Intercompany Transactions Section 2020

1 Intercompany S IN THIS SECTIONT hissection was revised as of January 2008 toincorporate references to the Federal ReserveBoard s Regulation W, primarily with regard tothe bank holding company (BHC) inspectionprocess. The Section includes also a discussionof the mandatory reporting of certain intercom-pany Transactions on the FR Y-8,The BankHolding Company Report of Insured DepositoryInstitutions Section 23A Transactions withAffiliates,and its instructions. The mandatoryreport is to be submitted quarterly to the Fed-eral Reserve by (1) all top-tier BHCs, includingfinancial holding companies, and (2) all foreignbanking organizations that directly own a bank. The examiner s inspectionresponsibilities are ANALYSIS OFINTERCOMPANY TRANSACTIONSThe analysis of Intercompany transactionsbetween a parent company, its nonbank sub-sidiaries, and its bank subsidiaries is primarilyintended to assess the nature of the relation-ships between these entities and the effect of therelationships on the subsidiary insured deposi-tory institutions (IDIs).

2 IDIs include any statebank, national bank, trust company, or bankingassociation and any institution that takes depos-its that are insured by the Federal Deposit Insur-ance Corporation, including savings associa-tions. Both the legal and financial ramificationsof such Transactions are areas of Intercompany Transactions are subject tothe provisions of Section 23A or 23B (or both)of the Federal Reserve Act and the FederalReserve Board s Regulation W. Section 23A ofthe Federal Reserve Act is one of the mostimportant statutes on limiting exposures toindividual institutions and protecting the fed-eral safety net. Several types of intercompanytransactions and the primary regulatoryconcerns of each are presented paid by subsidiaries to the are a highly visible cash outflow bysubsidiaries. If the dividend payout ratioexceeds the level at which the growth ofretained earnings can keep pace with the growthof assets, the subsidiary s capital ratios willdeteriorate.

3 These dividends may also have anegative effect on the subsidiary s with affiliates. Transactionsbetween subsidiary IDI affiliates is another areaof potential abuse of subsidiary banks. Regula-tory concern centers on the quantitative limitsand collateral restrictions on certain transactionsby subsidiary banks with their affiliates. Theserestrictions are designed to protect subsidiaryIDIs from losses resulting from transactionswith paid by or ser-vice fees are another cash outflow of banksubsidiaries. These fees may be paid to theparent, the nonbank subsidiaries, or, in somecases, to the other bank subsidiaries. Regulatoryconcern focuses on whether such fees are rea-sonable in relation to the services rendered andon the financial impact of the fees on the a bank holding companyorganization determines to allocate taxes amongits component companies involves questions ofboth the magnitude and timing of the cash-floweffects.

4 Unreasonable or untimely tax paymentsor refunds to the bank can have an adverseeffect on the financial condition of the or swaps of purchasesor swaps between a bank and its affiliates cancreate the potential for abuse of subsidiarybanks. Regulatory concern focuses on the fair-ness of such asset Transactions and their finan-cial impact and timing. Fairness and financialconsiderations include the quality and collect-ibility and fair values of such assets and theirliquidity effects. IDIs generally are prohibitedfrom purchasing low-quality assets from affili-ates. Asset exchanges may be a mechanism toavoid regulations designed to protect subsidiarybanks from becoming overburdened with non-earning assets. Improper timing or certain struc-turings of asset Transactions also can cause themto be regarded as extensions of credit to affili-ates.

5 As such, these types of Transactions couldpotentially violate applicable regulations Supervision ManualJanuary2014 Page 1 Compensating bank maybe required to maintain excess balances at acorrespondent bank that lends to other parts ofthe holding company organization, possibly tothe detriment of the bank. The subsidiary bankmay be foregoing earnings on such excessfunds, which may adversely affect its expense general, a subsidi-ary bank should be adequately compensated forits services or for the use of its facilities andpersonnel by other parts of the holding companyorganization. Furthermore, a subsidiary bankshould not pay for expenses for which it doesnot receive a ROLE OF THE EXAMINERTo properly assess Intercompany transactionsand relationships between affiliates, the exam-iner must make a thorough analysis of mostintercompany Transactions and must have aknowledge of applicable laws, regulations, andrulings.

