Federal Reserve System

1 Friday,May 11, 2001 Part IIFederal ReserveSystem12 CFR Parts 223 and 250 Transactions Between Banks and TheirAffiliates; Proposed RuleApplicability of Section 23A of theFederal Reserve Act to the Purchase ofSecurities From Certain Affiliates; FinalRule Loans and Extensions of CreditMade by a Member Bank to a ThirdParty; Final RuleApplication of Sections 23A and 23B ofthe Federal Reserve Act to DerivativeTransactions With Affiliates and IntradayExtensions of Credit to Affiliates; InterimRuleVerDate 11<MAY>2000 13:11 May 10, 2001 Jkt 194001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\ pfrm08 PsN: 11 MYP224186 Federal Register/ Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules112 371c(f), 371c 1(e).2 Pub. L. No. 106 102, 113 Stat. 1338 (1999).3 See 63 FR 32766, June 16, 1998; 62 FR 37744,July 15, Reserve SYSTEM12 CFR Part 223[Regulation W; Docket No. R 1103]Transactions Between Banks and TheirAffiliatesAGENCY: Board of Governors of theFederal Reserve : Notice of proposed : The Board of Governors of theFederal Reserve System (Board) isproposing a new rule (Regulation W) toimplement comprehensively sections23A and 23B of the Federal Reserve proposed rule would combinestatutory restrictions on transactionsbetween a bank and its affiliates withnumerous existing and proposed Boardinterpretations and exemptions in aneffort to simplify compliance withsections 23A and : Comments must be submitted onor before August 15, : Comments should refer toDocket No.

2 R 1103 and should be sentto Ms. Jennifer J. Johnson, Secretary,Board of Governors of the FederalReserve System , 20th Street andConstitution Avenue, NW., Washington,DC 20551 (or mailed electronically addressed to Ms. Johnsonalso may be delivered to the Board smail room between the hours of 8 and 5:15 weekdays and,outside of those hours, to the Board ssecurity control room. Both the mailroom and the security control room areaccessible from the Eccles Buildingcourtyard entrance, located on 20thStreet, NW., between ConstitutionAvenue and C Street, NW. Members ofthe public may inspect comments inRoom MP 500 of the Martin Buildingbetween 9 and 5 weekdays,except as provided in section ofthe Board s Rules Regarding Availabilityof Information (12 CFR ).FOR FURTHER INFORMATION CONTACT:Pamela G. Nardolilli, Senior Counsel(202/452 3289), or Mark E. Van DerWeide, Counsel (202/452 2263), LegalDivision; or Michael G. Martinson,Associate Director (202/452 3640), orMolly S. Wassom, Associate Director(202/452 2305), Division of BankingSupervision and Regulation; Board ofGovernors of the Federal ReserveSystem, 20th Street and ConstitutionAvenue, NW.)

3 , Washington, DC INFORMATION:IntroductionSections 23A and 23B of the FederalReserve Act are two of the mostimportant statutory protections against abank suffering losses because of itstransactions with affiliates and,correspondingly, are two of the mosteffective means of limiting the ability ofa bank to transfer to its affiliates thesubsidy arising from the bank s access tothe Federal safety net. Althoughsections 23A and 23B of the FederalReserve Act each explicitly grant theBoard broad authority to issueregulations to administer the section,1the Board has never issued a regulationfully implementing either , banks seeking guidance on howto comply with sections 23A and 23 Bhave relied on a series of Boardinterpretations and informal staffguidance. Banks have increasinglysought guidance from the Board onsection 23A issues in recent years as aresult of the increasing scope ofactivities conducted by modernfinancial holding companies and thegrowing complexities of the Board now believes that adoptionof a comprehensive regulationimplementing sections 23A and 23 Bwould be appropriate for severalreasons.

