[Federal Register Volume 78, Number 75 (Thursday, April 18, 2013)]
[Rules and Regulations]
[Pages 23438-23456]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-09166]



[[Page 23437]]

Vol. 78

Thursday,

No. 75

April 18, 2013

Part III





Farm Credit Administration





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12 CFR Part 615





Funding and Fiscal Affairs, Loan Policies and Operations, and Funding 
Operations; Liquidity and Funding; Final Rule

  Federal Register / Vol. 78 , No. 75 / Thursday, April 18, 2013 / 
Rules and Regulations  

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FARM CREDIT ADMINISTRATION

12 CFR Part 615

RIN 3052-AC54


Funding and Fiscal Affairs, Loan Policies and Operations, and 
Funding Operations; Liquidity and Funding

AGENCY: Farm Credit Administration.

ACTION: Final rule.

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SUMMARY: The Farm Credit Administration (FCA, we or us) adopts a final 
rule that amends its liquidity regulation. The purpose of the final 
rule is to strengthen liquidity risk management at Farm Credit System 
(FCS, Farm Credit, or System) banks, improve the quality of assets in 
their liquidity reserves, and bolster the ability of System banks to 
fund their obligations and continue operations during times of 
economic, financial, or market adversity.

DATES: Effective Date: This regulation will be effective 30 days after 
publication in the Federal Register during which either or both Houses 
of Congress are in session. We will publish a notice of the effective 
date in the Federal Register.

FOR FURTHER INFORMATION CONTACT: 
David Lewandrowski, Senior Policy Analyst, Office of Regulatory Policy, 
Farm Credit Administration, 1501 Farm Credit Drive, McLean, VA, (703) 
883-4498, TTY (703) 883-4056; or
Richard A. Katz, Senior Counsel, Office of General Counsel, Farm Credit 
Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-
4056.

SUPPLEMENTARY INFORMATION: 

I. Objectives

    The objectives of the final rule are to:
     Improve the capacity of FCS banks to pay their obligations 
and fund their operations by maintaining adequate liquidity to 
withstand various market disruptions and adverse economic or financial 
conditions;
     Strengthen liquidity management at all FCS banks;
     Enhance the liquidity of assets that System banks hold in 
their liquidity reserves;
     Require FCS banks to maintain a three-tiered liquidity 
reserve. The first tier of the liquidity reserve must consist of a 
sufficient amount of cash and cash-like instruments to cover each 
bank's financial obligations for 15 days. The second and third tiers of 
the liquidity reserve must contain cash and highly liquid instruments 
that are sufficient to cover the bank's obligations for the next 15 and 
subsequent 60 days, respectively;
     Establish a supplemental liquidity buffer that a bank can 
draw upon during an emergency and is sufficient to cover the bank's 
liquidity needs beyond 90 days; and
     Strengthen each bank's Contingency Funding Plan (CFP).

II. Background

    The FCS is a nationwide network of borrower-owned financial 
cooperatives that lend to farmers, ranchers, aquatic producers and 
harvesters, agricultural cooperatives, rural utilities, farm-related 
service businesses, and rural homeowners. Its primary purpose is to 
furnish ``sound, adequate, and constructive credit and closely related 
services'' necessary for efficient agricultural operations in the 
United States.\1\ By law, FCS institutions are instrumentalities of the 
United States,\2\ and Government-sponsored enterprises (GSEs).\3\
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    \1\ See Section 1.1(a) of the Act; 12 U.S.C. 2001(a).
    \2\ See Sections 1.3(a), 2.0(a), 2.10(a), 3.0, 4.25, and 
8.1(a)(1) of the Act; 12 U.S.C. 2011(a), 2071(a), 2091(a), 2121, 
2211, and 2279aa-1.
    \3\ Pub. L. 101-73, Sec.  1404(e)(1)(A), 103 Stat. 183, 552-53, 
(Aug. 9, 1989).
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    FCS banks issue Systemwide debt securities, which are the primary 
source of funding System loans to farmers, ranchers, cooperatives, and 
other eligible borrowers.\4\ The System depends on continuing access to 
the debt markets in order to finance agriculture, rural utilities, and 
rural housing in both good and bad economic times. If access to the 
debt markets becomes impeded for any reason, Farm Credit banks must 
have enough readily available funds and assets that can be quickly 
converted into cash to continue operations and pay maturing 
obligations. In contrast to non-System financial institutions, the FCS 
does not have an assured governmental lender of last resort that it 
could turn to in an emergency.\5\ As a result, FCS banks must rely on 
their liquidity reserves more heavily than other federally regulated 
lending institutions if market access is impeded.\6\
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    \4\ Farm Credit banks (which are the three Farm Credit Banks and 
the Agricultural Credit Bank) issue and market Systemwide debt 
securities through the Federal Farm Credit Banks Funding Corporation 
(Funding Corporation). The Funding Corporation, which is established 
pursuant to section 4.9 of the Act, is owned by all Farm Credit 
banks.
    \5\ The Federal Reserve Banks, the Federal Home Loan Banks, and 
National Credit Union Administration Central Liquidity Facility 
serve as a source of liquidity for commercial banks, savings 
associations, and credit unions both in ordinary times and during 
emergencies.
    \6\ Section 1101 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act amended section 13(3) of the Federal Reserve 
Act, 12 U.S.C. 343(3), to allow the Board of Governors of the 
Federal Reserve System, in consultation with the Secretary of the 
Treasury, to establish by regulation, policies and procedures that 
would govern emergency lending under a program or facility for the 
purpose of providing liquidity to the financial system. Under 
section 13(3) of the Federal Reserve Act, as amended, the Board of 
Governors of the Federal Reserve System must establish procedures 
that prohibit insolvent and failing entities from borrowing under 
the emergency program or facility. Pursuant to section 13(3) of the 
Federal Reserve Act, as amended, the Board of Governors of the 
Federal Reserve System, with the approval of the Secretary of the 
Treasury could authorize the Federal Reserve Banks to serve as an 
emergency source of liquidity for the FCS, but it is not obligated 
to do so. See Public Law 111-203, title XI, Sec.  1101(a), 124 Stat. 
1376, 2113 (Jul. 21, 2010).
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III. History of This Rule

    We have periodically amended our liquidity rule over the past 19 
years as part of our ongoing efforts to limit the adverse effect that 
changing economic, financial, or market conditions have on the 
liquidity of FCS banks.\7\ On December 27, 2011, the FCA published a 
proposed rule in the Federal Register to amend its liquidity regulation 
at Sec.  615.5134.\8\ The FCA proposed this rule after it identified 
vulnerabilities that could impair the ability of FCS banks to pay their 
obligations, fund their assets, and continue operations whenever 
economic or financial turmoil impedes System access to the debt 
markets. The purpose of this rulemaking is to improve the System's 
ability to withstand market disruptions by strengthening liquidity 
management practices at Farm Credit banks and enhancing the liquidity 
of assets in their liquidity reserves. Proposed Sec.  615.5134 would:
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    \7\ See 58 FR 63056 (Nov. 30, 1993); 64 FR 28896 (May 28, 1999); 
70 FR 51590 (Aug. 31, 2005).
    \8\ See 76 FR 80817 (Dec. 27, 2011).
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    (1) Require FCS banks to manage their liquidity reserves primarily 
as an emergency source of funding;
    (2) Require boards to adopt stronger and more focused policies 
concerning liquidity management and the contingency funding plan;
    (3) Divide the 90-day liquidity reserve into tiers so each FCS bank 
has a sufficient amount of cash and cash-like instruments available to 
pay its obligations and fund its operations for the next 15 days, and 
maintain a pool of cash or highly liquid instruments for the subsequent 
15 days and the 60 days after that;
    (4) Require each FCS bank to establish and maintain a supplemental 
liquidity buffer that would provide a longer term, stable source of 
funding beyond the 90-day minimum liquidity reserve; and
    (5) Specify corrective actions that the FCA could compel FCS banks 
to

[[Page 23439]]

implement under a reservation of authority.

IV. Comment Letters

    The four System banks and the Farm Credit Council (Council) 
commented on the proposed rule. All five commenters acknowledge sound 
liquidity management enables the FCS to fulfill its statutory mandate 
to fund agriculture. As the FCA noted in the preamble to the proposed 
rule, the commenters emphasized that all FCS banks withstood the 
financial crisis of 2008 with their liquidity intact. The commenters 
attribute this success to effective liquidity management at FCS banks 
and the current regulatory framework, which they deem to be 
appropriate. For this reason, the commenters suggest that the FCA 
should make only minor adjustments to the existing liquidity 
regulation, Sec.  615.5134, rather than comprehensive revisions. In 
this context, all commenters expressed the view that the proposed rule 
is excessive, complex, and overly prescriptive.
    The commenters also claim that the FCA's proposal would result in 
undue regulatory burden on System banks because it goes far beyond what 
they believe is necessary for effective liquidity risk management. The 
commenters raised a number of substantive issues about the proposed 
liquidity rule, and they recommended specific revisions for the final 
rule. The main areas of concern that the commenters raised are:
     The proper roles of both board and management in devising 
and implementing liquidity policies for the bank;
     The extent to which FCS banks should distinguish or 
segregate investments held for liquidity management from investments 
held for other purposes;
     The role of short-term discount notes in the funding 
strategies of Farm Credit banks;
     The extent to which guidance from the Basel Committee on 
Banking Supervision (Basel Committee) and the Federal banking 
regulators \9\ about liquidity at depository institutions should 
influence the FCA's efforts to develop liquidity regulations for FCS 
banks;
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    \9\ The Federal banking agencies are the Office of the 
Comptroller of the Currency, the Board of Governors of the Federal 
Reserve System, the Federal Deposit Insurance Corporation, and the 
National Credit Union Administration. Prior to July 2011, the former 
Office of Thrift Supervision jointly issued guidance about liquidity 
with the other four banking agencies. Title III of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act abolished the Office 
of Thrift Supervision and transferred its authorities over: (1) 
Savings and loan holding companies to the Board of Governors of the 
Federal Reserve System; (2) Federal savings associations to the 
Office of the Comptroller of the Currency; and (3) State savings 
associations to the Federal Deposit Insurance Corporation. See 
Public Law 111-203, Title III, Sec.  312, 124 Stat. 1376, 1521 (Jul. 
21, 2010).
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     The lack of a lender of last resort for FCS banks;
     GSE status and the extent to which Farm Credit banks 
should generate earnings from their investments; and
     Development of a consistent regulatory approach for 
liquidity at both FCS banks and the Federal Agricultural Mortgage 
Corporation (Farmer Mac).

V. The FCA's Approach in the Final Rule

    The commenters have not persuaded the FCA that the proposed rule is 
unduly burdensome or overly prescriptive, or that only minor 
adjustments to the existing liquidity regulation are warranted. Recent 
financial crises and continuing global economic uncertainty clearly 
demonstrate that strong liquidity management practices and access to 
reliable sources of emergency funding are crucial both to the viability 
of each financial institution, including FCS banks, and to the 
financial system as a whole. We proposed substantial revisions to Sec.  
615.5134 in order to redress vulnerabilities in liquidity management 
that we identified at System banks in the aftermath of the 2008 
crisis.\10\ The purposes of this rulemaking are to strengthen the 
System's ability to withstand future crises by limiting the adverse 
effects that sudden changes in economic, financial and market 
conditions may have on the liquidity of FCS banks, both individually 
and collectively. For these reasons, both the proposed and final rules 
follow the same basic supervisory and regulatory approaches to 
liquidity.
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    \10\ See 76 FR 80817 supra. at 80819.
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    The commenters offered many constructive and practical suggestions 
for improving the regulation that we incorporated into the final rule. 
Based on these comments, we restructured and refined the rule to make 
it easier to read, understand, and implement. Additionally, the 
comments caused us to reconsider and revise some of our positions. As 
we explain the final rule and how it differs from our original 
proposal, we will respond to comments about our overall regulatory and 
supervisory approach to liquidity as well as specific issues arising 
from each provision of Sec.  615.5134.

A. Reasons for Revising the Liquidity Regulation

    Liquidity refers to the ability of financial institutions to pay 
obligations and fund operations on an ongoing basis at a reasonable 
cost. Recent financial crises demonstrate how quickly liquidity can 
vanish at seemingly strong financial institutions, which could impair 
their viability and jeopardize their survival. If economic or financial 
conditions quickly or unexpectedly deteriorate, financial institutions 
may find that their routine funding sources have become too scarce or 
costly, and that they then do not have sufficient liquid assets to meet 
their immediate funding needs. This lack of adequate liquidity can 
threaten the safety and soundness of individual institutions, and the 
financial system as a whole.
    The FCA noted in the preamble to the proposed rule that throughout 
the 2008 crisis, FCS banks were able to raise funds and pay their 
obligations in a timely manner. However, the FCA and System commenters 
drew very different conclusions from the 2008 crisis, especially 
concerning whether FCS banks need to strengthen both their liquidity 
reserves and their liquidity risk management practices so they are in 
the best position possible to weather future financial and economic 
storms. The FCA identified several vulnerabilities at FCS banks that 
could adversely affect their liquidity during economic, financial, or 
market turmoil in the future. For this reason, the FCA proposed to 
correct these potential weaknesses by proposing substantial revisions 
to Sec.  615.5134.
    In contrast, FCS commenters concluded that the crisis in 2008 
vindicated the existing liquidity regulation. Three commenters 
attribute effective risk management practices under the existing 
regulatory framework as the reason why System banks had adequate 
liquidity to continue operations without disruptions throughout the 
2008 crisis. Additionally, these commenters point out that System 
banks, on their own initiative, implemented various measures to improve 
their liquidity management practices so they could continue their 
operations unabated whenever financial markets became distressed. For 
example, FCS banks refined the liquidity standards and measures in the 
Contractual Interbank Performance Agreement (CIPA).\11\ The

