The FHLBank System was established in 1932 and consists of 12 FHLBanks (see fig. 1). Member financial institutions, which typically are commercial banks and thrifts (or savings and loans), cooperatively own each of the 12 FHLBanks. To become a member of its local FHLBank, a financial institution must maintain an investment in the capital stock of the FHLBank in an amount sufficient to satisfy the minimum investment required for that institution in accordance with the FHLBank’s capital plan. In addition to the ability to obtain advances, other benefits of FHLBank membership for financial institutions include earning dividends on their capital investments and access to various products and services, such as letters of credit and payment services. As of December 31, 2009, more than 8,000 financial institutions with approximately $13 trillion in assets were members of the FHLBank System. The FHLBank System’s total outstanding advances stood at more than $631 billion. As established by statute and FHFA regulations, the FHLBanks are required to develop and implement collateral standards and other policies to mitigate the risk that member institutions may default on outstanding advances. To help do so, the FHLBanks generally apply a blanket lien on all or specific categories of a member’s assets to secure the collateral underlying the advance. In general, a blanket lien agreement is intended to fully protect the FHLBank by securing its right to take and possibly sell any or all of a member’s assets in the event it fails or defaults on its outstanding advances. In limited circumstances, FHLBanks may permit or require their members to pledge collateral under (1) a listing (specific detail) lien agreement in which the members are to report detailed information, such as the loan amount, payments, maturity date, and interest rate for the loans pledged as collateral; or (2) a delivery lien agreement, in which members are required to deliver the collateral to the FHLBank or an approved safekeeping facility. From a member’s perspective, the benefits of listing collateral in lieu of a blanket lien agreement can include better pricing terms. Some FHLBanks may require members to list or deliver collateral to better protect their financial interests in instances in which a member is in danger of failure or its financial condition begins to deteriorate. FHLBanks also seek to manage risk and mitigate potential losses by applying varying haircuts, or discounts, to collateral pledged to secure advances. To illustrate: suppose that an FHLBank member sought to pledge a single-family residential mortgage loan portfolio with a value of $100 million to secure an advance from its district FHLBank. If the FHLBank applied a haircut of 25 percent to such collateral, the member would generally be able to secure advances of up to $75 million subject to other risk-management policies the FHLBank may have established. In general, the FHLBanks’ haircut levels tend to increase based on the perceived risks associated with the collateral being pledged. As described in this report, single-family mortgages and other forms of traditional collateral generally are perceived as representing less risk than alternative forms of collateral, such as agricultural and small business loans. Since FHLBanks generally issue advances under blanket lien agreements, they may calculate a member’s total borrowing capacity by applying varying haircuts to each form of eligible collateral on the member’s books and communicating this information to the member on a periodic basis. In the event that a member institution fails, FHLBanks have a “first lien” on its assets. That is, they have priority over all other creditors, including FDIC, to obtain the collateral necessary to protect against losses on their outstanding advances. In a typical bank or thrift failure, FDIC pays off outstanding FHLBank advances in full and takes possession of the collateral on the institution’s books to help offset its losses. According to the FHLBank Office of Finance, in the 78-year history of the FHLBank System, no FHLBank has ever suffered a credit loss on an advance. The FHLBanks’ haircuts and other risk management policies are intended to mitigate potential losses; however, they also may limit some members’ interest in obtaining advances. For example, an FHLBank member may perceive that the level of haircuts applied to the collateral it pledges may unduly restrict the amount of financing it would like to obtain through advances. Administrative and other costs associated with obtaining advances also may factor into an FHLBank member’s decision making process. For example, FHLBank officials conduct on-site inspections to assess members’ collateral management practices or require members to have such practices independently audited. For some FHLBank members, the costs of such administrative procedures may outweigh the potential benefits of obtaining advances, particularly if they view the haircuts applied to the collateral as unreasonable. While the FHLBank System’s primary mission over