NCB’s mission is to support eligible cooperatives with credit and technical assistance and encourage broad-based ownership, control, and participation in NCB. In general, cooperatives eligible for NCB loans and services are organizations operating on a cooperative, not-for-profit basis to produce or furnish goods, services, or facilities primarily for the benefit of their member-stockholders who are the ultimate consumers. Under the 1978 National Consumer Cooperative Bank Act, NCB was established as a mixed-ownership government corporation and “instrumentality of the United States.” NCB received initial federal funding through Treasury purchases of shares of its class A stock. In 1981, Congress converted NCB from an instrumentality of the United States to a federally chartered, private financial institution that is owned and controlled by its cooperative stockholders. The 1981 amendments to the act provided that all Treasury-held stock be exchanged for NCB class A notes. The act prohibited Treasury from purchasing any class A stock issued by NCB after the exchange occurred on December 31, 1981. Treasury now holds approximately $183 million in class A notes, which must be repaid no later than October 31, 2020. In addition to these public funds, NCB raises funds from private lenders; its major creditors are banks and insurance companies. NCB uses these funds and funds from other liabilities, combined with members’ equity (retained earnings and members’ stock), to make loans and provide services to eligible cooperatives. The act requires all borrowers to own not less than 1 percent of the face amount of their loans in class B stock when the loan is made. It has been NCB’s practice to guarantee that it will redeem the borrowers’ stock at par value when the loan is repaid. It is through this required stock purchase that borrowers become member-stockholders in NCB. NCB’s total common stock and retained earnings comprised its core capital of 20 percent as of December 31, 1993. The business activities of NCB have diversified since its creation. Initially, NCB served cooperatives in retail food, sporting goods and other industries, and housing cooperatives. Today, NCB serves community health centers, health maintenance organizations, and employee stock ownership plans as well as worker-owned cooperatives in manufacturing, retail, and service industries. In addition, NCB serves retailer-owned wholesale food and hardware cooperatives. NCB’s transactions range from making a simple loan to a quilting cooperative in rural Alabama to securitizing assets to improve liquidity for cooperatives. NCB is governed by a 15-member board of directors. Twelve members are elected by the stockholders, who are borrowers or organizations controlled by eligible borrowers. Three members are appointed by the president of the United States, with the advice and consent of the U.S. Senate. Of these three members, the act requires that small business proprietors, eligible low-income borrowers, and the federal government be represented. The government position on the Board has been vacant since 1990. The act, as amended in 1981, provides for the creation of a nonprofit affiliate of NCB that does not have capital stock. This affiliate, the NCB Development Corporation, specializes in lending to low-income and newly established cooperatives and also provides loans and technical support to established cooperative enterprises. The Development Corporation’s assets are not included on NCB’s consolidated financial statements. As of December 31, 1993, the Development Corporation’s fund balance was over $56 million, which was derived from about $25 million in government appropriations, $13 million from NCB, and about $18 million in retained earnings. Its nine-member board includes six NCB directors who elect three outside directors. Since 1984, NCB has acquired a federally insured savings bank and created six subsidiaries to help serve its customers. The NCB Savings Bank (NCBSB) had approximately $76 million in assets at December 31, 1993. NCBSB is examined and regulated by the Office of Thrift Supervision (OTS). Deposits of up to $100,000 at the savings bank, like those of other thrift institutions, are insured by the Savings Association Insurance Fund (SAIF), which is backed by the full faith and credit of the U.S. government. If NCBSB were to fail, SAIF would be responsible for repaying insured depositors. The subsidiaries perform services for cooperatives, such as investment management. See appendix I for a list of NCB subsidiaries and affiliates. As shown in table 1, the consolidated assets of NCB, its subsidiaries, and NCBSB totaled approximately $536 million at December 31, 1993. NCB acquired NCBSB to help fulfill its mission of providing credit to cooperatives. According to NCB’s application, its primary reasons for acquiring NCBSB were to have an institution that could solicit nontransactional deposits from its cooperative members, originate loans to cooperative borrowers, and buy portions of NCB loans using the NCB-attracted deposits