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banks also voluntarily adopted an additional three-tiered liquidity 
standard that they implemented through their policies and procedures. 
One commenter noted that the System adopted other strategies to enhance 
liquidity, such as adjusting debt maturities and loan pricing, and 
increasing the amount of highly liquid assets (cash and Treasuries) in 
their liquidity portfolios. For these reasons, the commenters 
encouraged the FCA to ``only make minor adjustments to existing 
regulatory requirements rather than comprehensive revisions.''
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    \11\ Under provisions of the CIPA, a CIPA score is a calculation 
that measures the financial condition and performance of each FCS 
bank. The calculation uses various ratios that take into account the 
capital, asset quality, earnings, interest-rate risk and liquidity 
of each Farm Credit bank. The CIPA score is compared to an agreed-
upon standard of financial condition and performance that each FCS 
bank must achieve and maintain. The CIPA score is designed as an 
early warning mechanism that helps monitor the financial condition 
of each FCS bank.
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    Although FCS banks survived the 2008 crisis with their liquidity 
intact under the existing regulatory framework, the FCA observes that 
it is not necessarily an adequate or effective bulwark against future 
market disruptions that would most likely occur under different 
circumstances. In 2008, the agricultural economy was strong and the 
System was sound when the housing bubble burst, causing a financial 
crisis that imperiled the liquidity of the global financial system. In 
these circumstances, FCS banks were able to continue issuing debt 
(overwhelmingly short-term discount notes) to investors, who remained 
confident in the System's ability to meet its obligations, but even 
then, most investors were only willing to buy very short-term 
instruments.
    In other plausible scenarios, however, distress in the agriculture 
sector could reduce the income of FCS banks and associations, thus 
making it more difficult for affected System institutions to pay their 
debts and fund their operations. As a result, the System's funding 
costs could rise as investor confidence becomes shaken, and market 
access could become partially or fully impeded. One or more of the 
following events could impair the liquidity of System banks:
     A steep drop in commodity prices that adversely affects 
the repayment capacity of a large percentage of FCS borrowers, thereby 
reducing the ability of System banks to repay their obligations and 
fund their operations;
     Extended declines in both commodity prices and 
agricultural land values would result in significant loan losses at FCS 
banks and associations, thereby impairing System capital and impeding 
market access;
     A sudden surge in borrower demand for funds under lines of 
credit that strains the bank's ability to meet these unfunded 
commitments at a time of market stress; or
     A large amount of System obligations become due and 
payable as a severe market disruption is reaching its peak.
    Any of these events could impair the viability of one or more FCS 
banks, thereby constricting the System's capacity to fund its normal 
operations. Substantially revising and strengthening Sec.  615.5134 
mitigates the System's vulnerabilities to such risks, and thereby 
improves the System's ability to withstand market disruptions in a wide 
range of circumstances.
    The FCA supports the measures that System banks implemented to 
strengthen liquidity. In our view, the System's efforts and our new 
regulation complement each other. For example, revised Sec.  615.5134 
divides the liquidity reserve into tiers that are similar to the tiers 
that FCS banks have already established. Additionally, the regulation 
reinforces enhanced practices at FCS banks to hold more cash and highly 
liquid investments in amounts sufficient to cover obligations maturing 
in the next 15, 30, and 90 days.
    The rule also strengthens internal controls and risk management 
practices at System banks. Under the revised regulation, System banks 
will retain ample flexibility to manage liquidity effectively in future 
crises, and adjust their strategies to changing circumstances. The new 
regulation enables FCS banks to further refine CIPA, or make 
adjustments to debt maturities or investments, as circumstances 
warrant. As amended, Sec.  615.5134 promotes comprehensive and sound 
liquidity management at FCS banks. For this reason, our new regulation 
aids, rather than hinders System banks as they combat liquidity risks 
in an ever-changing environment.

B. Comparisons and Contrasts With Guidance of Other Regulators

    The preamble to the proposed rule frequently referred to guidance 
that international and Federal regulators developed to enhance 
liquidity management practices at the financial institutions they 
regulate. In September 2008, the Basel Committee issued the Principles 
for Sound Liquidity Risk Management and Supervision, which contained 17 
core principles detailing international supervisory guidance for sound 
liquidity risk management. In December, 2010, the Basel Committee 
issued Basel III: International framework for liquidity risk 
measurement, standards, and monitoring (Basel III). The Federal banking 
agencies published their Interagency Policy Statement on Funding and 
Liquidity Risk Management on March 22, 2010, which sets forth the 
supervisory expectations for depository institutions and their related 
entities.\12\
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    \12\ See 75 FR 13656 (Mar. 22, 2010).
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    We received several comments about the extent to which Basel III 
and the approach of other regulators influences our new liquidity 
regulation. System commenters expressed conflicting opinions on this 
issue. One bank opined that the proposed rule is ``too detailed and 
prescriptive compared to the principles-based approach'' of other bank 
regulators. In contrast, two commenters applauded the FCA's efforts to 
create regulatory requirements for liquidity that are similar to the 
approach of the Basel Committee and the Federal banking agencies, when 
it is appropriate to do so. However, they cautioned the FCA not to 
``get ahead of these regulators with respect to their consideration and 
implementation of Basel III.'' A commenter expressed concern that our 
proposed rule was significantly more onerous than the liquidity 
requirements imposed on commercial banks.
    Our new regulation incorporates many of the principles that the 
Basel Committee and the Federal banking agencies have articulated on 
liquidity management because many of these fundamental concepts apply 
to all financial institutions, including FCS banks and depository 
institutions. The comprehensive supervisory approach developed by the 
Basel Committee and the Federal banking agencies effectively 
strengthens both the liquidity reserves and the liquidity risk 
management practices at regulated financial institutions. The most 
important features of the framework of other regulators that we adopted 
pertain to: (1) A multi-tiered approach to the liquidity reserve that 
requires FCS banks to keep a sufficient amount of cash and highly 
liquid investments on hand to pay obligations that fall due in next 15, 
30, and 90 days; (2) a supplemental liquidity buffer that provides FCS 
banks with a stable source of liquidity over a longer period of time; 
(3) specific policies and internal controls that combat liquidity risk; 
and (4) contingency funding planning based in part on the results of 
liquidity stress tests.
    This principles-based approach is comprehensive, yet flexible 
because it applies to all types of financial

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institutions, regardless of size, structure, or complexity. This 
approach is also suitable to FCS banks, both collectively and 
individually. These principles enhance liquidity throughout the FCS 
while accommodating differences among System banks in size, business 
models, and complexity of operations.
    As the preamble to the proposed rule explains, and some commenters 
acknowledge, we tailored these principles and concepts to the System's 
unique structure and circumstances. Accordingly, we modified the 
supervisory approach of the Basel Committee and the Federal banking 
agencies to apply it to the System. As noted above, the FCS is a 
nationwide network of borrower-owned financial cooperatives that 
primarily lend to agricultural enterprises in rural areas. Other 
fundamental differences between the System and depository institutions 
are: (1) FCS institutions are instrumentalities of the United States 
and GSEs; (2) their common equity is not publicly traded; (3) the 
issuance of Systemwide debt securities is the primary source of System 
funding; and (4) the System has no assured governmental lender of last 
resort. Generally, the funding sources, asset portfolios, and 
investment activities of regulated non-System financial institutions 
are more diversified and complex than those of the FCS. We took all of 
these factors into account as we developed this new liquidity 
regulation to meet the unique structure, needs, and circumstances of 
FCS institutions, and threats they face. Thus, our revised liquidity 
regulation diverges from the approach of the Basel Committee and the 
Federal banking agencies when circumstances warrant it.\13\
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    \13\ Our regulation adopts many of the basic concepts in the 
Basel III liquidity framework. However, the FCA's approach is not 
identical to Basel III. The Basel III liquidity framework 
established two minimum standards for funding liquidity. The first 
standard is the Liquidity Coverage Ratio (LCR), which ensures that 
commercial banking organizations have sufficient high-quality liquid 
assets to survive a significant stress event that lasts 1 month. The 
purpose of the LCR is to promote short-term resilience of a bank's 
liquidity risk profile. The second standard of the Basel III 
liquidity framework is the Net Stable Funding Ratio (NSFR), which is 
designed to provide a stable and sustainable maturity structure for 
a bank's assets and liabilities over a time horizon of 1 year.
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    The commenters asked the FCA not to get ahead of the other 
regulators in implementing the concepts of Basel III. This request 
seems to reflect System concerns that our new liquidity regulation will 
become effective before Basel III.\14\ From a supervisory and 
regulatory prospective, delaying the implementation of this regulation 
until Basel III is fully phased in is not in the System's best interest 
because amended Sec.  615.5134 strengthens liquidity at FCS banks and 
helps protect them from future market upheavals. Although no one can 
predict when the next market disruption will occur, System banks will 
be better prepared for it after they make the changes required by this 
new regulation.
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    \14\ Originally, commercial banking organizations would have 
been required to fully meet the LCR by January 1, 2015. On January 
6, 2013, the Basel Committee delayed the full implementation of the 
LCR requirement until January 1, 2019.
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    Basel III is not the only basis for the new liquidity regulation. 
The revised regulation also builds upon the System's own initiatives to 
improve liquidity management as well as the FCA's experiences from 
examining liquidity risk management at Farm Credit banks and the 
Funding Corporation. In this context, the new regulation implements the 
best practices for liquidity management at FCS banks, and there is no 
reason for the FCA to delay implementation until Basel III is fully 
implemented at other financial institutions. Of course, the FCA will 
closely monitor how the Federal banking agencies adjust Basel III and 
apply it to the institutions they supervise. As always, the FCA has 
authority to further amend Sec.  615.5134, or take other appropriate 
actions concerning liquidity at FCS banks in response to external 
developments, including changes to the Basel III framework.
    Some commenters allege that our new regulatory approach to 
liquidity is ``too detailed and prescriptive compared to the 
principles-based approach'' of the other regulators. Yet, we observe 
that our new regulation follows the core concepts of the principles-
based approach of the other regulators by requiring FCS banks to: (1) 
Retain an adequate stockpile of high-quality liquid assets to cover the 
next 15, 30, and 90 days; (2) maintain supplemental liquidity over a 
longer timeframe; (3) improve liquidity risk management practices; and 
(4) and enhance contingency funding planning. These requirements will 
put FCS banks in a stronger position to endure and outlast future 
crises that could impede their access to funding. Although the 
commenters may view this approach as ``too detailed and prescriptive,'' 
it is essential from a safety and soundness perspective.

C. Discount Notes

    We received two comments about how the new liquidity regulation may 
adversely affect the ability of System banks to issue short-term 
discount notes to fund their operations when financial markets are in 
turmoil. These commenters assert that discount notes are a strong 
source of System liquidity during times of crisis. From the commenters' 
perspective, GSE status enables FCS banks to sell discount notes to 
investors, who seek high-quality investments during times of market 
turmoil. The commenters ask the FCA to recognize the liquidity that 
discount notes provide the FCS during times of market upheaval, and 
avoid promulgating an inflexible rule that compel System banks to 
lengthen the maturity of their liabilities and hold more low-yielding 
liquid assets. The commenters expressed concern that the proposed rule 
would significantly curtail the issuance of discount notes, which in 
turn, would raise the costs to the System's customer-owners.
    Discount notes are one of many tools that System banks have at 
their disposal to mitigate liquidity risk. The FCA expects FCS banks to 
develop balanced and flexible strategies that they can utilize under 
different scenarios, especially when economic and financial conditions 
rapidly change. System banks should not become overly dependent on 
discount notes.
    Although discount notes performed well in the last financial 
crisis, their effectiveness is much less certain when the agricultural 
sector or the FCS is experiencing significant stress. For example, 
during the agricultural credit crisis of the mid-1980s, investors 
demanded high risk premiums on all System debt obligations, including 
short-term instruments.
    By encouraging System banks to diversify their repayment sources 
for maturing debt, the FCA's regulatory approach enhances safety and 
soundness. FCS banks face potential refunding risks when they replace 
maturing debt with new debt issuances especially, very short-term 
discount notes. If market conditions rapidly deteriorate, investors may 
demand exorbitant premiums for purchasing System debt securities, and/
or FCS banks may find few buyers for their Systemwide securities. 
Including more high-quality liquid assets in their liquidity reserves 
is a prudent practice because it helps System banks mitigate these 
potential refunding risks.
    Discount notes are currently in high demand primarily because of 
the System's strong financial condition and its GSE status. As a 
result, discount notes are an inexpensive source of funding for the 
FCS, which can help offset the costs that System banks incur

[[Page 23442]]

from holding short-term, high quality liquid assets in their liquidity 
reserves.
    For all these reasons, the final rule is likely to lessen System 
overall usage of discount notes, but it should not significantly affect 
the program.

D. Lender of Last Resort

    In contrast to depository institutions and other financial 
institutions, the FCS lacks an assured governmental lender of last 
resort that could inject liquidity into System banks during times of 
prolonged paralysis in financial markets. Some commenters encouraged 
the FCA to accelerate its efforts to find an assured lender of last 
resort for FCS banks so they will have an emergency source of liquidity 
if their access to the market becomes impeded.
    The FCA and Farm Credit System Insurance Corporation (FCSIC) have 
undertaken efforts to establish an emergency source of liquidity for 
the System. These efforts, however, are separate from the FCA's 
supervision and regulation of liquidity risk management at FCS banks. 
In the absence of an assured governmental lender of last resort, System 
banks must maintain sufficient liquidity to absorb the impact of market 
disruptions and economic downturns. Through FCA's effective regulation 
and supervision of the System, the System banks are able to assure 
investors that they have adequate liquidity to meet their obligations, 
even though they have no assured lender of last resort.

E. GSE Status

    Two passages in the preamble to the proposed rule addressed the 
relationship between investments held for liquidity and the System's 
GSE status.\15\ These passages reiterated the FCA's longstanding 
position that choosing liquid investments primarily for their ability 
to generate revenue is fundamentally incompatible with the System's GSE 
status.\16\
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    \15\ See 76 FR 80817 supra. at 80820, 80823.
    \16\ See 70 FR 51587 (Aug. 31, 2005); 58 FR 63039, (Nov. 30, 
1993).
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    These preamble statements generated comments from the Council and 
one FCS bank. Both commenters interpret our preamble statements as 
suggesting that GSE status prohibits System banks from generating 
positive earnings from their liquidity reserves and supplemental 
liquidity buffers. These commenters claim that these statements 
indicate that the FCA expects System banks to either lose money or 
break even on their liquidity portfolios. One commenter asserts that 
nothing in the Farm Credit Act of 1971, as amended (Act) supports the 
conclusion that the System's GSE status means that investments cannot 
generate profits, or at a minimum, cover funding costs. Both commenters 
claim the proposed rules for Farmer Mac specifically recognize income 
generation as a legitimate investment purpose and allow Farmer Mac to 
hold profitable assets in its liquidity reserve and supplemental 
liquidity buffer. As result, the commenters ask the FCA to provide 
flexibility so FCS banks can also manage their liquidity portfolios 
``in a manner to generate reasonable long-term returns and minimize the 
cost of liquidity management.''
    The FCA reiterates its longstanding position that System banks are 
GSEs and, therefore, the primary purpose of their investment portfolios 
is to maintain adequate liquidity, manage market risks on their balance 
sheets, and to manage short-term, surplus funds. Although generating 
positive earnings should never be the primary reason why System banks 
buy and hold marketable investments, the FCA has never expected the 
banks to incur losses or only break even on investments. When FCS banks 
select assets for their liquidity portfolios, the FCA expects them to 
consider the liquidity characteristics of prospective investments as a 
more important priority than their earnings-generating capacity. The 
earning streams from such investments are ancillary to the protection 
that its liquidity reserve and supplemental liquidity buffer provide 
each System bank in the event that market access becomes impeded.
    Maintaining an adequate stock of high quality liquid assets that 
can withstand turbulence in the markets often means that System banks 
must forego higher earnings on certain investments. The highest quality 
liquid assets can be easily and quickly converted into cash at little 
or no loss compared to book value. For this reason, highly liquid 
investments entail less risk and, therefore, they tend to generate 
lower earnings. Higher earning investments, such as certain mortgage-
backed securities (MBS), often proved unsuitable as a backup source of 
liquidity during the 2008 crisis.\17\
---------------------------------------------------------------------------

