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and Bank Regulation
Bank directors are responsible for their bank’s compliance with banking laws, rules and regulations. All corporations must obey laws and regulations to which they are subject. However, because of their importance in our financial system and the federal bank safety net (deposit insurance and the Federal Reserve discount window), banks are subject to specific laws and regulations. Consequently, many decisions regarding your bank and its operations must take into consideration their implications for the bank’s regulatory compliance. Having a basic understanding of banks and their regulation will help you be a more effective director.What is a Bank?
A bank is a financial intermediary, taking in deposits and lending or investing a portion of those deposits to borrowers, hopefully for a higher interest rate than what is paid on the deposits. That intermediary role poses many risks to banks, risks that the board of directors need to identify, measure, monitor and control.
Also because of that intermediary role, banks play an important role in our nation’s financial system. They are an important source of short-term credit; a storehouse for much of the nation’s wealth, the primary operators of the payment system and the place where final payment for goods and services occurs. Click here for more information on the basic business of banking.
A unique feature of federally regulated banks is that many of their liabilities (deposits) are federally insured. Deposit insurance is provided by the Federal Deposit Insurance Corporation (FDIC).
Although you, as a director, are ultimately responsible for your bank’s regulatory compliance, you do not need to be an expert on bank regulation. Instead, you must ensure that your management team has established the necessary controls and processes to identify, implement and train personnel to comply with these laws and regulations. You should receive periodic reports that verify the bank’s compliance.
The list below highlights some of these laws and regulations, their purposes, and warnings on compliance pitfalls. This basic information will help you spot potential trouble areas that your bank may need to address to ensure its regulatory compliance.
Laws and Regulations of Particular Interest
The Bank Secrecy Act (BSA) (31 U.S.C. 5311 et seq.; 31 CFR Part 103; and Regulation H, 12 CFR 208.62 and 208.63)
Assigns specific responsibilities to banks to know their customers, and to detect and report large cash transactions and suspicious activities. These responsibilities are important to ensure banks are not used as intermediaries for transferring funds obtained from criminal activities. Because of this, you may hear the term anti-money laundering (AML) in the context of BSA.Compliance Reminders
Banks must have a written BSA/AML compliance program that includes these four components:
A Customer Identification Program (CIP) must be included as part of the BSA/AML compliance program.
Prohibits common directors and management officials among unaffiliated institutions in the same community in order to maintain competition among institutions.
There are limits on your service as a director or management official at other unaffiliated financial institutions and bank holding companies, particularly if:
Loans to Executive Officers, Directors and Principal Shareholders, Federal Reserve Regulation O (12 CFR 215)
Prevents bank insiders (directors, management officials, and principal shareholders) from obtaining credit on more favorable terms than other customers of their banks.Compliance Reminders
Combine credit extensions to insiders with those of their immediate family and businesses to make sure that loans to insiders stay within lending limits specified in the regulation.
Ensures safeguarding of nonpublic, personal information that customers provide to the bank.Compliance Reminders
The regulation requires an annual notice to customers describing the bank’s policy on sharing of their information with nonaffiliated third parties.
Transactions with Affiliates, Federal Reserve Act, Sections 23A and 23B (12 U.S.C. 371c and 371c-1) and Regulation W (12 CFR Part 223)
Prevents misuse of bank resources resulting from non-arm’s-length transactions with affiliates.Compliance Reminders
Your bank cannot buy a low-quality asset from an affiliate, except under very limited circumstances.
Implements the Community Reinvestment Act (CRA), which encourages banks to meet the credit needs of their communities, including low- and moderate-income (LMI) neighborhoods.Compliance Reminders
The bank’s most recent Community Reinvestment Act (CRA) rating is public information and must be made available to the public upon request.
Review the bank’s assessment area to make sure it includes all the bank's branches, deposit-taking ATMs and a substantial portion of its loans.
Notice of Change in Directors and Senior Executive Officers, Federal Deposit Insurance Act Notices (12 U.S.C. 1831i(a) and Federal Reserve Regulation Y (12 CFR 225.71 et seq.)
Apprises regulators of senior management changes that may be detrimental to banks in troubled condition.Compliance Reminders
Applies to banks that are deemed to be in troubled condition
Requires a 30-day prior notice for:
Golden Parachutes and Indemnification (12 U.S.C. 1828(k) and 12 CFR 359)
Limits severance payments and indemnification in order to safeguard bank assets; limits rewards to institution-affiliated parties who may have contributed to a bank’s less than satisfactory condition or who may have otherwise harmed the bank.Compliance Reminders
The limitation on indemnification applies to all banks. The limitation on severance payments applies only to banks that are in a troubled condition.
For additional information on golden parachute payments, please see the Federal Reserve Board’s SR 03-6.
Change in Bank Control Act (12 U.S.C. 1817(j)); Bank Holding Company Act (12 U.S.C. 1841, et seq.); and Regulation Y (12 CFR Part 225)
Requires shareholders to receive prior regulatory approval before taking a controlling position in banks and bank holding companies.Compliance Reminders
Stock transactions, such as treasury stock redemptions, may take a shareholder’s ownership over 10 percent of the outstanding shares of the bank or its parent bank holding company, which may require a change in control notification.
Promotes diversification in a bank’s loan portfolio by limiting loans to a single, non-insider borrower. Single borrower includes family members, affiliates and business relationships.
Be cognizant of the bank’s statutory lending limit and its internal lending limits.
Safeguarding Customer Information, Federal Reserve Regulation H (12 CFR 208.3(d)(1))
Requires banks to protect customer information by:
The information security program is to identify internal and external risks associated with information technology systems and activities, ensure the implementation of risk-mitigating controls, and establish periodic tests of key controls, systems and procedures.Compliance Reminders
Periodically test the key controls set out in the bank's information security program.
Prohibits lenders from discriminating against credit applicants, establishes guidelines for gathering and evaluating credit information, and requires written notification when credit is denied.Compliance Reminders
Make credit decisions based on objective information regarding a borrower’s ability to pay, rather than any of the “prohibited bases.”
Implements the National Flood Insurance Act which makes federally backed flood insurance available to owners of improved real estate or manufactured (mobile) homes located in high flood risk areas.Compliance Reminders
Banks may not make, increase, extend or renew a loan on improved property located in a flood hazard area and in a “participating” community, unless the improvements are covered by flood insurance.
Failure to comply may lead to Civil Money Penalties and potential enforcement action.
Truth in Lending, Federal Reserve Regulation Z (12 CFR 226)
Prescribes uniform methods for computing the cost of credit, for disclosing credit terms, and for resolving errors on certain types of credit accounts.Compliance Reminders
Inaccurate disclosure of credit terms, particularly understating the annual percentage rate of interest or the finance charge, can result in reimbursements to the customer.
Reg. Z requires certain pieces of information that must be disclosed to a borrower prior to extending credit:
Banks are specifically defined legal entities that play a unique, vital role in the nation’s financial system. Because of that role, they are subject to an extensive system of supervision and regulation. Ensuring that the bank complies with all applicable laws and regulations is an important dimension to your job as a director.
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