Regulation W Flashcards
Regulation W protects the bank’s balance sheet from being compromised for the benefit of an affiliate as well as limiting the transfer of its federal subsidy to affiliated companies. Regulation W identifies transactions both subject to and exempt from the regulation and if an institution complies with the quantitative limitations, collateral requirements, and other restrictions or prohibitions outlined in the regulation.
Describe the purpose of Regulation W as well as Sections 23A and 23B of the Federal Reserve Act
to prevent the misuse of a bank’s resources through not at-arm’s-length transactions with its affiliates, as well as limit the ability of a bank to transfer its federal subsidy (derived from its FDIC insurance) to its affiliates
Identify which financial institutions must comply with Regulation W and which entities are considered affiliates
Regulation W applies to all federally insured depository institutions, as well as transactions between U.S. branches and agencies of foreign banks and certain financial affiliates they may own in the United States .
The definition of “affiliate” within Regulation W applies to relationships that might lead a bank to enter into a transaction with another company on terms and conditions that have been compromised due to a direct or indirect relationship. Under the regulation, an affiliate is not an individual and must be an entity such as a company, partnership, limited liability company or business trust.
Describe the types of covered transactions outlined within Regulation W, as well as the quantitative limitations imposed on transactions with each affiliate and with all affiliates as a whole.
1- an advance to an affiliate by means of an overdraft, cash item, or otherwise
2- the sale of federal funds to an affiliate
3- the lease that is the functional equivalent of a loan
4-the purchase of a note or other obligation of an affiliate, including commercial paper or debt securities
5-any change in terms of an extension of credit to an affiliate, such as increasing loan amount or maturity
6-any transaction where an affiliate becomes obligated to pay money to the member bank
Identify what types of covered transactions must be collateralized, the types of eligible collateral, and the relevant collateral margins.
making or renewing a loan, granting a line of credit, or extending credit in any manner whatsoever, including on an intraday basis
eligible collateral -
100% US agency obligations ie GNMA, FHLB, FHA
110% state or policital/municipal bonds
120% debt (ie loan and other receivable), privately issued CMO (collateralized mortgage obligation)
130% - stock, leases, other real or personal property (ie land, improvements & buildings)
Define what a low-quality asset is for purposes of Regulation W and whether an asset transfer complies with provisions of the regulation.
- has been classified or treated as special mention at a recent exam or classified under the bank’s own internal classification system
- that is in non accrual status
- where principal and interest are over 30 days past due
- whose terms have been renegotiated due to the deteriorating financial condition of the borrower
- that has been acquired through foreclosure, repossession or otherwise satisfaction of a debt previously contracted, if the asset has not yet been reviewed in an examination or inspection.
Identify transactions between a bank and its affiliates that are subject to the market terms requirements of Regulation W.
If the bank would have entered the transaction with anyone outside of the organization—and the bank is not disadvantaged financially—the transaction is considered an arms-length transaction, even if the transaction is with an affiliate.
Describe advertising practices and guarantees that are prohibited by Regulation W and Section 23B of the Federal Reserve Act.
Section 223.54 generally prohibits a bank or a bank affiliate from publishing an advertisement or entering into an agreement that suggests or guarantees that the bank is in any way responsible for the affiliates’ obligations.
Describe the purpose of Regulation W and Sections 23A and 23B of the Federal Reserve Act.
These provisions attempt to prevent the misuse of a bank’s resources through non-arm’s length transactions with its affiliates, as well as limit the ability of a bank to transfer the benefits of being an FDIC-insured
financial institution to affiliates.
Section 23A- limits and collateral
Section 23A was intended to limit covered transactions between a member bank and its affiliate to 10 percent of the bank’s capital stock and surplus as well as to limit aggregate covered transactions between a member bank and all of its “affiliates” to 20 percent of the member bank’s capital stock and surplus. In addition, Section 23A requires all credit-like covered transactions to be collateralized
Section 23B - arms length and market term
Section 23B complements Section 23A by ensuring that transactions between banks and their affiliates are arm’s length and at fair market value. The primary purpose is to prevent banks from using low-cost FDIC-insured deposits to provide preferential funding to affiliates, which would provide them with a competitive advantage over competitors not affiliated with banks. Preferential funding relationships have also lead to unsafe and unsound lending practices as banks relax their normal credit criteria to support affiliate
Identify which financial institutions must comply with Regulation W.