    \17\ During the global financial crisis in 2008, financial 
institutions that held non-agency mortgage-backed securities and 
asset-backed securities experienced credit quality deterioration, 
increased credit risk premiums, declines in market valuations, and 
ultimately reduced liquidity.
---------------------------------------------------------------------------

F. Farmer Mac

    The Council and a System bank commented that the FCA treats Farmer 
Mac more leniently than FCS banks. According to these commenters, the 
FCA is imposing more onerous liquidity requirements on System banks 
than Farmer Mac, and it is encouraging Farmer Mac to generate earnings 
from investments while discouraging FCS banks from doing so.
    The Council raised these issues when it commented on the investment 
management rules for System banks and Farmer Mac, and we responded to 
these concerns in the preambles to the final rules.\18\ Our approach 
towards liquidity is the same as it is for investment management. The 
liquidity requirements that Sec.  615.5134 imposes on FCS banks are not 
significantly different or more onerous than the liquidity requirements 
that proposed Sec. Sec.  652.35 and 652.40 would impose on Farmer Mac. 
Although the liquidity rules for System banks and Farmer Mac will 
continue to differ where appropriate,\19\ we made changes to this rule 
and anticipate changes to the Farmer Mac rule to make the requirements 
more consistent. Separately, the preamble to the final investment 
management rule for Farmer Mac stated that Sec.  652.15 would allow 
Farmer Mac to use non-program investments, including those held for 
liquidity, to primarily generate earnings and enhance returns for 
investors.\20\ We incorporate by reference our response in the preamble 
to final Sec.  652.15(a) into this preamble.
---------------------------------------------------------------------------

    \18\ See 77 FR 66362 (Nov. 5, 2012).
    \19\ Farmer Mac, in contrast to FCS banks, has a line of credit 
for $1,500,000,000 with the Secretary of Treasury under section 8.13 
of the Act. Farmer Mac may issue obligations to the Secretary of 
Treasury, and use the proceeds to cover losses it incurs in 
providing guarantees on securities backed by qualified loans. Farmer 
Mac may draw on its line of credit with the Secretary of Treasury 
only after it exhausts the reserves it must maintain under section 
8.10 of the Act.
    \20\ See 77 FR 66375, 66377 (Nov. 5, 2012).
---------------------------------------------------------------------------

VI. Section-by-Section Analysis of the Final Rule

    In response to the comments, the FCA has restructured and 
consolidated the final regulation. The nine main provisions of the 
proposed rule have been reduced to six in the final rule. The FCA 
combined proposed Sec. Sec.  615.5134(b), 615.5134(e), and 615.5134(g) 
into a single provision, final Sec.  615.5134(b), which now: (1) 
Establishes the liquidity reserve requirement for all FCS banks; (2) 
addresses the composition of the liquidity reserve; and (3) specifies 
the discounts for assets held in the liquidity reserve. We have also 
deleted the FCA's reservation of authority in proposed Sec.  
615.5134(i) from the final regulation. Many of the individual 
provisions of the

[[Page 23443]]

final rule have been revised and reorganized to address the commenters' 
concerns and to enhance their clarity.

A. Section 615.5134(a)--Liquidity Policy

    The cornerstone of effective liquidity management at each FCS bank 
is its liquidity policy, which the board of directors adopts and 
management implements. Existing Sec.  615.5133(c) requires FCS banks to 
adopt a liquidity policy. However, the only affirmative requirement 
that it imposes is that bank policies describe the liquidity 
characteristics of eligible investments that each Farm Credit bank 
holds to meet its liquidity needs and institutional objectives. The FCA 
proposed adding a new paragraph to the liquidity regulation, Sec.  
615.5134(a), that for the first time would require Farm Credit banks to 
address specific issues in their liquidity policies. Proposed Sec.  
615.5134(a)(1) focused on the responsibilities of the bank's board of 
directors while proposed Sec.  615.5134(a)(2) specified seven issues 
that bank policies must address.
1. Board Responsibility
    Proposed Sec.  615.5134(a)(1) would require the board of directors 
of each FCS bank to adopt a written liquidity policy, which must be 
compatible with the bank's investment management policies under Sec.  
615.5133. The preamble to the proposed rule stated that the FCA expects 
the bank's liquidity policy to fit into its overall investment strategy 
because effective liquidity risk management is critically important to 
the bank's long-term viability.\21\ The next provision of proposed 
Sec.  615.5134(a)(1) would require the bank's board of directors to 
review its liquidity policy at least once every year, ``affirmatively 
validate'' the sufficiency of its liquidity policy, and make any 
revision it deems necessary. The purpose of this provision is to compel 
the board to ascertain whether its policies enable the bank to respond 
promptly and effectively to events that could threaten its 
liquidity.\22\ The final sentence of proposed Sec.  615.5134(a)(1) 
mandates that the board of directors ensure that adequate internal 
controls are in place so that management complies with and carries out 
the bank's liquidity policy. As the preamble to the proposed rule 
explained, strong internal controls prevent losses caused by fraud or 
mismanagement, and enable FCS banks to respond more quickly and 
effectively when significant market turmoil arises and impedes access 
to funding.\23\
---------------------------------------------------------------------------

    \21\ See 76 FR 80817 supra. at 80819.
    \22\ Id.
    \23\ See 76 FR 80817 supra. at 81820.
---------------------------------------------------------------------------

    The Council commented on proposed Sec.  615.5134(a)(1). These 
comments focused on the proper roles and responsibilities of the board 
of directors and senior management in developing and executing the 
bank's strategies for containing liquidity risk. The Council indicated 
that the FCA failed to recognize that boards of directors and senior 
management play different roles in developing, approving, and applying 
policies, strategies, and procedures. From the commenter's perspective, 
the proposed rule seems to require boards to develop and adopt 
liquidity strategies and policies, rather than clearly articulating an 
appropriate risk tolerance level for the bank. The commenter also 
asserted that it is the responsibility of senior management to develop 
strategy, policies, and procedures to manage liquidity, which the board 
then reviews and approves. Finally, the commenter claims that the FCA's 
approach about the respective roles of boards of directors and senior 
management on liquidity policy is the opposite of guidance from the 
Federal banking agencies.
    The FCA responds that the board of directors is ultimately 
responsible for ensuring that the bank always maintains sufficient 
liquidity so it can pay maturing obligations and fund its operations. 
The board discharges this responsibility by adopting policies, 
procedures, and parameters for monitoring, measuring, managing, and 
mitigating liquidity risk to the bank. More specifically, the board 
articulates risk tolerance levels, internal controls, and other limits 
in its policies, while senior management operates within those 
parameters as it carries out the board's policy. Contrary to the 
commenters' claims, the plain language of Sec.  615.5134(a)(1) 
recognizes that the board of directors and senior management have 
distinct roles and separate powers in protecting the bank's liquidity. 
In fact, the preamble to the proposed rule acknowledged that senior 
management, not the board of directors, develops and implements 
strategies for managing liquidity risk on a day-to-day basis.\24\
---------------------------------------------------------------------------

    \24\ Id. at 80819.
---------------------------------------------------------------------------

    The Council suggested a technical revision to the third sentence of 
proposed Sec.  615.5134(a)(1), which would require the board to review 
its liquidity policy at least once a year, and ``affirmatively 
validate'' its sufficiency, and make any revision it deems necessary. 
The commenter advised us that FCS banks are uncertain about how boards 
of directors are supposed to ``affirmatively'' validate the sufficiency 
of the bank's liquidity policy. The commenter also expressed concern 
that the word ``affirmatively'' creates unnecessary regulatory 
uncertainty because it is a vague requirement and is, therefore, 
subject to varying interpretations over time. For these reasons, the 
commenter asked us to drop the term ``affirmatively'' from Sec.  
615.5134(a)(1), and bring it more in line with the approach of the 
Federal banking agencies.
    The commenter has persuaded us that this provision of proposed 
Sec.  615.5134(a)(1) is vague and susceptible to different 
interpretations. Boards of directors at Farm Credit banks should 
clearly understand exactly what Sec.  615.5134(a)(1) requires them to 
do. For this reason, we have deleted the phrase ``affirmatively 
validate'' from the third sentence of Sec.  615.5134(a)(1), and 
replaced it with the word ``assess.'' Final 615.5134(a)(1) now requires 
the board of directors of each FCS bank, at least once a year, to: (1) 
Review its liquidity policy; (2) assess the sufficiency of this policy; 
and (3)make any revisions to the liquidity policy that it deems 
necessary. This amendment also addresses the commenters' substantive 
concerns by more clearly differentiating the roles and responsibilities 
of the board and senior management. By assessing the sufficiency of the 
liquidity policy, the board evaluates whether senior management has 
effectively monitored, measured, managed, and mitigated liquidity risk 
in accordance with the board's existing policy.
2. Policy Content
    Proposed Sec.  615.5134(a)(2) focused on the content of the board's 
liquidity policies. This regulatory provision identifies seven 
different issues that a Farm Credit bank, at a minimum, must address in 
its liquidity policies. As noted in the preamble to the proposed rule, 
the policies of each FCS bank should be comprehensive and commensurate 
with the complexities of the bank's operations and its risk 
profile.\25\
---------------------------------------------------------------------------

    \25\ Id. at 80820.
---------------------------------------------------------------------------

    Proposed Sec.  615.5134(a)(2) elicited comments from the Council 
and all four Farm Credit banks. These comments ranged from general 
statements about the effects that Sec.  615.5134(a)(2) would have on 
liquidity management at FCS banks to detailed critiques and 
recommendations about each clause of this provision. All five 
commenters

[[Page 23444]]

deemed proposed Sec.  615.5134(a)(2) as too complex, detailed and 
prescriptive. These commenters urged the FCA to enact a regulatory 
provision that is more general in nature, rather than specify the 
content of board policies in detail.
    Several commenters expressed concern that Sec.  615.5134(a)(2) 
would inhibit the banks' ability to effectively manage their liquidity 
and investments. We received comments that proposed Sec.  
615.5134(a)(2), when combined with the new investment management 
regulation, create a complex layering of regulatory requirements that 
are both duplicative and unduly burdensome to the banks. The Council 
commented that our regulation would hamper the banks from taking an 
integrated risk management approach to investments and liquidity. By 
detailing what a policy must contain, this commenter claimed that FCA 
inappropriately interfered with the discretion of the board to direct 
and oversee liquidity management at the bank.
    The FCA declines the System's request to replace Sec.  
615.5134(a)(2) with a regulatory provision that is general in nature. 
This provision is a vital component of FCA's new regulation because it 
strengthens liquidity risk management practices at FCS banks. By 
requiring board policies to address specific core issues, the 
regulation instills greater discipline in liquidity risk management 
practices that will better enable System banks to outlast adverse 
economic, financial, and market conditions under differing 
circumstances and scenarios. Rather than interfering with the 
discretion of the board to direct and oversee liquidity management at 
the bank, Sec.  615.5134(a)(2) requires board policies, at a minimum, 
to focus on those basic core components of liquidity risk management 
that are crucial to the bank's safety and soundness.
    This regulation does not prevent System banks from adopting an 
integrated risk management approach to liquidity and investments. In 
fact, prudent risk management requires financial institutions to 
simultaneously monitor, manage, and mitigate risks to individual 
assets, various portfolios, and the entire institution. Our regulation 
requires boards to specifically address liquidity risk as part of their 
efforts to manage the bank's investments. Nor is this provision 
duplicative of our investment management regulation because it states 
that board policies must describe how assets in the liquidity reserve 
or supplemental liquidity buffer would enable the bank to continue 
funding its operations if market access is impeded.
    One bank commented that our approach compels System banks to engage 
in management practices that focus on regulatory compliance rather than 
sound liquidity management. The FCA disagrees with the commenter. No 
conflict exists between compliance with this regulation and sound 
liquidity management practices at System banks. To the contrary, 
regulatory compliance works in tandem with sound and disciplined 
liquidity management practices at financial institutions. In fact, 
sound management practices already in place at System banks influenced 
us as we developed this regulatory requirement.
    The Council, on behalf of System banks, offered comments and 
suggestions about each of the seven different issues that proposed 
Sec.  615.5134(a)(2) requires every FCS bank to address, at a minimum, 
in its liquidity policy. As explained in greater detail below, we 
revised Sec.  615.5134(a)(2)(i) by reducing the number of issues that 
the board's policy must address from seven to five. Additionally, we 
modified some of the provisions in Sec.  615.5134(a)(2) to address the 
commenters' concerns. However, we also retained other provisions of 
proposed Sec.  615.5134(a)(2) without revision.
    Proposed Sec.  615.5134(a)(2)(i) would require the bank's policy to 
address the purpose and objectives of the liquidity reserve. The 
preamble to the proposed rule stated that this section of the bank's 
policies should distinguish the purpose and objectives of the liquidity 
reserve from the other operations and asset-liability functions of the 
bank, including management of interest rate risk.\26\ Effective 
liquidity management at a Farm Credit bank should reflect its board's 
philosophy and position about the purpose and objective of the 
liquidity reserve.\27\ When market access becomes impeded, the 
liquidity reserve should enable each Farm Credit bank to maintain 
sufficient cash flows to pay its obligations, meet its collateral 
needs, and fund operations in a safe and sound manner.\28\ The preamble 
to the proposed rule observed that Sec.  615.5134(a)(2)(i) would help 
instill greater discipline in liquidity risk management at System banks 
by requiring them to shift their focus from the financial performance 
of the liquidity reserve to its primary function as an emergency source 
of funding.\29\
---------------------------------------------------------------------------

    \26\ Id.
    \27\ Id.
    \28\ Id.
    \29\ Id.
---------------------------------------------------------------------------

