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Upcoming Changes to Regulation W Simplify Compliance for Bankers

Tuesday, April 1, 2003

The Board of Governors of the Federal Reserve System has published a final Regulation W, which takes effect April 1. Regulation W implements sections 23A and 23B of the Federal Reserve Act, imposing limits on transactions between a bank and its affiliates. For the first time, all of the Board's interpretations, staff opinions and comments on those sections have been consolidated into one public document.

Section 23A restricts certain "covered transactions" between a bank and any of its defined affiliates to an amount equal to 10 percent of the bank's capital stock and surplus. The aggregate limit for a bank's transactions with all its affiliates is 20 percent. In addition, Section 23A imposes requirements for collateral on certain transactions, requiring covered transactions—and other exempted transactions—to be on terms "consistent with safe and sound banking practices."

Section 23B requires market terms not only for covered transactions with defined affiliates but also for certain other transactions. (The 23B definition of "affiliates" varies from the 23A definition.)

The original laws were designed to prevent banks from being abused as a funding source for their affiliates. The laws' broad scope, however, often made application somewhat complicated.

The new regulations clarify how the Board will treat a number of transactions of concern and provide exemptions that ease the compliance burden. Four treatments identified as among the most significant are summarized below.

Derivative Transactions: The revised Regulation W:

  • stipulates that derivative transactions between banks and their affiliates be subject to the 23B market terms requirement and
  • requires banks to adopt policies and procedures to manage credit risk resulting from those transactions.

Most derivative transactions, however, will not be subject to the 23A quantitative and collateral limitations.

Intraday Credit: Similarly, under new rules required by Graham-Leach-Bliley, intraday credit extensions from a bank to an affiliate will be subject to 23B market terms requirements; however, these extensions will be exempt from the percentage limits and collateral requirements under 23A, if the bank:

  • adopts policies and procedures to manage the credit exposure that may arise and
  • has no reason to believe that the affiliate would have difficulty repaying the credit according to its terms.

Financial Subsidiaries: Consistent with 23A, the new rule defines a bank's financial subsidiaries as affiliates; therefore, transactions between a bank and its financial subsidiary are subject to 23A and 23B. The rule further defines a financial subsidiary as any subsidiary of a national or state bank that engages (directly or indirectly) in an activity not permissible for a national bank to conduct directly.

Insurance agency subsidiaries of both national and state banks, however, are exempt, so they are not considered affiliates. Subsidiaries of a state bank are exempt if they only engage in activities that either:

  • are permissible for a state bank to conduct directly or
  • were conducted lawfully by a subsidiary before the final rule was implemented.

General Purpose Credit Card Transactions: Under 23A, transactions—including extensions of credit—with non-affiliates of a bank are deemed covered transactions if the proceeds were transferred to or used for the benefit of the bank's affiliate. The new rule includes an exemption where any non-affiliated entity can use a general-purpose credit card issued by a bank to purchase products or services from the issuing bank's affiliate.

Although those extensions of credit meet the 23A standard for covered transactions, they are considered exempt if:

  • the credit card used is widely accepted by merchants not affiliated with the bank and
  • less than 25 percent of purchases (by all cardholders) are with bank affiliates.

To ease the compliance burden, a bank is deemed to meet the 25 percent test if it has no commercial affiliates and has no reason to believe it wouldn't meet the test. A bank with commercial affiliates beyond those authorized by Bank Holding Company Act subsection 4 must either present information to the Federal Reserve Board showing that its card is expected to always comply with the 25 percent test or establish systems to calculate and validate compliance.

For more information, visit the Board of Governors web site.