4 First, the new regulatoryframework established by the Gramm-Leach-Bliley Act ( GLB Act )2emphasizes the importance of sections23A and 23B as a means to protectbanks from losses in connection withthe newly authorized affiliates underthe GLB Act. In addition, the GLB Actamended section 23A in severalimportant respects and requires theBoard to address by rule under section23A the credit exposure arising fromderivative transactions and intradaycredit , the Board believes thatadoption of a comprehensive regulationwould simplify the interpretation andapplication of sections 23A and 23B,ensure that the statute is consistentlyinterpreted and applied, and minimizeburden to the extent consistent with thestatute s goals. Finally, issuing aproposed regulation would allow thepublic an opportunity to comment onBoard and staff interpretations ofsections 23A and 23B, many of whichwere adopted without the benefit of apublic comment proposed regulation wouldsupersede outdated Board and staffinterpretations concerning sections 23 Aand 23B and would incorporate otherexisting interpretations.

5 In addition, theregulation would incorporate the resultsof the Board s earlier proposals to clarifythe scope of the attribution rule, expandthe section 23A(d)(6) exemption forpurchases of readily marketable assets,and, consistent with the GLB Act,extend the coverage of section 23A tosubsidiaries of a bank engaged inactivities that the bank cannot , the proposedregulation would answer questions thathave arisen frequently in the Board sadministration of the statutoryprovisions and in their enforcement byeach of the Federal banking Board emphasizes that RegulationW is a proposed rule and expects tomake changes to the rule to reflectpublic comments as appropriate. UntilRegulation W is finalized, all previouslyissued valid Board interpretations andstaff opinions regarding sections 23 Aand 23B will remain in full force andeffect. After the Board issues theregulation in final form, any Boardinterpretations or staff opinions on thestatute that are inconsistent with theregulation will be deemed supersededby the noted above, sections 23A and 23 Bof the Federal Reserve Act are designedto limit the risks to a bank (and theFederal deposit insurance funds) fromtransactions between the bank and itsaffiliates and to limit the ability of abank to transfer to its affiliates thesubsidy arising from the bank s access tothe Federal safety net.

6 Section 23 Aachieves these goals in three majorways. First, it limits a bank s coveredtransactions with any single affiliate to no more than 10 percent of the bank scapital and surplus, and transactionswith all affiliates combined to no morethan 20 percent of capital and surplus. Covered transactions includepurchases of assets from an affiliate,extensions of credit to an affiliate,investments in securities issued by anaffiliate, guarantees on behalf of anaffiliate, and certain other transactionsthat expose the bank to an affiliate scredit or investment risk. A bank s affiliates include, among othercompanies, any companies that controlthe bank, any companies under commoncontrol with the bank, and certaininvestment funds that are advised by thebank or an affiliate of the , the statute requires alltransactions between a bank and itsaffiliates to be on terms and conditionsthat are consistent with safe and soundbanking practices, and prohibits a bankfrom purchasing low-quality assets fromits affiliates.

7 Finally, the statute requiresthat a bank s extensions of credit toVerDate 11<MAY>2000 16:12 May 10, 2001 Jkt 194001 PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 E:\FR\FM\ pfrm02 PsN: 11 MYP224187 Federal Register/ Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules4 Garn-St Germain Depository Institutions Act of1982, Pub. L. No. 97 320, 410, 96 Stat. 1515(1982) (codified at 12 371c).5 Pub. L. No. 89 485, 12(c), 80 Stat. 242 (1966)(codified at 12 1828(j)).6 Financial Institutions Reform, Recovery, andEnforcement Act of 1989, Pub. L. No. 101 73, 301,103 Stat. 342 (1989) (codified at 12 1468)( FIRREA ).7 Pub. L. No. 100 86, 102, 101 Stat. 552, 564(1987) (codified at 12 371c 1).8 Section 23A excludes from the definition of affiliate most subsidiaries of a bank. See 371c(b)(2)(A).9 See 12 24a, 1464(c)(4)(B), and 1831a; 12 CFR and FR 37744, July 15, 12 transactions between a bank and anyof its financial subsidiaries would count toward thebank s 20 percent limit for covered transactionswith all affiliates in the Act section 121(e)(3) (codified at 12 (f)(3)).