    The Council commented that proposed Sec.  615.5134(a)(2)(i) 
addresses a ``superfluous and self-evident matter'' that needs no 
regulation. The commenter also took issue with our position that the 
board's liquidity policy should distinguish liquidity management from 
asset-liability management by stating that there is no reason why any 
bank would confuse the two.
    The commenter has not persuaded us to omit Sec.  615.5134(a)(2)(i) 
from the final rule. Our reasons for incorporating this provision into 
the revised liquidity rule remain valid and, therefore, we adopt Sec.  
615.5134(a)(1)(i) as a final regulation without change. This provision 
does not add a new regulatory requirement for FCS banks. Since 1993, 
our investment management regulation at Sec.  615.5133 has required the 
boards of Farm Credit banks to adopt written policies that address the 
purpose and objectives of the banks' investments, including those held 
for liquidity.
    Adding a provision to the liquidity regulation that specifically 
requires bank boards to address the purpose and objectives of the 
liquidity reserve in written policies strengthens the System's safety 
and soundness by instilling greater discipline in the liquidity risk 
management practices at System banks. An integrated approach to all 
aspects of asset-liability management is crucial to safety and 
soundness, and in this context, System liquidity reserves must be 
adequately stocked so each bank can pay its debts and fund its 
operations when deteriorating economic and financial conditions 
obstruct market access. The goal of Sec.  615.5134(a)(2)(i) is to 
prompt boards and senior management to more carefully consider how 
various types of prospective investments help counteract liquidity risk 
to their banks. A policy that specifically focuses on the purpose and 
objectives of the liquidity reserves will guide each bank to select a 
proper mix of high-quality liquid assets that will counteract liquidity 
risk to the bank based on the complexity of its operations and its risk 
tolerance level. In addition to their liquidity reserves, System banks 
may hold other eligible investments for the purposes of managing 
interest rate risks and investing surplus short-term funds.
    The commenter also disputed our preamble statements that the 
liquidity reserve is primarily an emergency source of funding. We 
already responded to this particular comment earlier in the discussion 
above about GSE status.
    Proposed Sec.  615.5134(a)(2)(ii) would require the board's 
liquidity policy to

[[Page 23445]]

establish diversification requirements for the liquidity reserve 
portfolio.\30\ For safety and soundness reasons, this diversification 
requirement would apply both to the liquidity reserve and supplemental 
liquidity buffer. As the FCA observed in the preamble to the proposed 
rule, diversification by tenor, issuer, issuer type, maturity, size, 
asset type, and other factors can reduce certain investment risks.\31\ 
The diversification policy should establish a desired mix of cash and 
investments that the bank should hold for liquidity under a variety of 
scenarios, including both normal and adverse conditions.\32\ Each bank 
should tailor its diversification policy so it is consistent with 
regulatory requirements, as well as the bank's individual needs and 
financial condition. Additionally, the diversification policy should be 
revised in response to changes in the business environment and the 
bank's circumstances.\33\ In formulating these criteria, each bank 
would consider, in light of its needs and circumstances, how 
diversification would better enable it to always maintain sufficient 
liquidity to pay its obligations and continue operations if market 
access is curtailed or fully impeded.
---------------------------------------------------------------------------

    \30\ The FCA plans to propose amendments to its eligible 
investment regulation, which in all likelihood, would address 
diversification of the entire investment portfolio. FCA's existing 
Sec.  615.5133(c) requires diversification of credit, market, and 
liquidity risk in the investment portfolio.
    \31\ See 76 FR 80817, supra.
    \32\ Id.
    \33\ Id.
---------------------------------------------------------------------------

    The FCA received comments about proposed Sec.  615.5134(a)(2)(ii) 
from the Council and a System bank. The Council found this requirement 
redundant to the diversification requirement in the investment 
management rule. The commenter asked the FCA to omit Sec.  
615.5134(a)(2)(ii) from the final rule, because it ``is unnecessary and 
* * * creates a complex and confusing layering of the regulatory 
requirements in the investment area.''
    The FCA retains Sec.  615.5134(a)(2)(ii) as a provision in the 
final rule without revision. Diversification of the liquidity 
portfolios at Farm Credit banks is essential to the System's overall 
safety and soundness, especially because the FCS is a GSE that finances 
primarily the agricultural sector of the economy and it currently has 
no assured governmental lender of last resort. The liquidity portfolio 
serves a different function than other segments of the investment 
portfolio that the bank relies on for other asset-liability risk 
management purposes. The 90-day liquidity reserve, for example, should 
be comprised of cash and high quality, shorter-term, and consequently 
lower-yielding liquid investments, whereas these kinds of assets may 
not necessarily be suitable for other investment purposes. For this 
reason, the FCA expects bank policies to focus on, and specifically 
address diversification of the liquidity portfolio separately from the 
diversification of other segments of the investment portfolio.
    A Farm Credit bank commented on a preamble passage, which stated 
that the policy must: (1) Address the desired mix of cash and 
investments that FCS banks should hold under a variety of scenarios; 
and (2) establish criteria for diversifying assets based on issuers, 
maturities, and other relevant factors. The commenter stated that these 
sorts of specific matter can and do change daily, which requires 
management to quickly respond. From the commenter's perspective, Sec.  
615.5134(a)(2)(ii) should not require boards to embed such specific 
details into a policy that cannot be quickly changed as an adverse 
scenario unfolds. In the commenter's opinion, this regulatory 
diversification requirement eliminates senior management's ability to 
exercise discretion and judgment to respond to a looming threat to the 
bank's liquidity. This commenter also perceives this and other 
provisions of proposed Sec.  615.5134(a)(2) as inappropriately blurring 
the board's responsibilities to set policy parameters with senior 
management's duty to establish best practices and operational 
procedures for day-to-day operations.
    The FCA responds that this provision requires the board to 
establish general parameters about diversification. Senior management 
works within the confines of the board's policy. Senior management 
should have the opportunity to provide input as the board develops its 
diversification policy for the bank's liquidity portfolio. This input 
should result in a diversification policy that enables senior 
management to adjust the composition of the liquidity portfolio as part 
of its daily operation of the bank in accordance with board policy.
    Proposed Sec.  615.5134(a)(2)(iii) would require board policies to 
establish maturity limits and credit quality standards for investments 
that the bank holds in its liquidity reserves. The preamble to the 
proposed rule explained this aspect of the bank's policies would help 
management to target and match cash inflows from loans and investments 
to outflows needed to pay its maturing obligations.\34\
---------------------------------------------------------------------------

    \34\ Id.
---------------------------------------------------------------------------

    The FCA received a comment about proposed Sec.  615.5134(a)(2)(iii) 
from the Council. The commenter agrees that the liquidity policy needs 
to address the composition of investments that System banks hold in 
their liquidity reserve. However, the commenter asked us to delete this 
provision from the final rule because the provisions of Sec.  
615.5134(b), which pertain to different levels of the liquidity 
reserve, already addresses this issue with sufficient specificity. The 
FCA is persuaded by this comment, and it omits this provision from the 
final regulation.
    The preamble to proposed Sec.  615.5134(a)(2)(iii) discussed the 
credit quality standards for investments held in the bank's liquidity 
portfolio. According to the preamble, FCS banks may consider the credit 
ratings issued by a Nationally Recognized Statistical Rating 
Organization (NRSRO) when it determines the credit quality of a 
security, but it may not rely solely or disproportionally on such 
ratings. The FCA also asked for comments on approaches concerning 
creditworthiness standards for investments. The Council commented that 
the System appreciated the FCA's position on this issue, and referred 
us to its comments on this issue in previous rulemakings pertaining to 
investment management and capital. The FCA plans to address how FCS 
institutions should use external credit ratings to assess the credit 
quality of securities in these other rulemakings.
    Under proposed Sec.  615.5134(a)(2)(iv), the board's policy should 
cover the target number of days of liquidity that the bank needs, based 
on its business model and risk profile. Estimating the target number of 
days of liquidity that the bank will need to outlast various stress 
events is an effective tool for managing and mitigating liquidity 
risks.\35\ The preamble to the proposed rule stated that the FCA 
expects each Farm Credit bank to include a prudent amount of unfunded 
commitments in its calculation of the target amount of liquidity it 
will need to survive a liquidity crisis in the markets.\36\
---------------------------------------------------------------------------

    \35\ Id.
    \36\ Id.
---------------------------------------------------------------------------

    The FCA received a comment about proposed Sec.  615.5134(a)(2)(iv) 
from the Council. The commenter agreed with this regulatory provision 
because it concurred that the days of liquidity target is an 
appropriate and logical risk tolerance measure that boards should 
include in their banks' policies. The FCA retains proposed

[[Page 23446]]

Sec.  615.5134(a)(2)(iv) without substantive change, but redesignates 
it as final Sec.  615.5134(a)(2)(iii).
    Proposed Sec.  615.5134(a)(2)(v) would require bank policies to 
address the elements of the CFP in proposed Sec.  615.5134(h). The CFP 
addresses unexpected events or unusual business conditions that 
increase liquidity risk at Farm Credit banks. One of the objectives of 
the proposed rule is to strengthen contingency funding planning at 
System banks. According to the preamble to proposed Sec.  
615.5134(a)(v), an effective CFP would cover at a minimum: (1) 
Strategies, policies, and procedures to manage a range of stress 
scenarios; (2) chains of communications and responsibility within the 
bank; and (3) implementation of the CFP during all phases of an adverse 
liquidity event.\37\
---------------------------------------------------------------------------

    \37\ 76 FR 80817, supra. at 80821.
---------------------------------------------------------------------------

    The Council and a System bank submitted comment letters opposing 
this provision. Both commenters encouraged us to delete this provision 
from the final rule. The commenters stated that when proposed Sec.  
615.5134(a)(v) is read literally, it seems to require the bank board to 
incorporate the entire CFP into its written policy. They advised us 
that the regulation should not require banks to document detailed 
operational procedures for the CFP in their policies. The bank pointed 
out that management may need to make practical operational changes that 
would have no significant impact on safety and soundness of the overall 
CFP. However, any such changes could require board approval if such 
procedures for the CFP are part of the policy. Accordingly, the 
commenters advised us that a more prudent approach is to require FCS 
banks to develop an effective CFP consistent with this regulation.
    The FCA agrees with the commenters that it is impractical and 
burdensome to require the board to incorporate the entire CFP into its 
written policy. Additionally, incorporation of the CFP into the board's 
policy could limit management's ability to dynamically modify the CFP 
as conditions change. For these reasons, the FCA omits Sec.  
615.5134(a)(2)(v) from the final regulation.
    Proposed Sec.  615.5134(a)(2)(vi) would require the board's policy 
to address delegations of authority pertaining to the liquidity 
reserves.
    The FCA received no comment about this regulatory provision. 
Accordingly, we adopt it as final Sec.  615.5134(a)(2)(iv) without 
revision.
    The final provision of proposed Sec.  615.5134(a)(2) would require 
the board's policy to address reporting requirements, which at a 
minimum would require management to report to the board at least once 
every quarter about compliance with the bank's liquidity policy and the 
performance of the liquidity reserve portfolio. This provision would 
also require management to report any deviation from the bank's 
liquidity policy, or failure to meet the board's liquidity targets 
immediately to the board. The purpose of this provision is to ensure 
that an effective reporting process is in place, and management 
communicates accurate and timely information to the board about the 
level and sources of the bank's exposure to liquidity risk. These 
reports should enable the board to take prompt corrective action if any 
problems arise. The FCA expects the board to consider these quarterly 
reports when it conducts its annual review of the bank's liquidity 
policy and decides whether to make any revisions pursuant to Sec.  
615.5134(a)(1).
    The Council commented on proposed Sec.  615.5134(a)(2)(vii). 
Although the commenter agreed that a quarterly reporting requirement is 
prudent, it advised us that the requirement that senior management 
``immediately report'' any deviation from the bank's policy or any 
failure to meet the liquidity targets was unworkable. The commenter 
asked us to clarify what level of deviation or failure would require 
senior management to ``immediately'' report to the board. The commenter 
also asked to quantify ``immediately.''
    The FCA redesignates proposed Sec.  615.5134(a)(2)(vii) as final 
Sec.  615.5134(a)(v). We have also revised this provision to address 
the commenter's concerns. The first sentence of this provision remains 
unchanged. As such, the board's policy must require management to 
report to the board at least once every quarter about compliance with 
the bank's liquidity policy and the performance of the liquidity 
reserve portfolio. However, the FCA has amended the second sentence of 
this provision to require management to report any deviation from the 
bank's liquidity policy, or failure to meet the board's liquidity 
targets, to the board before the end of the quarter if such deviation 
or failure has the potential to cause material loss to the bank. This 
revision, which is self-explanatory, addresses the commenter's concern 
by requiring early reporting of deviations or failures that threaten 
the bank's liquidity or viability.

B. Liquidity Reserve and Discounts

    The proposed rule contained three separate provisions that 
established a liquidity reserve requirement, addressed the composition 
of the liquidity reserve, and specified discounts for assets held in 
the liquidity reserve. More specifically, proposed Sec.  615.5134(b) 
articulated the core liquidity reserve requirement for FCS banks, while 
proposed Sec.  615.5134(e) governed the composition of the liquidity 
reserve, and proposed Sec.  615.5134(g) specified the discounts for the 
different assets in bank liquidity reserve. We organized proposed Sec.  
615.5134(e) in a table format, while the other two provision were 
expressed in text.
    The Council asked us to incorporate the discount table in the 
preamble to the proposed rule into the text of the final regulation. 
The commenter suggested that the table ``would be a superior and 
cleaner approach than the wording of the proposed regulation text.'' In 
accepting the commenter's advice, we decided to incorporate the 
discount table into final Sec.  615.5134(b), rather than keeping it as 
a free-standing regulatory provision. As we reorganized and 
restructured the regulation, we realized that the final rule would be 
easier to read, understand, and implement if we also merged proposed 
Sec.  615.5134(e) into final Sec.  615.5134(b). We received no 
substantive comments about the specific discount percentages in 
proposed Sec.  615.5134(g). Accordingly, we incorporate them into final 
Sec.  615.5134(b) without amendment.
    Proposed Sec.  615.5134(b) would require each Farm Credit bank to 
maintain at all times a liquidity reserve sufficient to fund at least 
90 days of the principal portion of maturing obligations and other 
borrowing of the bank. The Council and a System bank supported this 
provision. Accordingly, the FCA is retaining this core requirement as 
the first sentence of final Sec.  615.5134(b) with one minor, stylistic 
revision.
    The second sentence of proposed Sec.  615.5134(b) would require 
each System bank to maintain a supplemental liquidity buffer in 
accordance with proposed Sec.  615.5134(f). As part of our 
restructuring and reorganization of the final liquidity regulation, 
this sentence has been removed from final Sec.  615.5134(b), although 
final Sec.  615.5134(e) still requires all Farm Credit banks to 
maintain a supplemental liquidity buffer. We received several 
substantive comments about the supplemental liquidity buffer, which we 
will address below in the preamble to final Sec.  615.5134(e).

