives for each major 
business activity and for all new business activities, which must 
include plans for

[[Page 25276]]

maximizing activities that enhance the carrying out of the mission of 
the Bank, consistent with part 940 of this chapter;
    (2) Discuss how the Bank will:
    (i) Address credit needs and market opportunities identified 
through ongoing market research and consultations with members, 
associates and public and private organizations; and
    (ii) Notify members and associates of relevant programs and 
initiatives;
    (3) Establish quantitative performance goals for Bank products 
related to multi-family housing, small business, small farm and small 
agri-business lending ;
    (4) Describe any proposed new business activities or enhancements 
of existing activities; and (5) Be supported by appropriate and timely 
research and analysis of relevant market developments and member and 
associate demand for Bank products and services.
    (b) Review and monitoring. Each Bank's board of directors shall:
    (1) Review the Bank's strategic business plan at least annually;
    (2) Amend the strategic business plan as appropriate;
    (3) Re-adopt the Bank's strategic business plan, including interim 
amendments, not less often than every three years; and
    (4) Establish management reporting requirements and monitor 
implementation of the strategic business plan and the operating goals 
and objectives contained therein.
    (c) Report to Finance Board. Each Bank shall submit to the Finance 
Board annually a report analyzing and describing the Bank's performance 
in achieving the goals described in paragraph (a)(3) of this section.


Sec. 917.6  Internal control system.

    (a) Establishment and maintenance. (1) Each Bank shall establish 
and maintain an effective internal control system that addresses:
    (i) The efficiency and effectiveness of Bank activities;
    (ii) The safeguarding of Bank assets;
    (iii) The reliability, completeness and timely reporting of 
financial and management information and transparency of such 
information to the Bank's board of directors and to the Finance Board; 
and
    (iv) Compliance with applicable laws, regulations, policies, 
supervisory determinations and directives of the Bank's board of 
directors and senior management.
    (2) Ongoing internal control activities necessary to maintain the 
internal control system required under paragraph (a)(1) of this section 
shall include, but are not limited to:
    (i) Top level reviews by the Bank's board of directors and senior 
management, including review of financial presentations and performance 
reports;
    (ii) Activity controls, including review of standard performance 
and exception reports by department-level management on an appropriate 
periodic basis;
    (iii) Physical and procedural controls to safeguard, and prevent 
the unauthorized use of, assets;
    (iv) Monitoring for compliance with the risk tolerance limits set 
forth in the Bank's risk management policy;
    (v) Any required approvals and authorizations for specific 
activities; and
    (vi) Any required verifications and reconciliations for specific 
activities.
    (b) Internal control responsibilities of Banks' boards of 
directors. Each Bank's board of directors shall ensure that the 
internal control system required under paragraph (a)(1) of this section 
is established and maintained, and shall oversee senior management's 
implementation of such a system on an ongoing basis, by:
    (1) Conducting periodic discussions with senior management 
regarding the effectiveness of the internal control system;
    (2) Ensuring that an internal audit of the internal control system 
is performed annually and that such annual audit is reasonably designed 
to be effective and comprehensive;
    (3) Requiring that internal control deficiencies be reported to the 
Bank's board of directors in a timely manner and that such deficiencies 
are addressed promptly;
    (4) Conducting a timely review of evaluations of the effectiveness 
of the internal control system made by internal auditors, external 
auditors and Finance Board examiners;
    (5) Directing senior management to address promptly and effectively 
recommendations and concerns expressed by internal auditors, external 
auditors and Finance Board examiners regarding weaknesses in the 
internal control system;
    (6) Reporting any internal control deficiencies found, and the 
corrective action taken, to the Finance Board in a timely manner;
    (7) Establishing, documenting and communicating an organizational 
structure that clearly shows lines of authority within the Bank, 
provides for effective communication throughout the Bank, and ensures 
that there are no gaps in the lines of authority;
    (8) Reviewing all delegations of authority to specific personnel or 
committees and requiring that such delegations state the extent of the 
authority and responsibilities delegated; and
    (9) Establishing reporting requirements, including specifying the 
nature and frequency of reports it receives.
    (c) Internal control responsibilities of Banks' senior management. 
Each Bank's senior management shall be responsible for carrying out the 
directives of the Bank's board of directors, including the 
establishment, implementation and maintenance of the internal control 
system required under paragraph (a)(1) of this section by:
    (1) Establishing, implementing and effectively communicating to 
Bank personnel policies and procedures that are adequate to ensure that 
internal control activities necessary to maintain an effective internal 
control system, including the activities enumerated in paragraph (a)(2) 
of this section, are an integral part of the daily functions of all 
Bank personnel;
    (2) Ensuring that all Bank personnel fully understand and comply 
with all policies, procedures and legal requirements applicable to 
their positions and responsibilities;
    (3) Ensuring that there is appropriate segregation of duties among 
Bank personnel and that personnel are not assigned conflicting 
responsibilities;
    (4) Establishing effective paths of communication upward, downward 
and across the organization in order to ensure that Bank personnel 
receive necessary and appropriate information, including:
    (i) Information relating to the operational policies and procedures 
of the Bank;
    (ii) Information relating to the actual operational performance of 
the Bank;
    (iii) Adequate and comprehensive internal financial, operational 
and compliance data; and
    (iv) External market information about events and conditions that 
are relevant to decision making;
    (5) Developing and implementing procedures that translate the major 
business strategies and policies established by the Bank's board of 
directors into operating standards;
    (6) Ensuring adherence to the lines of authority and responsibility 
established by the Bank's board of directors;
    (7) Overseeing the implementation and maintenance of management 
information and other systems;
    (8) Establishing and implementing an effective system to track 
internal control weaknesses and the actions taken to correct them; and