8 Affiliates and guarantees on behalf ofaffiliates be appropriately secured by astatutorily defined amount of 23B protects a bank byrequiring that certain transactionsbetween the bank and its affiliates occuron market terms; that is, on terms andunder circumstances that aresubstantially the same, or at least asfavorable to the bank, as thoseprevailing at the time for comparabletransactions with unaffiliatedcompanies. Section 23B applies thisrestriction to any covered transaction (asdefined in section 23A) with an affiliateas well as certain other transactions,such as the sale of securities or otherassets to an affiliate and the payment ofmoney or furnishing of services to 23A originally was enacted aspart of the Banking Act of 1933 andapplied only to banks that weremembers of the Federal Reserve System ( member banks ). Since 1933,Congress has amended the statuteseveral times, including acomprehensive revision in also amended the FederalDeposit Insurance Act in 1966 to extendsection 23A to cover insurednonmember 1989, Congressfurther extended the coverage of section23A to insured savings enacted section 23B of theFederal Reserve Act as part of theCompetitive Equality Banking Act of1987,7and has subsequently expandedits scope to cover the same set ofdepository institutions as are covered bysection 23A.

9 Consequently, sections23A and 23B now apply to all insureddepository institutions and uninsuredmember part of its comprehensive revisionof section 23A in 1982, Congressamended the statute to exempttransactions between a bank and 1982, a subsidiary of abank generally was permitted to engageonly in activities that its parent bankcould conduct. Since 1982, however,some subsidiaries of banks have begunto engage in activities impermissible tothe banks 1997, toaddress these subsidiaries, the Boardissued for comment a proposal to extendsections 23A and 23B to transactionsbetween a bank and a subsidiary of thebank engaged in activities notpermissible for the bank to engage with thisproposal, the GLB Act recently amendedthe Federal Reserve Act so that sections23A and 23B would apply totransactions between a bank and its financial subsidiaries. Section 23A, asamended by the GLB Act, defines afinancial subsidiary as any subsidiary ofa bank that would be a financialsubsidiary of a national bank undersection 5136A of the Revised Statutes ofthe United statutoryprovision defines a financial subsidiaryof a national bank as a subsidiary of aninsured depository institution thatengages in activities that are notpermissible for a national bank toengage in directly (unless a nationalbank is authorized by the express termsof a Federal statute (other than the GLBAct) to own or control the subsidiary).

10 The GLB Act provides that a financialsubsidiary of a bank is considered an affiliate of the bank for purposes ofsections 23A and 23B and requires, withcertain limited exceptions, that anycovered transactions between a bankand its financial subsidiaries complywith the same quantitative, collateral,and other restrictions imposed bysections 23A and 23B on other GLB Act also establishes certainspecial rules for financial example, the GLB Act extends therestrictions of sections 23A and 23B toinvestments by a bank s affiliate insecurities issued by any financialsubsidiary of the bank. The GLB Actalso authorizes the Board to extendsections 23A and 23B to loans and otherextensions of credit made by a bank sother affiliates to any financialsubsidiary of the bank, if the Boarddetermines that such action is necessaryor appropriate to prevent evasions of theFederal Reserve Act or the GLB , the GLB Act provides that the10 percent restriction on coveredtransactions with any individualaffiliate does not apply to transactionsbetween a bank and any individualfinancial subsidiary of the regulation addresses theseprovisions of the GLB addition, the GLB Act requires theBoard to adopt, by May 12, 2001, finalrules to address as a covered transactionthe credit exposure arising out ofderivative transactions between banksand their affiliates and intradayextensions of credit by banks to with proposedRegulation W, the Board is issuinginterim final rules that address thesecredit exposures to affiliates as coveredtransactions under section 23A.