[[Page 23447]]

    The third sentence of proposed Sec.  615.5134(b) would require FCS 
banks to discount liquid assets in accordance with proposed Sec.  
615.5134(g). As addressed above, we have incorporated proposed Sec.  
615.5134(g) into final Sec.  615.5134(b) without substantive revision.
    The final sentence of proposed Sec.  615.5134(b) states that the 
liquidity reserve must be comprised only of cash, including cash due 
from traded but not yet settled debt, and qualified eligible 
investments under Sec.  615.5140 that are unencumbered and marketable 
under proposed Sec.  615.5134(c) and (d). Both the existing and 
proposed regulations specify that the liquidity reserve must be 
comprised of cash, including cash due from traded but not yet settled 
debt, and qualified eligible investments under Sec.  615.5140. We 
received no comment about this requirement.
    The final sentence of proposed Sec.  615.5134(b) differs from the 
existing rule in that it requires all investments held in the liquidity 
reserve to be marketable under proposed Sec.  615.5134(d). The FCA 
received several comments about our definition of ``marketability'' in 
proposed Sec.  615.5134(d), and how this definition applied to the 
bank's liquidity assets in different situations. The FCA responded to 
the commenters' concerns by adjusting the definition of ``marketable'' 
in final Sec.  615.5134(d), and discussing their concerns in the 
appropriate preamble section below.
    Proposed Sec.  615.5134(e) addressed the composition of the 
liquidity reserve. The first two sentences of the proposed rule 
contained cross-references to proposed Sec.  615.5134(b) and (e). The 
FCA has omitted these cross-references from the final rule because they 
are superfluous now that the FCA has combined all three paragraphs into 
a single provision.
    More substantively, the FCA proposed for the first time to divide 
the 90-day liquidity reserve into two levels. Under our original 
proposal, the first level of the liquidity reserve would provide the 
bank with sufficient liquidity to pay its obligations and continue 
operations for 30 days if market access became partially or fully 
impeded during a national security emergency, a natural disaster, or 
intense economic or financial turmoil. The proposed rule would require 
FCS banks to use the instruments in the first level of the liquidity 
reserve to meet obligations that mature starting on day 1 through day 
30. Additionally, the proposed rule would mandate that cash and certain 
instruments with a final maturity of 3 years or less comprise at least 
15 days of the first level of the liquidity reserve. The 15-day 
sublevel would provide the bank with enough cash and short-term, highly 
liquid assets so it could pay its obligations and fund its operations 
for 15 consecutive days during an emergency when the debt markets are 
closed, or the System's funding costs become untenable.
    Final Sec.  615.5134(b) divides the liquidity reserve into three 
levels. This revision is part of our efforts to restructure and 
reorganize this provision so it is easier to read, understand, and 
apply, as the commenters requested. However, this revision is not 
substantive. Under final Sec.  615.5134(b), the first level of the 
liquidity reserve covers obligations that mature on days 1 through 15. 
Similarly, level 2 applies to days 16 through 30, while level 3 covers 
days 31 through 90. This revision improves the clarity of the 
regulation by more clearly communicating: (1) The exact period of time 
each level of the liquidity reserve covers; and (2) which assets a bank 
may hold in each level.
    The table in proposed Sec.  615.5134(e) identified the assets that 
would comprise Level 1 of the bank's liquidity reserve. All of these 
assets are highly liquid because they are either cash, or investments 
that are high quality, close to their maturity, and marketable. Under 
the proposed rule, Farm Credit banks could hold the following assets in 
Level 1 of their liquidity reserve:
     Cash (including cash balances on hand, cash due from 
traded but not yet settled debt, insured deposits held at federally 
insured depository institutions in the United States;
     United States Treasury securities that have final 
maturities and other characteristics that would best enable the bank to 
fund operations if market access becomes obstructed;
     Other marketable obligations backed by the full faith and 
credit of the United States \38\;
---------------------------------------------------------------------------

    \38\ Obligations that are backed by the full faith and credit of 
the United States, but are not marketable, are ineligible for the 
bank's liquidity reserve under Sec.  615.5134(d).
---------------------------------------------------------------------------

     MBS issued by the Government National Mortgage Association 
(Ginnie Mae);
     Senior debt securities of Government-sponsored agencies 
that mature within 60 days, excluding the debt securities of FCS banks 
and Farmer Mac; and
     Diversified investment funds that are comprised 
exclusively of Level 1 instruments.
    Under the proposed rule, the second level of the liquidity reserve 
would provide System banks with sufficient liquidity to fund their 
obligations and continue operations for the next 60 days (days 31 
through 90). Under proposed Sec.  615.5134(e), FCS banks would hold 
Level 2 assets to mitigate liquidity risks associated with a prolonged 
stress event. Level 2 investments would include:
     Additional amounts of Level 1 investments;
     Government-sponsored agency senior debt obligations with 
maturities that exceed 60 days, excluding FCS debt securities;
     Government-sponsored agency MBS; and
     Diversified investment funds that are comprised 
exclusively of Levels 1 and 2 instruments.
    The FCA received no comments that opposed the assets that the 
proposed rule designated for the liquidity reserve. Under final and 
redesignated Sec.  615.5134(b), Level 1 assets are:
     Cash (including cash balances on hand, cash due from 
traded but not yet settled debt, insured deposits held at federally 
insured depository institutions in the United States;
     Overnight money market instruments;
     Obligations of the United States with a final remaining 
maturity of 3 years or less;
     Senior debt securities of Government-sponsored agencies 
that mature within 60 days, excluding the debt securities of FCS banks 
and Farmer Mac; and
     Diversified investment funds that are comprised 
exclusively of Level 1 instruments.
    In the proposed rule, we inadvertently excluded overnight money 
market investments from the list of highly liquid assets that FCS banks 
could hold in the first 15 days of their liquidity reserve. Overnight 
money market investments are promptly convertible into cash at their 
face value, and as their name implies, they mature overnight. As a 
result, these assets have characteristics that are similar to cash. 
Adding overnight money market investments to the list of assets that 
FCS banks are authorized to hold in Level 1 of the liquidity reserve 
should raise no objection or controversy. It is a standard practice of 
financial institutions to hold overnight money market investments for 
liquidity. For this reason, we have included these instruments in the 
list of highly liquid assets that FCS banks are authorized to hold in 
their liquidity reserve.
    Under the final rule, the following assets qualify for Level 2 of 
the liquidity reserve:

[[Page 23448]]

     Additional Level 1 instruments;
     Obligations of the United States with a final remaining 
maturity of more than 3 years;
     MBS that are backed by the full faith and credit of the 
United States as to the timely repayment of principal and interest; and
     Diversified investment funds comprised exclusively of 
Level 1 and Level 2 instruments.
    Under the final rule, Level 3 assets are:
     Additional Level 1 and Level 2 instruments;
     Government-sponsored agency senior debt securities with 
maturities exceeding 60 days, excluding the senior debt securities of 
FCS banks and Farmer Mac;
     Government-sponsored agency MBS that the timely repayment 
of principal and interest is not explicitly backed by the full faith 
and credit of the United States;
     Money market instruments maturing within 90 days; and
     Diversified investment funds comprised exclusively of 
Levels 1, 2, and 3 instruments.
    The Council and two Farm Credit banks submitted substantive 
comments about concerns they had with three policy positions that the 
FCA articulated in the preamble to proposed Sec.  615.5134(e). Only one 
of these concerns necessitates an adjustment to the regulation. We 
respond to the two other issues below.
    One FCS bank acknowledged that proposed Sec.  615.5134(e) was 
remarkably close to the practices that FCS banks already follow. 
According to the commenter, System banks voluntarily maintain 15 days 
of ``pristine'' liquidity, followed by a sufficient amount of high 
quality assets that provide liquidity for the next 60 days. Beyond 
that, FCS banks comply with current regulatory minimum of 90 days of 
liquidity with other investments. The commenter pointed out that all 
Farm Credit banks have voluntarily agreed to hold at least 120 days of 
liquidity.
    However, this bank along with the Council commented that proposed 
Sec.  615.5134(e) introduces greater complexity and burden to liquidity 
management in a way that does not strengthen the liquidity of any FCS 
bank. The commenters illustrated the System's concern by pointing to a 
passage in the preamble to the proposed rule which stated that FCS 
banks would first draw on the 15-day sublevel in the event of 
significant stress. The commenters advised us that drawing down 
instruments in the 15 days of ``pristine'' instruments may not 
necessarily be the best approach for a bank to take in certain 
scenarios. According to the commenters, the bank may anticipate more 
difficult market conditions in the future and, therefore, it may decide 
that a more prudent approach is to continue holding its most 
``pristine'' liquid assets in place. Thereby, other factors may favor 
the sale of the least ``pristine'' liquid assets first. The commenters 
expressed concern that our interpretation of proposed Sec.  615.5134(e) 
would deny System banks the flexibility to determine which assets in 
the liquidity reserve to draw upon first during a crisis.
    The commenters' concerns have merit. The FCA confirms that final 
Sec.  615.5134(b) does not prescribe which assets in the liquidity 
reserve a System bank must draw upon first during a crisis. Instead, 
the final rule will leave this matter to the discretion of the bank. 
Changes to the text and format of Sec.  615.5134(b) clarify that the 
final regulation does not require FCS banks to liquidate their most 
``pristine'' liquid assets first during times of market stress. 
Additionally, language in the proposed rule that would have required 
FCS banks to ``sequentially apply'' specific instruments to obligations 
that mature within specified timeframes has been omitted from the final 
rule. Finally, the FCA modified the text of the provision so it 
requires each Farm Credit bank to structure its liquidity reserve so 
that it has sufficient assets of various calibers to meet obligations 
that mature within each of the specified timeframes. These changes 
signal that each bank has discretion to liquidate assets in whatever 
order that best serves its interests as it responds to mounting 
distress in the markets.
    Next, the Council asked us to clarify a passage in the preamble 
which stated that ``each FCS bank must document and be able to 
demonstrate to FCA examiners how its liquidity reserve mitigates the 
liquidity risk posed by the bank's business mix, balance sheet 
structure, cash flows, and on-and-off balance sheet obligations.'' The 
commenter wanted to know if this preamble statement signals that the 
FCA is increasing documentation requirements on FCS banks, and 
subjecting their liquidity practices to more stringent examination. 
After noting that FCS banks currently document and demonstrate 
compliance with our liquidity regulations to FCA examiners, the 
commenter requested that FCA examiners maintain open lines of 
communication with the directors and senior managers of System banks 
instead of making examinations of liquidity more rigorous.
    The FCA responds that the commenter is misconstruing the preamble 
passage. The commenter is referring to a broader preamble passage which 
verified that proposed Sec.  615.5134(e) would allow each FCS bank to 
exceed the minimum 90-day liquidity reserve requirement based on its 
individual liquidity needs. As the preamble to the proposed rule 
discussed, each bank must determine the appropriate level, size, and 
quality of its liquidity reserve based on its liquidity risk profile so 
it is able to meet both expected and unexpected cash flows and 
collateral needs without adversely affecting its daily operations and 
financial condition. The size and level of the liquidity reserve should 
also correlate to the bank's ability to fund its obligations at 
reasonable cost.
    The preamble passage in question reaffirms the FCA's longstanding 
position that each FCS bank must be able to demonstrate to FCA 
examiners how its liquidity reserves mitigate the liquidity risk posed 
by the bank's business mix, balance sheet structure, cash flows, and 
on- and off-balance sheet obligations. This preamble statement does not 
signal that the FCA is changing its approach to examining liquidity at 
System banks, or that such examinations will now become 
confrontational. Instead, it indicates how the FCA will apply its 
longstanding examination approach to the new liquidity regulation.
    The Council and a Farm Credit bank commented about the role that 
MBS and collateralized mortgage obligations (CMOs) issued or guaranteed 
by a Government agency or a Government-sponsored agency \39\ play in a 
bank's liquidity reserve under proposed Sec.  615.5134(e). Under the 
proposed rule, FCS banks could hold: (1) MBS issued by Ginnie Mae in 
Level 1 of the liquidity reserve; and (2) Government-sponsored agency 
MBS (primarily issued by Fannie Mae and Freddie Mac) in Level 2. The 
commenters expressed concern that our proposal excluded MBS and CMOs 
that are guaranteed by Ginnie Mae, Fannie Mae, and Freddie

[[Page 23449]]

Mac from both levels of the liquidity reserve.
---------------------------------------------------------------------------

    \39\ Our regulation, Sec.  615.5131, defines a ``government 
agency'' as ``the United States Government or an agency, 
instrumentality, or corporation of the United States Government 
whose obligations are fully and explicitly insured or guaranteed as 
to the timely repayment of principal and interest by the full faith 
and credit of the United States Government.'' The same regulation 
defines a ``Government-sponsored agency'' as ``an agency, 
instrumentality, or corporation chartered or established to serve 
public purposes specified by the United States Congress but whose 
obligations are not fully and explicitly insured or guaranteed by 
the full faith and credit of the United States Government, including 
but not limited to any Government-sponsored enterprise.''
---------------------------------------------------------------------------

    These two commenters want the final rule to authorize Farm Credit 
banks to hold MBS and CMOs issued or guaranteed by Ginnie Mae and the 
two Government-sponsored agencies in both Levels 1 and 2 of their 
liquidity reserves because these instruments, in their opinion, are 
inherently liquid and marketable. The commenters asked us to explicitly 
recognize that such investments are consistent with the definition of 
``marketable'' in Sec.  615.5134(d) because of the ease and certainty 
of their valuation. The commenters contend that the FCA is more 
restrictive than the Board of Governors for the Federal Reserve System, 
which proposed to allow systemically important financial institutions 
(SIFIs) to include unencumbered government and agency guaranteed MBS 
and CMO in their 30-day liquidity reserves.\40\
---------------------------------------------------------------------------

    \40\ See 77 FR 594, 609 (Jan. 5, 2012).
---------------------------------------------------------------------------

    These comments appear to be based on a passage in another section 
of the preamble which stated that the regulation, in practice, 
effectively excludes structured investments from the liquidity reserve 
at FCS banks, although banks could hold these assets in their 
supplemental liquidity buffer.\41\ This same preamble passage carved 
out an exception that would allow System banks to hold MBS issued by 
Ginnie Mae in their liquidity reserves because they are highly 
marketable securities backed by the full faith and credit of the United 
States.
---------------------------------------------------------------------------

    \41\ See 76 FR 80817 supra. at 80822.
---------------------------------------------------------------------------

