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New Regulation Addresses Banks’ Transactions with AffiliatesBy James T. Bork, J.D., LL.M., editor, CCH BANKING COMPLIANCE LIBRARY. Bork has practiced banking law and served as in-house bank counsel. He also has written articles and spoken on bank regulatory and compliance issues.On April 1, 2003, the Federal Reserve’s new Regulation W took effect. That regulation places limits on banks’ transactions with affiliates (TWAs). The regulation, codified at 12 CFR Part 223, also replaces the Fed’s existing interpretations of Federal Reserve Act sections 23A and 23B.Although Reg. W does not, by its express terms, apply to insured nonmember banks, other federal laws subject insured nonmember banks and insured thrifts to sections 23A and 23B to the same extent as if they were member banks. Also, the Fed has noted that insured nonmember banks must comply with Reg. W and may take advantage of its exemptions. Federal Reserve Act sections 23A and 23B and the interpretations have been around for years, and most compliance professionals should therefore be aware of the basic provisions of Reg. W. This article, therefore, constitutes a review for some readers and a reminder for others. OVERVIEW OF REG. W The TWAs that Reg. W focuses on are “covered transactions,” a term that is carried forward intact from section 23A. The most general statement of the new rule is that all covered transactions must be on terms and conditions that are consistent with safe and sound banking practices. As with all regulations, though, it’s the details that count. LimitsRegulation W limits a bank’s covered transactions with any one affiliate to no more than 10 percent of the bank’s capital stock and surplus. The total of the bank’s covered transactions with all affiliates may not exceed 20 percent of the bank’s capital stock and surplus. The final rule also allows for certain exceptions to these limits.Credit transactions between banks and their affiliates must be adequately secured, with the amount of the security being determined by the nature of the collateral. The rule also restricts a bank’s ability to purchase low-quality assets from an affiliate. Effect of the GLB ActThe Gramm-Leach-Bliley Act expanded the range of affiliations permitted to financial institutions. Under the regulatory framework contemplated by GLB, therefore, the need to protect institutions from losses in TWAs has increased and sections 23A and 23B have taken on added importance. This is especially true in light of the Fed’s recent warning that “[r]eviews for compliance with the affiliate transaction rules should be frequent and rigorous, and any violations or potential violations should be resolved quickly.”REG. W COMPLIANCE Much of Reg. W compliance should be handled by a bank’s accounting department or by other personnel who report to the chief financial officer. Experience shows, however, that compliance professionals and internal audit staff often have continuing responsibility—either direct or residual—for monitoring these aspects of a bank’s regulatory compliance. Following are some aspects of the new rule that the Fed has clarified. Financial SubsidiariesFor purposes of Reg. W, a bank’s financial subsidiaries are included as affiliates of the bank. Thus, under the final rule, transactions between a bank and its financial subsidiary, as well as other affiliates, are subject to the requirements of sections 23A and 23B. Reg. W defines “financial subsidiary” in a manner consistent with the definition of that term in the GLB Act.In addition, certain transactions between an affiliate and a financial subsidiary of the same bank are subject to sections 23A and 23B. Any purchase of, or investment in, the securities of a financial subsidiary of a bank by an affiliate of the bank is treated as a direct purchase or investment by the bank. Also, an extension of credit by a bank’s affiliate to one of its financial subsidiaries is treated as an extension of credit by the bank if the extension of credit is treated as regulatory capital of the financial subsidiary. Limited Credit Card ExemptionRegulation W generally exempts from section 23A extensions of credit by a bank under a general purpose credit card where the borrower uses the credit to purchase goods or services from an affiliate of the bank. For purposes of this exemption, a general purpose credit card is a credit card issued by a bank that is widely accepted by merchants (such as Visa or Mastercard) as long as less than 25 percent of the aggregate amount of purchases with the card are purchases from an affiliate of the bank.Section 250.250 ExemptionFor almost 30 years, a bank’s purchase of loans from an affiliate has not been subject to section 23A if the bank makes an independent evaluation of the creditworthiness of the borrower before the affiliate makes the loan and the bank commits to purchase the loan prior to the affiliate’s making the loan. This exemption arises under 12 CFR §250.250, and it is named for that section.In 1995, Fed staff opined that this exemption was not available to any bank whose loan purchases from an affiliate represented more than 50 percent of the loans made by that affiliate. Regulation W retains the 50-percent test but allows a bank’s primary federal regulator to reduce the 50-percent threshold if that would be appropriate to protect the safety and soundness of the bank. The Fed sought comments on a proposed rule that would limit a bank’s purchases of extensions of credit from an affiliate under this exemption to 100 percent of the bank’s capital stock and surplus. The comment period closed earlier this year. |