- National and State Member Banks (Fed members, but not FDIC insured trusts)
- FDIC-Insured State Nonmember Banks
- FDIC-Insured Savings Associations
- U.S. Branches and Agencies of Foreign Banks
A sister bank exemption occurs with transactions between affiliated banks when the parent company owns at least 80 percent or more of the shares of each bank, or when one bank owns at least 80 percent of the other bank’s shares. A sister bank exemption is limited to FDIC-insured banks and thrifts.
Identify whether an entity is considered an affiliate for purposes of Regulation W.
The “affiliate” concept within Regulation W captures those relationships that might lead a bank to enter into a transaction with another entity on terms and conditions that have been compromised due to a direct or indirect
relationship. In other words, the regulation applies to situations where a bank’s transaction with another entity might not be on an at-arms-length basis. Under the regulation, an “affiliate” must be a corporation, partnership, limited liability company, business trust or similar entity. A natural person or sole proprietorship is not considered an “affiliate” and, as such, transactions with them are not subject to the regulation. An exception to this latter situation occurs, however, if the transaction in some fashion benefits an affiliate, which is referred to as the “attribution rule.”
Define “control” for purposes of Regulation W and determine whether control exists.
A company that directly or indirectly owns, controls or votes at least 25 percent of any class of voting securities of another company, or a shareholder that directly or indirectly (acting through one or more other persons) controls at least 25 percent of a class of voting securities of a company.
It is important to note that ownership or control of shares in a fiduciary capacity does not constitute control, unless
the shares are held by a company controlled by a trust for the benefit of shareholders that also control a bank, or if
the company owning or controlling the shares is a business trust.
List companies that are exempt from the definition of “affiliate”.
For purposes of Section 23B, the term affiliate, as defined in Section 23A, excludes banks; therefore, transactions between sister banks and banks that are part of a chain banking organization are technically exempt.
Describe steps that a bank can take to identify and manage affiliate relationships.
it is necessary for each bank to prepare and update—at least annually or when changes occur—a list of companies that meet the definition of “affiliate.” To accurately prepare this list, management should ensure that all executive officers, directors and significant shareholders of the bank and its affiliates disclose information about their affiliations. This information should include their titles and stock ownership positions in other companies as well as their ability to control other companies through other means (i.e., power-of-attorney documents, trust agreements, etc.).
List the types of covered transactions that are outlined in Regulation W.
- extension of credit - overdrafts/ term loans, revolving lines of credit, and standby letter of credit
- asset purchase - securities and loans
- investment in a secuirty issued by an affiliate - investment in financial subsidiary / residual overnight positions in affiliated mutual funds related to sweep accounts
- acceptance of a security issued by an affiliate as collateral for a loan to a 3rd party
- loans secured by stock of the parent bank holding company
Define an extension of credit for purposes of Regulation W.
overdraft
term loans, revolving lines of credit and standby letters of credit
Describe the quantitative limitations on covered transactions that are imposed on each affiliate and on all affiliates as a whole.
single non-financial 10%
single financial 20%
all affiliates - 20%
Explain the attribution rule
Without this rule, it would be easy to evade the regulation’s requirements by running a transaction through a third party.
Explain the safety and soundness requirement
Even if transactions are structured in a manner fully consistent with the requirements of the regulation, examiners can still criticize the transactions if they are abusive, involve undue transfer of risk or circumvent the purpose of the regulation.
Identify and explain the different types of exemptions that are available under Regulation W.