    Our regulatory approach towards the MBS of Ginnie Mae, Fannie Mae, 
and Freddie Mac is rooted in safety and soundness considerations. A 
diverse selection of MBS instruments is available in the markets, each 
exhibiting different credit, prepayment, and other risks. As a result 
of the risk factors, many of these instruments are less suitable for 
the higher levels of the liquidity reserve although they may generate 
more earnings for the bank. The 2008 crisis illustrated the limitations 
of MBS as a liquidity backstop.
    For these reasons, the FCA's regulatory approach assigns different 
categories of MBS to different levels of the liquidity reserve based on 
their liquidity characteristics. Final Sec.  615.5134(b) excludes MBS 
from the first level of the liquidity reserve (days 1 through 15) 
because they lack the liquidity characteristics of cash, overnight 
money market instruments, United States Treasuries with a final 
remaining maturity of 3 years or less, or the senior debt securities of 
Government-sponsored agencies that mature within 60 days. Under the 
final rule, MBS and CMOs issued or guaranteed by a Government agency or 
a Government-sponsored agency qualify for either Level 2 or Level 3 of 
the bank's liquidity reserve. The liquidity characteristics and risk 
profiles of these Ginnie Mae, Fannie Mae, or Freddie Mac MBS or CMOs 
determine whether they belong in Level 2 or Level 3 of the liquidity 
reserve.
    The final rule does not treat all MBS and CMOs of government 
agencies and Government-sponsored agencies equally, as the commenters 
requested. As discussed above, Ginnie Mae, Fannie Mae, and Freddie Mac 
offer a diverse array of MBS, and each exhibits different liquidity 
characteristics and risk factors. The final rule recognizes these 
differences by assigning MBS and CMOs issued or guaranteed by Ginnie 
Mae, Fannie Mae, and Freddie Mac to different levels of the liquidity 
reserve.
    Fannie Mae and Freddie Mac are currently under the conservatorship 
of the United States Treasury, and their long-term status is uncertain. 
This complicates the FCA's efforts to devise an approach that balances 
our safety and soundness concerns with the needs of System banks for 
flexibility in selecting Ginnie Mae, Fannie Mae, and Freddie Mac MBS 
for their liquidity reserves. While the ultimate status of Fannie Mae 
and Freddie Mac is unresolved, the FCA has decided that the full faith 
and credit of the United States is the standard that determines whether 
particular MBS or CMOs belong in Level 2 or Level 3 of the bank's 
liquidity reserve. Under the final rule, MBS that are issued or 
guaranteed by Ginnie Mae, Fannie Mae, and Freddie Mac qualify for Level 
2 of the liquidity reserve if they are explicitly backed by the full 
and credit of the United States as to the timely payment of principal 
and interest. Conversely, MBS that are issued or guaranteed by Fannie 
Mae and Freddie Mac belong in Level 3 of the liquidity reserve if the 
timely payment of principal and interest are not explicitly backed by 
the full faith and credit of the United States. The reason the final 
rule relegates MBS of Government-sponsored agencies that are not 
explicitly backed by the full faith and credit of the United States to 
Level 3 of the liquidity reserve is because they could potentially 
experience reduced marketability during a widespread market crisis.
    We are unable to confirm, as the commenter requests, that all 
Government-sponsored agency MBS are automatically marketable within the 
meaning of Sec.  615.5134(d). Their ``ease and certainty of valuation'' 
depends on whether they exhibit low market risks under stressful 
conditions. We note that the Federal banking regulators continue to 
require depository institutions to risk weight the MBS of Fannie Mae 
and Freddie Mac at 20 percent, while the MBS of Ginnie Mae are risk 
weighted at zero. Under the circumstances, the FCA does not conclude 
that Fannie Mae and Freddie Mac MBS have the same low risks and ease of 
valuation as Ginnie Mae MBS. This is another reason why the final rule 
does not treat all MBS of government agencies and Government-sponsored 
agencies the same.
    The approach that the Board of Governors of the Federal Reserve 
System follows for SIFIs is not appropriate for FCS banks in this 
situation. FCS banks are GSEs that primarily finance a single industry, 
and they have no assured government lender of last resort. Some FCS 
banks were vulnerable to an overabundance of MBS of Government-
sponsored agencies in their liquidity portfolios during the 2008 
crisis. SIFIs are large, diversified, and complex organizations that 
have a different risk profile than FCS banks. In contrast to SIFIs and 
federally chartered or federally insured commercial banks, FCS banks do 
not have assured access to the discount windows at Federal Reserve 
Banks. Under the circumstances, there is no certainty that the Federal 
Reserve Banks would extend lines of credit to Farm Credit banks during 
times of stress and accept MBS as collateral.
    The preamble to the proposed rule stated that the FCA was 
contemplating whether to add a specific provision to the final 
regulation that would require the liquidity reserve to cover unfunded 
commitments and other contingent obligations. As the preamble observed, 
unfunded commitments and other material contingent obligations 
potentially expose FCS banks to significant safety and soundness risk. 
Requiring FCS banks to hold sufficient liquidity to cover unfunded 
commitments and other contingencies would mitigate risks that pose a 
threat to their liquidity, solvency, and viability, but it could also 
impose significant burdens and opportunity costs on these System banks. 
For this reason, we asked the public whether the final rule should 
explicitly require the liquidity reserve to cover unfunded commitments 
and other contingency, and if so, under what conditions.
    The Council, on behalf of System banks, responded that the FCA 
should wait until the Federal banking agencies

[[Page 23450]]

finalize Basel III guidance for the calculation of the liquidity 
coverage ratio and net stable funding ratio. Under the circumstances, 
the commenter recommended that we subsequently address this matter in 
another rulemaking, or through policy guidance. The FCA agrees, and has 
not added a provision addressing unfunded commitments and other 
contingencies to final Sec.  615.5134(b) during this rulemaking. 
Instead, the FCA will pay close attention to how the Basel Committee 
and the Federal banking agencies address unfunded commitments. If 
appropriate, the FCA will revisit this issue at a later time.

C. Unencumbered Investments in the Liquidity Reserve

    Currently, existing Sec.  615.5134(b) requires all investments that 
System banks hold to meet their liquidity reserve requirement to be 
free of lien. The proposed rule would expand upon this concept by 
requiring FCS banks to hold only unencumbered assets in their liquidity 
reserve. Under proposed Sec.  615.5134(c), an asset is unencumbered if 
it is free of lien and is not explicitly or implicitly pledged to 
secure, collateralize, or enhance the credit of any transaction. 
Proposed Sec.  615.5134(c) also would prohibit any FCS bank from using 
an investment in the liquidity reserve as a hedge against interest rate 
risk pursuant to Sec.  615.5135 if liquidation of that particular 
investment would expose the bank to a material risk of loss. As the FCA 
explained in the preamble to the proposed rule, unencumbered 
investments are free of the impediments or restrictions that would 
otherwise curtail the bank's ability to liquidate them to pay its 
obligations when normal access to the debt market is obstructed.
    The FCA received one comment about proposed Sec.  615.5134(c) from 
the Council. The commenter agreed that investments in the liquidity 
reserve must be free of lien, and not pledged for any other purpose. 
However, the commenter opposed the provision in proposed Sec.  
615.5134(c) that would prohibit a Farm Credit bank from using an 
investment in the liquidity reserve as a hedge against interest rate 
risk pursuant to Sec.  615.5134 if liquidation of the particular 
investment would expose the bank to a material risk of loss. Besides 
claiming that ``material risk of loss'' is an ambiguous standard, the 
commenter contends that this requirement is ``unreasonably limiting and 
complex.''
    The commenter believes that our regulations should grant System 
banks greater flexibility to use liquid securities for multiple 
investment purposes. During normal times, securities that Farm Credit 
banks hold to manage interest rate risk can also provide liquidity 
without sacrificing the bank's hedge position. For this reason, the 
commenter claims that securities used to hedge interest rate risk are 
not diminished from a liquidity perspective. If economic or financial 
adversity impedes market access, the commenter asserts a System bank 
could prudently choose to sell a liquid security held as an interest 
rate hedge so it could raise funds to pay maturing obligations. 
Finally, the commenter claims that our position is inconsistent with 
the position of the Federal banking agencies, which only excludes 
investments from liquidity reserves when they are used to hedge trading 
assets.
    The FCA retains, without revision, the last sentence in final Sec.  
615.5134(c), which prohibits a Farm Credit bank from using an 
unencumbered investment held in its liquidity reserve as a hedge 
against interest rate risk if liquidation would expose the bank to a 
material risk of loss. The objective of this regulatory provision is to 
require System banks to primarily concentrate on counteracting 
liquidity risks when they select assets for the 90-day liquidity 
reserve. As discussed elsewhere in this preamble, System banks must 
stock the liquidity reserve with cash and high-quality liquid 
securities that are readily convertible into cash at or close to their 
book value at times when market access becomes impeded. Farm Credit 
banks dilute the liquidity reserve's capacity to serve as an emergency 
source of funding when these assets are used for multiple purposes. The 
purpose of this provision is to ensure that liquidity is the dominant 
consideration of a System bank when it purchases a security for 
inclusion in its liquidity reserve. Farm Credit banks may, however, 
choose investments for the supplemental liquidity buffer that serve the 
dual purpose of mitigating liquidity risk and hedging interest rate 
risk.
    Moreover, this provision does not ban System banks from hedging 
interest rate risk with assets held in the liquidity reserve. Instead, 
it specifically states that an unencumbered investment held in the 
liquidity reserve cannot be used as a hedge against interest rate risk 
only if liquidation of that particular investment would expose the bank 
to a material risk of loss. The FCA disagrees with the commenter that 
this provision is ambiguous about what constitutes a material risk of 
loss. Exposure to material risk of loss would depend on the risk 
profile and financial condition of each bank. A Farm Credit bank could 
be exposed to a material risk of loss if it must sell investments that 
double as hedges for interest rate risks in order to pay its 
obligations and fund its operations when market access is impeded. Once 
these securities have been sold, the bank will then have an exposure to 
interest rate risk that is no longer hedged. If its interest rate risk 
exposure is significant, the bank could incur a material risk of loss.
    The Council claims that a Farm Credit bank could pledge these 
securities as collateral in a secured borrowing (repo) transaction, 
rather than liquidating its hedge position. A passage in the 
commenter's letter states that ``when used as collateral, these 
investments can generate liquidity without loss to the hedge 
position.''
    In response, the FCA notes the repo market for certain types of 
securities may cease to function during economic or financial crises. 
In fact, during the 2008 crisis, many financial institutions discovered 
that they could not pledge many types of securities as collateral in 
the repo markets although in other circumstances these assets were 
liquid, marketable, and valuable as collateral. For these reasons, the 
FCA declines to change its position on this issue.
    Finally, we address the Council's comment that our position is 
inconsistent with the position of the Federal banking agencies, which 
only excludes investments from liquidity reserves when they are used to 
hedge trading assets. Farm Credit banks generally hold investments 
until maturity, rather than trading for profit. As stated above, the 
final rule allows a System bank to hedge interest rate risk with assets 
held in the liquidity reserve provided that the hedging activity would 
not expose the bank to a material risk of loss in a liquidity crisis. 
Additionally, FCS banks may hold investments that hedge market risks in 
their supplemental liquidity buffers. From a safety and soundness 
perspective, the Federal banking agencies' position on this issue is 
not suitable for the FCS. The FCS is a GSE that lends almost 
exclusively to a single sector of the economy, it does not take 
deposits, and it lacks an assured governmental lender of last resort. 
These reasons justify the FCA's more conservative regulatory approach.

D. Marketable Security

    Under our proposal, all eligible investments that a System bank 
hold in its liquidity reserve must be marketable. Proposed Sec.  
615.5134(d) specifies the criteria and attributes that determine

[[Page 23451]]

whether investments are marketable for the purposes of this regulation. 
Investments that meet all the proposed marketability criteria would be 
deemed to possess the characteristics of high-quality liquid assets 
that are suitable for the liquidity reserve at each FCS bank. Proposed 
Sec.  615.5134(d)(1) states that an investment is marketable if it:
    1. Can be easily and immediately converted into cash with little or 
no loss in value;
    2. Exhibits low credit and market risks;
    3. Has ease and certainty of valuation; and
    4. Can be easily bought or sold.
    We received one comment on this section from the Council on behalf 
of the four System banks. The commenter stated that the four criteria 
impose ``an impossible and unworkably vague standard'' and suggested 
that the FCA adopt an approach that emphasized asset quality rather 
than marketability. The commenter raised objections to three of the 
four criteria described above. The commenter did not object to the 
second criterion, which specifies that a marketable investment displays 
low market and credit risks.
    According to the commenter, the criterion that a marketable 
investment must be easily and immediately converted into cash with 
little or no loss in value is particularly problematic. The commenter 
claims that this criterion lacks specificity because it: (1) Cannot be 
applied in any consistent manner; and (2) is subject to varying 
interpretations over time. For this reason, the commenter asked us to 
revise the first criterion so that Sec.  615.5134(d)(1) simply states 
that a marketable investment ``can be easily converted into cash.'' In 
the commenter's view, this change would allow Farm Credit banks to 
include more investments in their liquidity reserve after applying the 
appropriate discount. The commenter believes that its recommended 
approach is more logical and workable, and consistent with safety and 
soundness.
    The FCA responds that section 4.3(c) of the Act requires Farm 
Credit banks to pledge certain securities as collateral for the debt 
obligations they issue. This provision of the Act includes marketable 
securities approved by the FCA as assets that System banks may pledge 
as collateral for their borrowings.
    A Farm Credit bank should be able to sell any instrument that it 
holds for liquidity quickly and at close to its book value. The sale of 
a security for which the fair value and book value diverge 
significantly can affect capital and earnings to the extent that it 
exacerbates liquidity risks. Of particular concern is a situation where 
the sale of an investment held primarily for liquidity results in a 
significant loss. Such an outcome may mean that a System bank will not 
generate sufficient revenue from the liquidation of an asset to pay its 
obligations and fund its assets when it is experiencing significant 
stress. For this reason, we continue to believe that each System bank 
must be able to sell any investment held for liquidity purposes with no 
or minimal effect on its earnings. The commenter's suggestion that the 
final rule allow investments to qualify for the liquidity reserve if 
the bank can ``easily'' convert them into cash at a steep discount from 
their book value does not address our safety and soundness concerns. In 
fact, this recommendation would relax an existing safety and soundness 
standard rather than strengthen it.
    However, the commenter's concern that proposed Sec.  615.5134(d)(1) 
is not susceptible to consistent application and interpretation over 
time has merit. For this reason, we have changed ``immediately'' to 
``quickly'' so FCS banks have clearer guidance and greater flexibility 
about converting liquid assets into cash. We consider ``quickly'' to 
mean hours or a few days even during adverse market conditions.
    We received no comment about proposed Sec.  615.5134(d)(2), which 
states that a marketable security exhibits low credit and market risks. 
This criterion is a vital safety and soundness standard for investments 
held in System bank's liquidity reserve. Accordingly, we adopt proposed 
Sec.  615.5134(d)(2) as a final regulation without revision.
    The Council asks the FCA whether proposed Sec.  615.5134(d)(3), 
which would require marketable investments to have ease and certainty 
of valuation, would exclude structured investments, such as CMOs, 
particularly those issued by Government-sponsored agencies, from the 
liquidity reserves at Farm Credit banks. From the commenter's 
perspective, such a result would be inconsistent with both: (1) The 
objectives of the liquidity reserve requirement; and (2) with the 
approach taken by the Basel Committee and the Federal banking agencies.
    The commenter's question stems from the preamble to proposed Sec.  
615.5134(d)(3), which stated that an instrument has ease and certainty 
of valuation if the components of its pricing formulation are publicly 
available. Additionally, the same preamble passage states that the 
pricing of high-quality liquid assets are usually easy to ascertain 
because they do not depend significantly on numerous assumptions. For 
these reasons, the preamble passage stated that proposed Sec.  
615.5134(d)(3) would ``in practice'' exclude most structured 
investments from System bank liquidity reserves. The preamble noted, 
however, that certain MBS, such as those issued by Ginnie Mae, are 
highly marketable under this criterion, and they would qualify for a 
System bank liquidity reserve.
    The FCA responds that Sec.  615.5134(d)(3) does not automatically 
include or exclude all structured investments, such as CMOs from bank 
liquidity reserves. Some CMOs have ease and certainty of valuation 
while others do not. For this reason, the FCA expects each bank to 
conduct due diligence on CMOs that it is considering for its liquidity 
reserve, and document its conclusions. Bank management should be able 
to explain its decision to FCA examiners.
    Under proposed Sec.  615.5134(d)(4), the final attribute of a 
marketable investment is that it can be easily bought or sold. As a 
general rule, money market instruments are easily bought and sold 
although they are not traded on a recognized exchange. Otherwise, 
proposed Sec.  615.5134(d)(4) recognizes securities as ``marketable'' 
if they are listed on a developed and recognized exchange market. 
Listing on a public exchange enhances the transparency of the pricing 
mechanisms of the investment, which in turn, enhances its marketability 
and liquidity. An investment also would comply with the requirements of 
proposed Sec.  615.5134(d)(4) if investors can sell or convert them 
into cash through repurchase agreements in active and sizeable markets, 
even in times of stress.
    The commenter advised us to reconsider our approach to this 
requirement. The commenter pointed out that exchanges enhance 
transparency of the price of stock, but not bonds and other debt 
obligations. Another concern of the commenter is that references to 
trading on public exchanges may conflict with guidance for the 
treatment of investments under FASB Fair Value Classification. For this 
reason, the commenter asks that we omit the phrase ``developed and 
recognized exchange markets'' and reorganize this provision so it 
aligns with the approach of the Federal banking agencies.
    The FCA acknowledges that this comment has merit. For this reason, 
final Sec.  615.5134(d)(4) will now state that ``Except for money 
market instruments, can be easily bought and sold in active and 
sizeable markets without significantly affecting prices.'' This

