US Federal Reserve board releases more guidance on key banking regulations

On December 30, 2021, the Board of Governors of the Federal Reserve System (“Board”) published additional answers to frequently asked questions (“FAQs”) about its Regulations H, O, W, and Y.1 Those regulations govern Federal Reserve System membership, extensions of credit to bank insiders, transactions with affiliates, and bank holding companies and change in control, respectively. The FAQs also addressed questions regarding the regulatory treatment of covered savings associations (“CSAs”) and their parent entities.

The FAQs are part of transparency initiative that was spearheaded by former Federal Reserve Vice Chair Randy Quarles and build on the significant body of guidance that was released in March 2021. (Please see our earlier Legal Update on the Board’s release of guidance in March.)

In this Legal Update, we summarize the FAQs with a particular focus on the effect their release may have on the industry’s understanding of the restrictions on affiliate transactions and implications of using the CSA regime.

Overview

The FAQs address Regulations H (five new answers), O (one new answer), W (34 new answers), and Y (nine new answers) and the CSA regime (29 answers). Some of the FAQs address highly fact-specific circumstances, such as the notice requirement for closing a seasonal branch or the operation of the sister-bank exemption. Other FAQs restate general principles of the regulation, such as the application of the restrictions on affiliate transactions to banks that are directly controlled by natural persons. However, many of the FAQs clarify items that are not apparent from the plain text of the regulation or had been understood only through agency discussions.

Regulation H – Membership of State Banking Institutions in the Federal Reserve System

The FAQs on Regulation H primarily address filing requirements for branches of state member banks. One FAQ also addresses when a state member bank is allowed to rely on the authority to make public welfare investments to invest in housing projects consisting of multiple buildings.

Potentially the most significant FAQ on Regulation H addresses a state member bank’s authority to acquire debt obligations under its lending authority. State member banks must comply with limitations under the Federal Reserve Act when purchasing, selling, underwriting, and holding investment securities. The FAQ states that the Board will not apply these limitations if a state member bank’s acquisition is an exercise of its lending authority under state law and would be an exercise of lending authority for a similarly situated national bank. In particular, the FAQ indicates that Board staff will look to interpretations issued by the staff of the Office of the Comptroller of the Currency (“OCC”) to understand the lending authority of national banks. More importantly, the FAQ states that Board staff will consider the circumstance at the time the bank acquired the obligation and will not permit banks to recharacterize past purchases of investment securities as exercises of the bank’s general lending powers.

Regulation O – Loans to Executive Officers, Directors and Principal Shareholders

The FAQ on Regulation O clarifies circumstances in which a member bank may offer discounts or preferential terms on loans to insiders. Specifically, it states that a member bank may extend credit to an insider as part of a benefit or compensation program that (i) is widely available to employees of the member bank and (ii) does not give preference to any insider of the member bank over other employees of the member bank. However, a member bank is prohibited from extending credit to an insider that is not made on substantially the same terms as, or is made without following credit underwriting procedures that are at least as stringent as, comparable transactions with persons that are non-insiders and not employees of the bank.

Regulation W – Transactions Between Banks and Their Affiliates

The FAQs on Regulation W focus on the attribution rule, sister-bank exemption, and valuation issues. As with the March 2021 guidance, some of the FAQs express positions of Board staff that are more akin to a rule than supervisory guidance. Among the more significant points of clarification are:

  1. The attribution rule should not apply to a series of transactions if the initial transaction involving the bank qualifies for an exemption.
  2. The Board should not apply the attribution rule if the bank did not know or have reason to know at the time of the transaction that the proceeds of the transaction may be used for the benefit of, or transferred to, an affiliate. This knowledge qualifier is conditioned on the bank maintaining a reasonable Regulation W compliance program.
  3. Extensions of credit to employees and insiders of affiliates typically should not be attributed to the affiliate.
  4. Floor-plan financing by a nonbank affiliate can create an attributed extension of credit when the bank extends credit to a third party to purchase a good from the floor-plan borrower.
  5. Regulation W applies to asset purchases at the time the bank commits or becomes legally obligated to purchase the asset from the affiliate.
  6. Loan renewals may terminate the attribution of a purchased loan, but refinancings and restructurings prior to maturity will not.
  7. Non-cash dividends, such as shares of an operating subsidiary, may create covered transaction issues.
  8. The meaning of “item” for purposes of the exemption for giving credit for uncollected items is generally limited to items as defined in Regulation J.
  9. Non-US dollar deposits may not be used as cash collateral.
  10. Cash collateral cannot be used to reduce the amount of a covered asset purchase transaction, but cash contributions from the affiliate should reduce the amount.