the years has been to promote housing finance generally through its advance business, it is also required by statute and regulation to meet other specific mission requirements. For example, FIRREA authorizes both the Affordable Housing Program (AHP) and the Community Investment Program (CIP) to assist the FHLBanks’ affordable housing mission. Under AHP, each FHLBank is required to set aside 10 percent of its previous year’s earnings to fund interest rate subsidies on advances to members engaged in lending for long-term, low- and moderate-income, owner-occupied, and affordable rental housing at subsidized interest rates. In using the advances, the FHLBank members are to give priority to qualified projects, such as the purchase of homes for low- or moderate-income families or to purchase or rehabilitate government-owned housing. FIRREA also established CIP, which requires FHLBanks to provide flexible advance terms for members to undertake community-oriented mortgage lending. CIP advances may be made at the FHLBank’s cost of funds (for advances with similar maturities) plus the cost of administrative fees. Moreover, FIRREA requires FHFB (now FHFA) to establish standards of community investment or service for members of FHLBanks to maintain continued access to long-term advances. These standards include the development of a Targeted Community Lending Plan (which is designed to help the FHLBanks assess the credit needs of the communities that they serve) and quantitative lending goals that address identified credit needs and marketing opportunities in each FHLBank’s district. FHFA has safety and soundness and mission oversight for the FHLBank System and Fannie Mae and Freddie Mac. For example, FHFA is responsible for ensuring that the FHLBanks establish appropriate collateral management policies and practices to mitigate the risks associated with their advance business. From a mission standpoint, FHFA also is responsible for ensuring that the FHLBanks are in compliance with statutes and regulations pertaining to the AHP and CIP programs. While GLBA does not establish specific requirements for alternative collateral, its legislative history suggests that the FHLBanks and FHFB, and by extension FHFA, should prioritize the FHLBank System’s economic development activities through the use of alternative collateral. To carry out its responsibilities, FHFA may issue regulations, establish capital standards, and conduct on-site safety and soundness or mission-related examinations. FHFA also may take enforcement actions, such as issuing cease and desist orders, and may place an FHLBank, Fannie Mae, or Freddie Mac into conservatorship or receivership if they become undercapitalized or critically undercapitalized. Officials from the 12 FHLBanks cited several factors to help explain the minimal use of alternative collateral to secure advances in the FHLBank System. These factors include a potential lack of interest among many CFI members; the view that many CFIs belong to the FHLBank System primarily to have access to letters of credit and other products or to obtain a backup source of liquidity; and that many CFIs may have sufficient holdings of traditional collateral to secure advances. Moreover, due to the potential risks associated with alternative collateral, the 10 FHLBanks that accept it have established risk-management strategies to mitigate potential losses, which also may limit its use. In particular, the FHLBanks generally have applied higher haircuts to alternative collateral than to any other type of collateral used to secure advances. Officials from many of the 30 CFIs we interviewed said that they valued their relationships with their local FHLBanks and the products and services provided. However, officials from half of these CFIs expressed concerns about the level of the haircuts applied to alternative collateral or other FHLBank risk-management strategies. In some cases, they said the haircuts or policies limited their willingness to pledge such collateral to obtain advances. According to representatives from the 12 FHLBanks, they have ongoing member outreach programs that are intended, in part, to address members’ credit and collateral needs and the various products available to them. The FHLBank officials said that outreach activities can include telephone calls or visits to members to discuss the availability of alternative collateral and its potential use by CFI members. Some FHLBanks also have annual meetings, online product tutorials, and electronic bulletins that provide information about alternative collateral. While officials from the 12 FHLBanks said they had outreach programs in place, some officials cited the significant differences in the membership characteristics across the FHLBank System as affecting the use of alternative collateral (see table 1). For example, CFIs represent more than 80 percent of the membership and about 30 percent of the assets of the FHLBanks in Dallas and Topeka, and many of these CFI members focus on agricultural lending due to its prominence in the regional economies.