[[Page 23452]]

revision addresses the commenter's concerns while ensuring that 
instruments in System bank liquidity reserves are marketable because 
they can be easily bought and sold in active markets where their prices 
are transparent.

E. Supplemental Liquidity Buffer

    The FCA proposed to strengthen liquidity management at Farm Credit 
banks by introducing the new concept of a supplemental liquidity buffer 
into this regulation. Proposed Sec.  615.5134(f) would require all Farm 
Credit banks to establish and maintain a supplemental liquidity buffer 
that would provide a longer term, stable source of funding beyond the 
90-day minimum liquidity reserve. The supplemental liquidity buffer 
would complement the 90-day minimum liquidity reserve. Whereas the 
primary purpose of the 90-minimum liquidity reserve is to furnish 
sufficient short-term funding to survive an immediate crisis, the 
supplemental liquidity buffer would enable Farm Credit banks to manage 
and mitigate liquidity risk over a longer time horizon.
    Under proposed Sec.  615.5134(f), Farm Credit banks would hold 
supplemental liquid assets that are specific and commensurate to the 
risks they face in maintaining stable longer term funding. Besides 
providing FCS banks with a longer term source of stable funding, each 
bank could draw on the supplemental liquidity buffer if a heavy demand 
for funds strains its 90-day minimum liquidity reserve during times of 
turbulence in the market. This supplemental liquidity buffer provides 
an additional cushion of liquidity that should enable FCS banks to 
endure prolonged periods of uncertainty. System banks could also deploy 
assets in the supplemental liquidity buffer to offset specific risks to 
liquidity that their boards have identified in their liquidity policies 
and CFPs.
    Proposed Sec.  615.5134(e) contained five provisions. First, as 
stated above, the proposed rule would require all FCS banks to hold 
liquid assets in excess of the 90-day minimum in the liquidity reserve. 
However, the proposed rule does not specify the length of time the 
supplemental liquidity buffer should cover. Second, proposed Sec.  
615.5134(f) states that the supplemental liquidity buffer be comprised 
of cash and qualified eligible investments listed in Sec.  615.5140. As 
a result, this regulation would allow FCS banks to hold qualified 
eligible investments in their supplemental liquidity buffer that they 
could not hold in their 90-day liquidity reserve. Third, proposed Sec.  
615.5134(f) states that each bank must be able to liquidate any 
qualified investment in its supplemental liquidity buffer within the 
timeframe established by the board's liquidity policies at no less than 
80 percent of its book value. Fourth, the proposed rule would require a 
Farm Credit bank to remove from its supplemental liquidity buffer any 
investment that has, at any time, a market value that is less than 80 
percent of its book value. These two provisions are designed to limit 
losses that the bank may incur on assets held in its supplemental 
liquidity buffer. As we explained in the preamble to the proposed rule, 
the liquidity and marketability characteristics of qualified 
investments in the supplemental liquidity buffer would be called into 
question if their market value were to fall 20 percent or more below 
book value. Finally, proposed Sec.  615.5134(f) would require the 
amount of supplemental liquidity that each bank holds, at a minimum, 
to: (1) Meet the requirements of the board's liquidity policy; (2) 
provide excess liquidity beyond the days covered by the liquidity 
reserve; and (3) comply with the applicable portions of the bank's CFP.
    The FCA received comments about the supplemental liquidity buffer 
from the Council and three Farm Credit banks. None of these commenters 
opposed the new regulatory requirement that all FCS banks establish a 
supplemental liquidity buffer. In fact, one commenter pointed out that 
all the banks have mutually agreed to hold a minimum of 120 days of 
liquidity, and in practice actually have much more.
    A Farm Credit bank commented that the supplemental liquidity 
reserve effectively increases the days of liquidity for System banks. 
As a result, the commenter claimed the supplemental liquidity buffer 
will compel System banks to further lengthen the maturity of their 
liabilities and potentially reduce the issuance of Discount Notes to 
fund their operations. The FCA has already responded to comments that 
assert our new liquidity regulation diminishes System reliance on 
discount notes. Before the 2008 crisis, FCS banks voluntarily held 
levels of liquidity far in excess of what the FCA requires under this 
final rule without detriment to the Discount Notes program.
    The Council and two banks opposed two provisions in proposed Sec.  
615.5134(f) that would require the market value of all qualified 
investments in the bank's supplemental liquidity buffer to remain at or 
above 80 percent of book value. These commenters deem this benchmark as 
an inappropriate regulatory requirement because, in their opinion, it 
is subjective, inflexible, unduly restrictive, and arbitrary. According 
to these three commenters, interest rate fluctuations could cause the 
market value of an asset to fall below 80 percent of its book value, 
but the asset could, nevertheless, remain marketable and liquid. 
Although a System bank may be less willing to sell securities that have 
declined in market value, the commenters point out that it could still 
liquidate these assets in most circumstances if the need to raise cash 
arises. From the commenters' perspective, the premise that a 20-percent 
decline in value impairs the marketability and liquidity of a security 
lacks sound support or substantiation. For these reasons, the 
commenters ask the FCA to eliminate these two provisions from the final 
regulation.
    Redesignated and final Sec.  615.5134(e) continues to require every 
qualified investment in the bank's supplemental liquidity buffer to 
retain a market value that equals or exceeds 80 percent of its book 
value. The FCA reasons that the liquidity reserve, combined with the 
supplemental liquidity buffer significantly fortify each FCS bank and 
the System as a whole so they can withstand a future financial crisis. 
Requiring all qualified investments in the supplemental liquidity 
buffer to retain at least 80 percent of their book value ensures that 
each FCS bank has a sufficient quantity of high quality liquid assets 
to outlast adverse economic or financial conditions that obstruct the 
System's access to the debt market. We are concerned that liquidation 
of assets at a loss would be problematic at any time, but especially 
during a crisis. Investments that can be liquidated only at substantial 
discounts may not provide the bank with adequate funds to pay its 
obligations when market access becomes impeded and, therefore, they 
would not comprise a stable funding source during times of financial 
stress. Also, the resulting recognition of loss could further 
exacerbate the financial stress being experienced by an individual FCS 
bank and the entire System. Additionally, if these types of investments 
could not be liquidated, or could be sold only at a significant loss, 
the alternative of a repo transaction to provide liquidity at that 
level of discount would most likely not be available given concerns as 
to their actual value. This 80-percent requirement ensures that all 
qualified investments in each bank's supplemental liquidity buffer 
provide a source of high quality assets that could

[[Page 23453]]

be used to meet liquidity demands in various (short- to long-term) 
timeframes.
    The FCA has revised its final rule so the 80-percent requirement is 
less burdensome to FCS banks. The proposed rule would have required 
banks to apply an 85-percent discount to all assets in the supplemental 
liquidity reserve that did not otherwise qualify for the different 
levels of the liquidity reserve. Under final Sec.  615.5134(e), each 
investment in the supplemental liquidity buffer that has a market value 
of at least 80 percent of its book value, but does not qualify for 
Levels 1, 2, or 3 of the liquidity reserve, must be discounted to 
(multiplied by) 90 percent of its book value. This 90-percent discount 
is less steep than the 85-percent rate that the FCA originally 
proposed. Additionally, this 90-percent rate is more consistent with 
Sec.  615.5134(b)(3) of our existing regulation which establishes a 90-
percent discount for securities with greater risks.

F. Contingency Funding Plan (CFP)

    The existing regulation requires all Farm Credit banks to have a 
contingency funding plan that addresses liquidity shortfalls during 
market disruptions. A CFP is a blueprint that helps financial 
institutions to respond to contingent liquidity events that may arise 
from external factors that adversely affect the financial system, or 
they may be specific to the conditions at an individual institution. 
The 2008 crisis revealed actual and potential vulnerabilities in 
contingency planning at FCS banks. As a result, the FCA proposed 
regulatory amendments that are designed to strengthen the System's 
contingency funding plans.
    Proposed Sec.  615.5134(h) would require each Farm Credit bank to 
have a CFP that ensures sources of liquidity are sufficient to fund 
normal operations under a variety of stress events. Whereas the 
existing regulation only requires the CFP to address liquidity 
shortfalls caused by market disruptions, the proposed rule would 
require the CFP to explicitly cover other stress events that threaten 
the bank's liquidity, such as: (1) Rapid increases in loan demand; (2) 
unexpected draws on unfunded commitments; (3) difficulties in renewing 
or replacing funding with desired terms or structures; (4) pledging 
collateral with counterparties; and (5) reduced market access.
    Additionally, the proposed rule would require each FCS bank to 
maintain an adequate level of unencumbered and marketable assets in its 
liquidity reserve that could be converted into cash to meet its net 
liquidity needs based on estimated cash inflows and outflows for a 30-
day time horizon under an acute stress scenario. The objective of this 
requirement is to instill discipline at each Farm Credit bank. As an 
integral and critical part of its contingency planning, the FCA expects 
each bank to be able to evaluate its expected funding needs and its 
available funding sources during reasonably foreseeable stress 
scenarios. In this context, the FCA expects each System bank to analyze 
its cash inflows and outflows, and its access to funding at different 
phases of a plausible, but acute, liquidity stress event that continues 
for 30 days.
    Proposed Sec.  615.5134(h) would require the CFP to address four 
specific areas that are essential to the bank's efforts to mitigate its 
liquidity risk. Taken together, these four areas constitute an 
emergency preparedness plan that should enable the bank to effectively 
cope with a full range of contingency that could endanger its 
liquidity. More specifically, the proposed rule would require the CFP 
to:
     Be customized to the financial condition and liquidity 
risk of the bank and the board's liquidity policy. As such, the CFP 
should be commensurate with the complexity, risk profile and scope of 
the bank's operations;
     Identify funding alternatives that the Farm Credit bank 
can implement whenever its access to funding is impeded. At a minimum, 
these funding alternatives must include arrangements for pledging 
collateral to secure funding and possible initiatives to raise 
additional capital;
     Mandate periodic stress testing, which would analyze the 
possible impacts on the bank's cash inflows and outflows, liquidity 
position, profitability and solvency under a variety of stress 
scenarios; and
     Establish a process for managing events that imperil the 
bank's liquidity, and assign appropriate personnel and implement 
executable action plans that carry out the CFP.
    The Council and one Farm Credit bank commented on the proposed 
rule's provisions governing the CFP. The Council acknowledged that 
proposed Sec.  615.5134(h) is consistent with the approach of the 
Federal banking agencies, but it judged the provision as ``too 
detailed.'' In the commenter's opinion, the provisions of proposed 
Sec.  615.5134(h) are more appropriate for a policy statement, rather 
than a regulation. Accordingly, the commenter urged us to revert to the 
generalized approach of the existing regulation, which in the 
commenter's view, would grant Farm Credit banks greater flexibility to 
develop and implement the CFP as circumstances change over time.
    The FCA denies this request. As explained earlier, the purpose of 
this regulatory provision is to correct deficiencies in contingency 
funding planning at FCS banks that the 2008 crisis revealed.
    Contingency funding planning is an essential and crucial element of 
effective liquidity risk management that enables Farm Credit banks to 
meet their obligations and continue operations as economic or financial 
adversity strikes. The FCA's new approach requires the CFP to address 
specific core issues which are essential to the bank's ability to 
continue funding its normal operations under a variety of plausible 
stress scenarios. Additionally, our approach grants FCS banks the 
flexibility that the commenter seeks by stipulating that each bank must 
tailor its CFP to its unique liquidity risk profile and tolerance 
level. In this context, our regulatory approach strikes an appropriate 
balance by instilling greater discipline in the contingency funding 
planning process at Farm Credit banks while preserving the banks' 
flexibility to devise and revise a CFP that addresses its own unique 
circumstances and conditions.
    Both commenters objected to the provision in the proposed rule that 
would require System banks to conduct periodic stress tests on their 
cash inflows and outflows, liquidity position, profitability and 
solvency under a variety of stress scenarios. According to these 
commenters, additional stress case scenarios are redundant with the 
investment management regulations, which already require quarterly 
stress tests. From the commenters' perspective, this new regulatory 
requirement does not improve effective liquidity management at FCS 
banks.
    The FCA responds that redesignated and final Sec.  615.5134(f)(3) 
specifically requires stress testing of those factors (such as the 
bank's cash inflow and outflows, liquidity position, profitability, and 
solvency) which are key indicators of liquidity. In contrast, the 
applicable provision of the investment management regulation, Sec.  
615.5133(f)(4), focuses on the stress testing in an asset-liability 
management context. Although some overlap exists, Sec.  615.5133(f) and 
final and redesignated Sec.  615.5134(f)(3) are neither duplicative, 
nor in conflict with each other. Instead, the two provisions complement 
each other as Sec.  615.5133(f) addresses stress testing from a global 
prospective while final Sec.  615.5134(f) requires specialized stress 
tests that probe the bank's ability to withstand shocks to its 
liquidity.