[[Page 25277]]

    (9) Monitoring and reporting to the Bank's board of directors the 
effectiveness of the internal control system on an ongoing basis.


Sec. 917.7  Audit committees.

    (a) Establishment. The board of directors of each Bank shall 
establish an audit committee, consistent with the requirements set 
forth in this section.
    (b) Composition. (1) The audit committee shall comprise five or 
more persons drawn from the Bank's board of directors, each of whom 
shall meet the criteria of independence set forth in paragraph (c) of 
this section.
    (2) The audit committee shall include a balance of representatives 
of:
    (i) Community financial institutions and other members; and
    (ii) Appointive and elective directors of the Bank.
    (3) The terms of audit committee members shall be appropriately 
staggered so as to provide for continuity of service.
    (4) At least one member of the audit committee shall have extensive 
accounting or related financial management experience.
    (c) Independence. Any member of the Bank's board of directors shall 
be considered to be sufficiently independent to serve as a member of 
the audit committee if that director does not have a disqualifying 
relationship with the Bank or its management that would interfere with 
the exercise of that director's independent judgment. Such 
disqualifying relationships include, but are not limited to:
    (1) Being employed by the Bank in the current year or any of the 
past five years;
    (2) Accepting any compensation from the Bank other than 
compensation for service as a board director;
    (3) Serving or having served in any of the past five years as a 
consultant, advisor, promoter, underwriter, or legal counsel of or to 
the Bank; or
    (4) Being an immediate family member of an individual who is, or 
has been in any of the past five years, employed by the Bank as an 
executive officer.
    (d) Charter. (1) The audit committee of each Bank shall adopt, and 
the Bank's board of directors shall approve, a formal written charter 
that specifies the scope of the audit committee's powers and 
responsibilities, as well as the audit committee's structure, processes 
and membership requirements.
    (2) The audit committee and the board of directors of each Bank 
shall:
    (i) Review, assess the adequacy of and, where appropriate, amend 
the Bank's audit committee charter on an annual basis;
    (ii) Amend the audit committee charter as appropriate; and
    (iii) Re-adopt and re-approve, respectively, the Bank's audit 
committee charter not less often than every three years.
    (3) Each Bank's audit committee charter shall:
    (i) Provide that the audit committee has the responsibility to 
select, evaluate and, where appropriate, replace the internal auditor 
and that the internal auditor may be removed only with the approval of 
the audit committee;
    (ii) Provide that the internal auditor shall report directly to the 
audit committee on substantive matters and that the internal auditor is 
ultimately accountable to the audit committee and board of directors; 
and
    (iii) Provide that both the internal auditor and the external 
auditor shall have unrestricted access to the audit committee without 
the need for any prior management knowledge or approval.
    (e) Duties. Each Bank's audit committee shall have the duty to:
    (1) Direct senior management to maintain the reliability and 
integrity of the accounting policies and financial reporting and 
disclosure practices of the Bank;
    (2) Review the basis for the Bank's financial statements and the 
external auditor's opinion rendered with respect to such financial 
statements (including the nature and extent of any significant changes 
in accounting principles or the application therein) and ensure that 
policies are in place that are reasonably designed to achieve 
disclosure and transparency regarding the Bank's true financial 
performance and governance practices;
    (3) Oversee the internal audit function by:
    (i) Reviewing the scope of audit services required, significant 
accounting policies, significant risks and exposures, audit activities 
and audit findings;
    (ii) Assessing the performance and determining the compensation of 
the internal auditor; and
    (iii) Reviewing and approving the internal auditor's work plan;
    (4) Oversee the external audit function by:
    (i) Approving the external auditor's annual engagement letter;
    (ii) Reviewing the performance of the external auditor; and
    (iii) Making recommendations to the Bank's board of directors 
regarding the appointment, renewal, or termination of the external 
auditor;
    (5) Provide an independent, direct channel of communication between 
the Bank's board of directors and the internal and external auditors;
    (6) Conduct or authorize investigations into any matters within the 
audit committee's scope of responsibilities;
    (7) Ensure that senior management has established and is 
maintaining an adequate internal control system within the Bank by:
    (i) Reviewing the Bank's internal control system and the resolution 
of identified material weaknesses and reportable conditions in the 
internal control system, including the prevention or detection of 
management override or compromise of the internal control system; and
    (ii) Reviewing the programs and policies of the Bank designed to 
ensure compliance with applicable laws, regulations and policies and 
monitoring the results of these compliance efforts;
    (8) Review the policies and procedures established by senior 
management to assess and monitor implementation of with the Bank's 
strategic business plan and the operating goals and objectives 
contained therein; and
    (9) Report periodically its findings to the Bank's board of 
directors.
    (f) Meetings. The audit committee shall prepare written minutes of 
each audit committee meeting.