- Sister bank exemption - transactions between 2 or more insured depository institutions that are at least 80% owned by the same parent company are exempt
- Purchase of loans on a non-recourse basis
- Internal corporate reorganizations
- Correspondent deposits
- Uncollected items
- Transactions secured by cash or US govt securities
- Purchase of an asset with a readily identifiable market quotation
- Purchase of securities with a ready market from a securities affiliate
- Purchase of municipal securities
- Purchase of loans
- Purchase of assets by newly formed banks
- Transactions approved under the Bank Merger Act
- Intraday extensions of Credit
- Riskless principal transactions
Describe the valuation and timing restrictions for covered transactions.
-A credit transaction with an affiliate must be valued based on the maximum amount of indebtedness that
could occur under the terms of the credit agreement.
-Asset purchases are generally valued based on the total amount of consideration provided, including any
liabilities that are assumed.
-The purchase of securities issued by an affiliate should be valued at the greater of the bank’s purchase price
or the carrying value of the securities.
-A loan to a third party that is secured by affiliate securities is valued at the lesser of the amount of the loan or the fair market value of the affiliate securities.
Explain the regulatory reporting requirements for Regulation W.
the FR Y-8 report as a means to track covered transaction volume within an organization. The report is titled “The Bank Holding Company Report of Insured Depository Institutions’ Section 23A Transactions with Affiliates.
Describe what types of transactions must be collateralized.
All credit transactions between a bank and its affiliate must be collateralized. The amount of collateral required depends upon the quality of collateral used to secure the transaction.
100% -Safe assets
110% - general obligation bonds like municipal revenue bonds and industrial revenue bonds
120% - FHA loans would be treated as debt instruments subject to the 120% category instead of the 100% category.
- when such CMOs are pledged to secure a loan to an
affiliate, the market value must equal at least 120% of the amount of the loan
130% - stock leases, or other real or personal property, such as land, improvements and bldgs
Provide example of pledge assets before granting a $120,000 loan
100% US treasury obligations and Time deposits - all $120M
120% consumer loans - need to pledge 144M of loans (120% of 120M)
130% real estate and leasehold improvements - 130% of 120 = 156M of appraised value of real estate
130% stocks - current mkt value in = 130% of 120M = stocks of 156M current market value.
Explain the purpose of Regulation W and Section 23B of the Federal Reserve Act.
As with Section 23A, Section 23B is designed to reduce a bank’s exposure to loss from affiliate relationships and to prevent a bank from being financially disadvantaged through its transactions with affiliated organizations
Describe who is an affiliate for the purpose of Regulation W and Section 23B of the Federal Reserve Act.
For purposes of Section 23B, the term affiliate, as defined in Section 23A, excludes banks; therefore, transactions between sister banks and banks that are part of a chain banking organization are technically exempt.
Identify transactions that are conducted on a market term basis
Subpart F of Regulation W (Section 23B) generally requires that transactions between affiliates be on comparable terms and conditions as transactions with non-affiliates. Section 223.51 requires that a bank’s transactions with a covered affiliate be on terms and under circumstances that are substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with nonaffiliated companies
Identify transactions that are conducted at arms’ length.
When comparable terms or conditions are not readily identifiable, the standard is whether the bank in good faith
would have made those transactions with non-affiliated companies. If the bank would have entered the transaction with anyone outside of the organization, and if the bank is not disadvantaged financially, the transaction is considered an arms-length transaction, even if the transaction is with an affiliate.
List common types of transactions that must comply with the market terms requirement of Regulation W and Section 23B of the Federal Reserve Act.
- Asset Sales to affiliates
- Management and inter company service fees and revenue sharing agreements
- Agent or broker fees
- Transactions with 3rd parties
- Tax sharing agreements
- Split dollar life insurance
Assess whether an affiliate asset transfer meets the low-quality asset transfer standards of Regulation W
There is an exemption from the overall prohibition on the purchase of low-quality assets in situations where the bank has participated in a loan originated by an affiliate that has since become low-quality
Is the bank in compliance with Reg W?
Yes, as the subsidiary banks are getting a better deal on the services than nonaffiliates (which would likely be construed as the market rate)
Regulation W does not require that affiliates pay the same amount as nonaffiliates, only that the affiliated banks get at least as favorable a rate as the nonaffiliates. In this case, the fact that the bank affiliates are getting a better deal is not a problem