[[Page 23454]]

    The Council asked the FCA to lessen the stress testing requirement 
for liquidity, which it views as unduly burdensome. The commenter 
claims that it would be more effective if managers spent more time on 
monitoring markets rather than performing ``numerous stress tests of 
implausible and improbable events.'' From the commenter's perspective, 
this stress testing requirement does not effectively improve safety and 
soundness, and the burdens of this provision outweigh its benefits.
    The FCA disagrees that stress testing for liquidity will only 
marginally improve safety and soundness at System banks, or that this 
regulatory provision is unduly burdensome. The commenter has provided 
no evidence that stress testing distracts from the bank's ability to 
monitor markets. Stress tests should be appropriate for the bank's 
business model and the complexity of its operations. Similarly, stress 
tests should be based on plausible and probable assumptions concerning 
stress events that could adversely affect the bank's ability to pay its 
obligations and continue normal operations during times of economic or 
financial turbulence. Stress testing is an integral part of effective 
liquidity risk management that will detect vulnerabilities in the 
bank's liquidity management early on so management can take corrective 
action. Appropriate stress testing is an effective liquidity risk 
management tool that effectively strengthens safety and soundness at 
FCS banks. From a regulatory perspective, the burdens of the stress 
testing requirement in final Sec.  615.5134(f)(3) is minimal, while the 
benefits are great.
    The FCA made three non-substantive technical corrections to this 
regulatory provision. The first sentence of proposed Sec.  615.5134(h) 
has been broken into two sentences in final and redesignated Sec.  
615.5134(f). Additionally, the proposed rule defined stress events as 
``including'' specific occurrences, whereas the final rule states that 
stress events ``include, but are not limited to'' these same 
occurrences. These changes clarify the scope of this provision without 
substantively altering its meaning. In the second to last sentence of 
the main paragraph of this provision, we changed ``based on estimated 
cash inflows and outflows for a 30-day time horizon under an acute 
stress scenario'' to ``based on estimated cash inflows and outflows 
under an acute stress scenario for 30 days.'' This revision corrects 
the grammar of this provision and enhances its clarity, without 
changing its meaning. Finally, we made two technical revisions in final 
and redesignated Sec.  615.5134(f)(3). We changed ``Requiring periodic 
stress testing, which analyzes the possible impacts'' to ``Requiring 
periodic stress testing that analyzes the possible effects.'' Changing 
``which'' to ``that'' corrects a grammatical error. We corrected the 
syntax of this provision by changing ``impacts'' to ``effects.'' In the 
context of this sentence, ``effects'' is more accurate than 
``impacts.'' Neither of these revisions is substantive.

G. The FCA's Reservation of Authority

    The FCA proposed to strengthen its supervisory and regulatory 
oversight of liquidity management at Farm Credit banks by adding a new 
reservation of authority provision to this regulation. Under proposed 
Sec.  615.5134(i), the FCA would expressly reserve the right to require 
Farm Credit banks, either individually or jointly, to adjust their 
treatment of any asset in their liquidity reserves so they always 
maintain liquidity that is sufficient and commensurate for the risks 
they face.
    The FCA justified this reservation of authority by invoking its 
Congressional mandate to ensure that FCS institutions comply with 
applicable laws, fulfill their public policy mission to finance 
agriculture and other specified activities in rural America, and 
operate safely and soundly. The Act grants the FCA comprehensive powers 
to examine, supervise, and regulate the FCS. The FCA reasoned that it 
must be able to act decisively when a sudden external crisis threatened 
the System's liquidity.
    The Council and a Farm Credit bank opposed proposed Sec.  
615.5134(i), and asked the FCA to withdraw it.
    After considering comments received, the FCA has decided to omit 
the reservation of authority from the final regulation. The FCA has 
comprehensive supervisory authority over all FCS institutions. As a 
result, the FCA through its examination and enforcement authorities can 
compel Farm Credit banks, individually or jointly, to promptly take 
specified action to correct deficiencies in their liquidity management 
practices if internal or external circumstances so warranted. By 
approving all obligations that FCS banks issue to fund System 
operations, and prescribing collateral requirements for such debt, the 
FCA has an additional mechanism for regulating System liquidity.\42\
---------------------------------------------------------------------------

    \42\ See Sections 4.2(c), 4.2(d), and 5.l7(a)(4)of the Act; 12 
U.S.C. 2153(c), 2153(d), and 2252(a)(4).
---------------------------------------------------------------------------

    As the commenters point out, the FCA may determine in other 
situations that the best course of action is to relax the liquidity 
requirements on FCS institutions. In fact, an existing regulation, 
Sec.  615.5136, authorizes the FCA during an emergency to: (1) Increase 
the amount of eligible investments that FCS banks may hold pursuant to 
Sec.  615.5132; or (2) waive or modify the liquidity reserve 
requirement. As noted in the preamble to the proposed rule, the FCA 
Board passed a Market Emergency Standby Resolution on November 13, 2008 
that would waive the 90-day liquidity reserve requirement for a limited 
period of time if a crisis shuts or severely restricts the System's 
access to the debt markets.
    For these reasons, the FCA determines it can effectively exercise 
its supervisory authority over FCS banks during times of economic, 
financial, or market adversity without inserting the reservation of 
authority into the liquidity regulation. Because we have omitted the 
reservation of authority from the final rule, we do not need to address 
whether it would have violated the APA.

VII. Regulatory Flexibility Act

    Pursuant to section 605(b) of the Regulatory Flexibility Act (5 
U.S.C. 601 et seq.), the FCA hereby certifies that the final rule will 
not have a significant economic impact on a substantial number of small 
entities. Each of the banks in the System, considered together with its 
affiliated associations, has assets and annual income in excess of the 
amounts that would qualify them as small entities. Therefore, System 
institutions are not ``small entities'' as defined in the Regulatory 
Flexibility Act.

List of Subjects in 12 CFR Part 615

    Accounting, Agriculture, Banks, banking, Government securities, 
Investments, Rural areas.

    For the reasons stated in the preamble, part 615 of chapter VI, 
title 12 of the Code of Federal Regulations is amended as follows:

PART 615--FUNDING AND FISCAL AFFAIRS, LOAN POLICIES AND OPERATIONS, 
AND FUNDING OPERATIONS

0
1. The authority citation for part 615 continues to read as follows:

    Authority: Secs. 1.5, 1.7, 1.10, 1.11, 1.12, 2.2, 2.3, 2.4, 2.5, 
2.12, 3.1, 3.7, 3.11, 3.25, 4.3, 4.3A, 4.9, 4.14B, 4.25, 5.9, 5.17, 
6.20, 6.26, 8.0, 8.3, 8.4, 8.6, 8.8, 8.10, 8.12 of the Farm Credit 
Act (12 U.S.C. 2013, 2015, 2018, 2019, 2020, 2073, 2074, 2075, 2076, 
2093, 2122, 2128, 2132, 2146, 2154, 2154a, 2160, 2202b, 2211, 2243, 
2252, 2278b, 2278b-6, 2279aa,

[[Page 23455]]

2279aa-3, 2279aa-4, 2279aa-6, 2279aa-8, 2279aa-10, 2279aa-12); sec. 
301(a) of Pub. L. 100-233, 101 Stat. 1568, 1608.


0
2. Revise Sec.  615.5134 to read as follows:


Sec.  615.5134  Liquidity reserve.

    (a) Liquidity policy--(1) Board responsibility. The board of each 
Farm Credit bank must adopt a written liquidity policy. The liquidity 
policy must be compatible with the investment management policies that 
the bank's board adopts pursuant to Sec.  615.5133 of this part. At 
least once every year, the bank's board must review its liquidity 
policy, assess the sufficiency of its liquidity policy, and make any 
revisions it deems necessary. The board of each Farm Credit bank must 
ensure that adequate internal controls are in place so that management 
complies with and carries out this liquidity policy.
    (2) Policy content. At a minimum, the liquidity policy of each Farm 
Credit bank must address:
    (i) The purpose and objectives of the liquidity reserve;
    (ii) Diversification requirements for the liquidity reserve 
portfolio;
    (iii) The target amount of days of liquidity that the bank needs 
based on its business model and risk profile;
    (iv) Delegations of authority pertaining to the liquidity reserve; 
and
    (v) Reporting requirements, which at a minimum must require 
management to report to the board at least once every quarter about 
compliance with the bank's liquidity policy and the performance of the 
liquidity reserve portfolio. However, management must report any 
deviation from the bank's liquidity policy, or failure to meet the 
board's liquidity targets to the board before the end of the quarter if 
such deviation or failure has the potential to cause material loss to 
the bank.
    (b) Liquidity reserve requirement. Each Farm Credit bank must 
maintain at all times a liquidity reserve sufficient to fund at least 
90 days of the principal portion of maturing obligations and other 
borrowings of the bank. At a minimum, each Farm Credit Bank must hold 
instruments in its liquidity reserve listed and discounted in the Table 
below that are sufficient to cover:
    (1) Days 1 through 15 only with Level 1 instruments;
    (2) Days 16 through 30 only with Level 1 and Level 2 instruments; 
and
    (3) Days 31 through 90 with Level 1, Level 2, and Level 3 
instruments.

------------------------------------------------------------------------
                                                      Discount (multiply
     Liquidity level              Instruments                by)
------------------------------------------------------------------------
Level 1..................   Cash, including  100 percent.
                            cash due from traded
                            but not yet settled
                            debt.
                            Overnight money  100 percent.
                            market investments.
                            Obligations of   97 percent.
                            the United States with
                            a final remaining
                            maturity of 3 years or
                            less.
                            Government-      95 percent.
                            sponsored agency senior
                            debt securities that
                            mature within 60 days,
                            excluding securities
                            issued by the Farm
                            Credit System.
                            Diversified      95 percent
                            investment funds
                            comprised exclusively
                            of Level 1 instruments.
Level 2..................   Additional       Discount for each
                            Level 1 investments.      Level 1 investment
                                                      applies.
                            Obligations of   97 percent.
                            the United States with
                            a final remaining
                            maturity of more than 3
                            years.
                            Mortgage-backed  95 percent.
                            securities that are
                            explicitly backed by
                            the full faith and
                            credit of the United
                            States as to the timely
                            repayment of principal
                            and interest.
                            Diversified      95 percent.
                            investment funds
                            comprised exclusively
                            of Levels 1 and 2
                            instruments.
Level 3..................   Additional       Discount for each
                            Level 1 or Level 2        Level 1 or Level 2
                            investments.              investment
                                                      applies.
                            Government-      93 percent for all
                            sponsored agency senior   instruments in
                            debt securities with      Level 3.
                            maturities exceeding 60
                            days, excluding senior
                            debt securities of the
                            Farm Credit System.
                            Government-
                            sponsored agency
                            mortgage-backed
                            securities that the
                            timely repayment of
                            principal and interest
                            are not explicitly
                            backed by the full
                            faith and credit of the
                            United States.
                            Money market
                            instruments maturing
                            within 90 days.
                            Diversified
                            investment funds
                            comprised exclusively
                            of levels 1, 2, and 3
                            instruments.
------------------------------------------------------------------------

     (c) Unencumbered. All investments that a Farm Credit bank holds in 
its liquidity reserve and supplemental liquidity buffer in accordance 
with this section must be unencumbered. For the purpose of this 
section, an investment is unencumbered if it is free of lien, and it is 
not explicitly or implicitly pledged to secure, collateralize, or 
enhance the credit of any transaction. Additionally, an unencumbered 
investment held in the liquidity reserve cannot be used as a hedge 
against interest rate risk if liquidation of that particular investment 
would expose the bank to a material risk of loss.
    (d) Marketable. All investments that a Farm Credit bank holds in 
its liquidity reserve in accordance with this section must be readily 
marketable. For the purposes of this section, an investment is 
marketable if it:
    (1) Can be easily and quickly converted into cash with little or no 
loss in value;
    (2) Exhibits low credit and market risks;
    (3) Has ease and certainty of valuation; and
    (4) Except for money market instruments, can be easily bought and 
sold in active and sizeable markets without significantly affecting 
prices.
    (e) Supplemental liquidity buffer. Each Farm Credit bank must hold 
supplemental liquid assets in excess of the 90-day minimum liquidity 
reserve. The supplemental liquidity buffer must be comprised of cash 
and qualified eligible investments authorized by Sec.  615.5140 of this 
part. A Farm Credit bank must be able to liquidate any qualified 
eligible investment in its supplemental liquidity buffer within the 
liquidity policy timeframe established in the bank's liquidity policy 
at no less than 80 percent of its book value. A Farm Credit bank must 
remove from its supplemental liquidity buffer any investment that has, 
at any time, a market value that is less than 80 percent of its book 
value. Each investment in the supplemental liquidity buffer that has a 
market value of at least 80 percent of its

[[Page 23456]]

book value, but does not qualify for Levels 1, 2, or 3 of the liquidity 
reserve, must be discounted to (multiplied by) 90 percent of its book 
value. The amount of supplemental liquidity that each Farm Credit bank 
holds, at minimum, must meet the requirements of its board's liquidity 
policy, provide excess liquidity beyond the days covered by the 
liquidity reserve, and satisfy the applicable portions of the bank's 
CFP in accordance with paragraph (f).
    (f) Contingency Funding Plan (CFP). The board of each Farm Credit 
bank must adopt a CFP to ensure sources of liquidity are sufficient to 
fund normal operations under a variety of stress events. Such stress 
events include, but are not limited to market disruptions, rapid 
increase in loan demand, unexpected draws on unfunded commitments, 
difficulties in renewing or replacing funding with desired terms and 
structures, requirements to pledge collateral with counterparties, and 
reduced market access. Each Farm Credit bank must maintain an adequate 
level of unencumbered and marketable assets in its liquidity reserve 
that can be converted into cash to meet its net liquidity needs for 30 
days based on estimated cash inflows and outflows under an acute stress 
scenario. The board of directors must review and approve the CFP at 
least once every year and make adjustments to reflect changes in the 
bank's risk profile and market conditions. The CFP must:
    (1) Be customized to the financial condition and liquidity risk 
profile of the bank and the board's liquidity risk tolerance policy.
    (2) Identify funding alternatives that the Farm Credit bank can 
implement whenever access to funding is impeded, which must include, at 
a minimum, arrangements for pledging collateral to secure funding and 
possible initiatives to raise additional capital.
    (3) Require periodic stress testing that analyzes the possible 
effects on the bank's cash inflows and outflows, liquidity position, 
profitability and solvency under a variety of stress scenarios.
    (4) Establish a process for managing events that imperil the bank's 
liquidity, and assign appropriate personnel and implement executable 
action plans that carry out the CFP.

    Dated: April 12, 2013.
Dale L. Aultman,
Secretary, Farm Credit Administration Board.
[FR Doc. 2013-09166 Filed 4-17-13; 8:45 am]
BILLING CODE 6705-01-P