6 In particular, the examiner should befamiliar with sections 23A and 23B of the Fed-eral Reserve Act and the Board s Regulation examiner should also be familiar with theFR Y-8,The Bank Holding Company Report ofInsured Depository Institutions Section 23 ATransactions with Affiliates,and its mandatory report is to be submitted to theFederal Reserve by (1) all top-tier bank holdingcompanies (BHCs), including financial holdingcompanies, and (2) all foreign banking organiza-tions that directly own a subsidiary completed quarterly reports are used by theFederal Reserve System to monitor bank expo-sures to affiliates and to ensure banks compli-ance with Section 23A of the Federal ReserveAct. With regard to the BHC s inspection, theexaminer should review and verify, since theprevious inspection, the BHC s accuracy andcomprehensiveness in its reporting based on theFR Y-8 report form and a subsidiary IDI of a holding company isnot a state member bank, the bank s primaryregulator should determine the bank s compli-ance with pertinent banking laws.

7 In reviewingthe subsidiary bank s examination report, anyviolations of laws and regulations applicable tointercompany Transactions should be noted. Ifthe violation resulted from the actions of anaffiliate, the affiliate s role should be identifiedand be subject to criticism in the of banking laws discovered duringthe inspection should be brought to manage-ment s attention and referred to the bank s pri-mary supervisor. However, any action or criti-cism levied directly on the bank should comefrom the bank s primary Supervision ManualJanuary2014 Page 2 Intercompany Transactions ( Transactions Between Member Banks and TheirAffiliates Sections 23A and 23B of the Federal Reserve Act) Section S NEW IN THISREVISED SECTIONThis Section has been revised to discuss statu-tory amendments of sections 23A and 23B of theFederal Reserve Act resulting from the Dodd-Frank Act.

8 One amendment involved the defini-tion of an affiliate, with regard to an invest-ment fund when an insured depositoryinstitution (IDI) or one of its affiliates is aninvestment adviser. Also, the definition of cov-ered Transactions was revised to include thecredit exposure resulting for derivative andsecurities lending and borrowing transactionsbetween the IDI and its affiliates. In addition,the Dodd-Frank Act removed the quantitative 10percent exemption limit between financial sub-sidiaries. The retained earnings of a financialsubsidiary are to be included as part of theIDI s investment. The amendments were effec-tive July 21, 2012. (See sections 608(a)(1)(A),608(a)(1)(B), and 609(a) of the Dodd-FrankAct.)Revised inspection objectives and inspectionprocedures also are SECTIONS 23A AND 23 BOF THE FEDERAL RESERVE ACT,AND REGULATION WSection 23A of the Federal Reserve Act (FRA)restricts the ability of insured depository insti-tutions (IDIs)1to engage in certain coveredtransactions with an affiliate.

9 Transactions thatare subject to Section 23A also are subject tothe provisions of Section 23B of the to these statutory provisions, theBoard issued Regulation W (the rule),3whichimplements sections 23A and 23B of the rule provides several exemptions and com-bines the statutory restrictions on transactionsbetween a member bank and its affiliates withnumerous previously issued Board a bank holding company inspection, Transactions between an IDI and an affiliate (forexample, a bank holding company parent orother nonbank subsidiary) are reviewed forcompliance with sections 23A and 23B andRegulation W, as well as other banking regula-tions and statutes. Any violations of sec-tions 23A and 23B of the FRA or Regulation Winvolving a transaction between an IDI and itsaffiliate that are disclosed or found during aninspection should be brought to management sattention, may be discussed in the inspectionreport as Other Matters, and referred to thebank s primary supervisor.

10 However, any actionor criticism levied directly on the bank shouldcome from the bank s primary supervisor. Seealso Section 23A OF THEFEDERAL RESERVE ACTS ection 23A of the FRA (12 371c) is theprimary statute governing Transactions betweenan IDI and its affiliates. Section 23A (1) desig-nates the types of companies that are affiliates ofan IDI; (2) specifies the types of transactionscovered by the statute; (3) sets the quantitativelimitations on an IDI s covered transactionswith any single affiliate, and with all affiliatescombined; (4) sets forth collateral requirementsfor certain Transactions with affiliates; and(5) requires all covered Transactions to be con-ducted on terms consistent with safe and soundbanking Definition of an AffiliateIn general, companies that control or are undercommon control with an IDI are defined bysection 23A as affiliates of the bank.