Regulation Y – Bank Holding Companies and Change in Bank Control

The FAQs on Regulation Y focus on anti-tying, control, and complementary authority issues. Notably, one of the FAQs seems to confirm the longstanding belief that the industry generally may rely on positions taken in the 2003 Anti-Tying Act proposal (e.g., what is a traditional banking product) even though it was never finalized.2

The FAQs also state that a financial holding company with physical commodity trading authority may not make or take physical delivery of a specific physical commodity solely on the basis that the commodity has swaps that are eligible to be traded on a swap execution facility because the relevant approval orders only address futures or options on futures that are authorized for trading on a US futures exchange.

Regulation of CSAs

Section 206 of the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act allows federal savings associations (“FSAs”) to elect to operate as CSAs.3 A CSA has the same rights and duties as a national bank that has its main office situated in the same location as the home office of the CSA but retains its FSA charter and is treated as an FSA for governance purposes. The OCC is the primary federal regulator of CSAs and adopted rules implementing Section 206 in 2019.4

The Board is the primary federal regulator of bank and savings and loan holding companies and regulates aspects of the operations of banks and savings associations. The Board has not adopted rules that implement Section 206, but the FAQs state how the Board construes the portions of the CSA regime that are within its remit.

The key points from the FAQs on the CSA regime are:

  1. A savings and loan holding company (“SLHC”) that controls a CSA is treated as a bank holding company (“BHC”), except for the governance purposes enumerated in Section 206, and does not need to register with the Board as a BHC. The exception would be for an SLHC that is not a “company” for purposes of the Bank Holding Company Act and, therefore, would remain supervised as an SLHC only for the enumerated governance purposes.
  2. A CSA must become a member of the Federal Reserve System. This requires the CSA to purchase stock of the appropriate Federal Reserve Bank.
  3. A company that already controls a CSA must file a FR Y-10 with the Board to report the CSA’s election and comply with any other Board reporting requirements for BHCs. A CSA must submit Form FR 2030a to the appropriate Federal Reserve Bank for the required stock purchase under the Federal Reserve Act and comply with any other Board reporting requirements for national banks. A company acquiring control of a CSA or a company that controls a CSA must submit an application to the Board under Section 3 of the Bank Holding Company Act.
  4. A company that controls a CSA may engage only in activities that are permissible for a BHC. A grandfathered unitary SLHC permanently loses its grandfathered rights following a CSA election.
  5. A CSA must continue to provide notice to the Board prior to declaring a dividend.

Conclusion

The publication of these and prior FAQs by the Board staff brings greater transparency to its historical guidance on the Board regulations to stakeholders who lack back-channel sources of communication with staff. However, because the use of supervisory guidance to establish new legal requirements raises concerns regarding the administrative rulemaking process, the Board staff was careful to note that the FAQs are staff interpretations and have not been approved by the Board, except as otherwise noted. Thus, banking organizations should recognize that while the FAQs are helpful in assessing their compliance requirements, they are not legally binding on the Board.

With respect to the FAQs related to Regulations H, O, W, and Y, the Board has indicated that it intends to propose amendments to the underlying regulations. Given the obligations imposed on institutions by several of those FAQs, such rulemakings may be needed to avoid due process and Administrative Procedures Act concerns. However, the Board is not doing the same for the FAQs for CSA, which impose significant requirements on CSAs and companies that control CSAs, including the divestiture of BHC-impermissible activities. It is unclear why the Board did not previously undertake, and apparently is not now contemplating undertaking, a rulemaking to implement Section 206 of the Economic Growth, Regulatory Relief, and Consumer Protection Act.

Lastly, it remains to be seen how much of the transparency initiative will outlive Governor Quarles’ time on the Board. While the expected rulemakings on Regulations H, K, O, W, and Y hopefully are far enough along to be issued in the coming months, the arrival later this year of a new vice chair for supervision and potentially up to three new governors to the Board may cause the Board to divert staff resources to other priorities and limit future releases of FAQs.

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