Sec. 917.8  Budget preparation.

    (a) Adoption of budgets. Each Bank's board of directors shall be 
responsible for the adoption of an annual operating expense budget and 
a capital expenditures budget for the Bank, and any subsequent 
amendments thereto, consistent with the requirements of the Act, this 
section, other regulations and policies of the Finance Board, and with 
the Bank's responsibility to protect both its members and the public 
interest by keeping its costs to an efficient and effective minimum.
    (b) No delegation of budget authority. A Bank's board of directors 
may not delegate the authority to approve the Bank's annual budgets, or 
any subsequent amendments thereto, to Bank officers or other Bank 
employees.
    (c) Interest rate scenario. A Bank's annual budgets shall be 
prepared based upon an interest rate scenario as determined by the 
Bank.
    (d) Board approval for deviations. A Bank may not exceed its total 
annual operating expense budget or its total annual capital 
expenditures budget without prior approval by the Bank's board of 
directors of an amendment to such budget.


Sec. 917.9  Dividends.

    A Bank's board of directors may declare and pay a dividend only 
from

[[Page 25278]]

previously retained earnings or current net earnings and only if such 
payment will not result in a projected impairment of the par value of 
the capital stock of the Bank. Dividends on such capital stock shall be 
computed without preference.


Sec. 917.10  Bank bylaws.

    A Bank's board of directors shall have in effect at all times 
bylaws governing the manner in which the Bank administers its affairs 
and such bylaws shall be consistent with applicable laws and 
regulations as administered by the Finance Board.

    4. In subchapter F, add a new part 940 to read as follows:

PART 940--MISSION OF THE BANKS

Sec.
940.1   Definitions.
940.2   Mission of the Banks.

    Authority: 12 U.S.C. 1422a(a)(3), 1422b(a), 1430, 1430b, 1431.


Sec. 940.1  Definitions.

    Community lending has the meaning set forth in Sec. 952.3 of this 
chapter.


Sec. 940.2  Mission of the Banks.

    The mission of the Banks is to provide to their members and 
associates financial products and services, including but not limited 
to advances, that assist and enhance such members' and associates' 
financing of:
    (a) Housing, including single-family and multi-family housing 
serving consumers at all income levels; and
    (b) Community lending.

    Date: March 22, 2000.
    By the Board of Directors of the Federal Housing Finance Board.
Bruce A. Morrison,
Chairman.
[FR Doc. 00-10427 Filed 4-28-00; 8:45 am]
BILLING CODE 6725-01-P