as the funding source. The act authorizes NCB to accept certificates of deposit and pay interest on them; but NCB officials said that they could not attract large deposits (e.g., in amounts of $10,000 or more) without federal insurance. In the past, we provided two legal opinions on NCB matters at the request of Congress. In a 1982 legal opinion, we determined that NCB’s conflict of interest policy met the statutory requirements and that a specific cooperative was an eligible NCB customer. In 1986, we opined that NCB was authorized to form subsidiaries and invest in affiliates. We also issued a report on NCB soon after it was converted to a federally chartered, private financial institution owned by its cooperative stockholders. The primary objective of our review was to determine if the financial safety and soundness of NCB is effectively monitored by the present oversight arrangement. In addition, we wanted to determine the extent of any potential losses to the government if NCB were to fail. Our work focused on NCB, including its relationship with NCBSB. In the course of our work, we analyzed the National Consumer Cooperative Bank Act to determine NCB’s mission and operational requirements and requirements related to its Treasury debt. We analyzed the statutory provisions applicable to safety and soundness. We reviewed FCA’s examination reports and related documents on NCB for 1990 through 1994 to determine the key safety and soundness and other issues FCA assessed. We also analyzed the deficiencies or problems examiners identified. We reviewed FCA, NCB, and other organizations’ relevant documents to determine NCB’s responses to FCA’s findings. We compared the scope and results of FCA’s examinations with issues that we have found, in previous work, to be important to the safety and soundness of financial institutions. In making this comparison, we looked for any constraints FCA examiners might have had in identifying or addressing NCB problems. We also asked FCA examination officials about their experiences and opinions regarding any such constraints. We reviewed OTS examination reports and other documents on NCBSB, and we also reviewed OTS reports for 1990 through 1994 on NCB as the savings bank’s holding company. We focused on any transactions between NCBSB and NCB, documented and analyzed any safety and soundness deficiencies examiners identified, and traced both institutions’ responses and OTS’ and FCA’s follow-up. To form our opinion on the adequacy of the government’s monitoring of NCB’s safety and soundness, we compared the results of our analyses to the safety and soundness provisions of the act, FCA’s own standards, and the characteristics of lax financial institution oversight that we had identified in previous work. We modified these criteria to reflect the fact that FCA does not have regulatory or enforcement authority over NCB. We considered whether FCA called for NCB to address examiner-identified deficiencies or problems documented in each examination report and whether FCA followed up until these issues were corrected. We met with NCB, FCA, OTS, and Treasury officials to discuss our work and solicit their opinions about the adequacy of federal oversight of NCB. To assess the discipline imposed by the private sector lenders, we analyzed opinions of NCB’s creditworthiness issued by credit rating firms and the performance requirements imposed by NCB’s major private creditors. We compared our findings to the performance requirements of selected federal regulators of financial institutions. To identify the extent of the government’s exposure to financial loss, we reviewed the Treasury-NCB financing agreement, notes, and applicable law. We compared NCB’s credit ratings and the characteristics of its financial relationship to the government with those of other business entities with government ties. We did our work between December 1993 and September 1994 at the NCB headquarters in Washington, D.C., and at the FCA headquarters in McLean, VA. Our work was done in accordance with generally accepted government auditing standards. We obtained written comments on a draft of this report from NCB, FCA, and Treasury. We incorporated these comments in the text where appropriate and summarized them on pages 24 and 25 of this report. In addition, the full text of each entity’s comments and our responses are provided in appendixes II through IV. One important reason that the government regulates financial institutions is to help stabilize the nation’s financial system. A second and related reason is to protect depositors whose accounts it insures and to protect the government deposit insurance funds from large losses. Neither of these reasons apply to NCB because it is a comparatively small institution that does not have insured deposits. The government also regulates certain financial institutions, e.g., certain government-sponsored enterprises (GSE), when the market perceives that the government stands behind their obligations. These GSEs expose the government to the potential for large losses.