US Federal Reserve Board Releases More Guidance On Key Banking Regulations - Financial Services - United States (2024)

On December 30, 2021, the Board of Governors of the FederalReserve System ("Board") published additional answers tofrequently asked questions ("FAQs") about its RegulationsH, O, W, and Y.1 Those regulationsgovern Federal Reserve System membership, extensions of credit tobank insiders, transactions with affiliates, and bank holdingcompanies and change in control, respectively. The FAQs alsoaddressed questions regarding the regulatory treatment of coveredsavings associations ("CSAs") and their parententities.

The FAQs are part of transparency initiative that wasspearheaded by former Federal Reserve Vice Chair Randy Quarles andbuild on the significant body of guidance that was released inMarch 2021. (Please see our earlier Legal Update on the Board'srelease of guidance in March.)

In this Legal Update, we summarize the FAQs with a particularfocus on the effect their release may have on the industry'sunderstanding of the restrictions on affiliate transactions andimplications of using the CSA regime.

Overview

The FAQs address Regulations H (five new answers), O (one newanswer), W (34 new answers), and Y (nine new answers) and the CSAregime (29 answers). Some of the FAQs address highly fact-specificcirc*mstances, such as the notice requirement for closing aseasonal branch or the operation of the sister-bank exemption.Other FAQs restate general principles of the regulation, such asthe application of the restrictions on affiliate transactions tobanks that are directly controlled by natural persons. However,many of the FAQs clarify items that are not apparent from the plaintext of the regulation or had been understood only through agencydiscussions.

Regulation H – Membership of State BankingInstitutions in the Federal Reserve System

The FAQs on Regulation H primarily address filing requirementsfor branches of state member banks. One FAQ also addresses when astate member bank is allowed to rely on the authority to makepublic welfare investments to invest in housing projects consistingof multiple buildings.

Potentially the most significant FAQ on Regulation H addresses astate member bank's authority to acquire debt obligations underits lending authority. State member banks must comply withlimitations under the Federal Reserve Act when purchasing, selling,underwriting, and holding investment securities. The FAQ statesthat the Board will not apply these limitations if a state memberbank's acquisition is an exercise of its lending authorityunder state law and would be an exercise of lending authority for asimilarly situated national bank. In particular, the FAQ indicatesthat Board staff will look to interpretations issued by the staffof the Office of the Comptroller of the Currency ("OCC")to understand the lending authority of national banks. Moreimportantly, the FAQ states that Board staff will consider thecirc*mstance at the time the bank acquired the obligation and willnot permit banks to recharacterize past purchases of investmentsecurities as exercises of the bank's general lendingpowers.

Regulation O – Loans to Executive Officers, Directorsand Principal Shareholders

The FAQ on Regulation O clarifies circ*mstances in which amember bank may offer discounts or preferential terms on loans toinsiders. Specifically, it states that a member bank may extendcredit to an insider as part of a benefit or compensation programthat (i) is widely available to employees of the member bank and(ii) does not give preference to any insider of the member bankover other employees of the member bank. However, a member bank isprohibited from extending credit to an insider that is not made onsubstantially the same terms as, or is made without followingcredit underwriting procedures that are at least as stringent as,comparable transactions with persons that are non-insiders and notemployees of the bank.

Regulation W – Transactions Between Banks and TheirAffiliates

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

1. The attribution rule should not apply to a series oftransactions if the initial transaction involving the bankqualifies for an exemption.
2. The Board should not apply the attribution rule if the bank didnot know or have reason to know at the time of the transaction thatthe proceeds of the transaction may be used for the benefit of, ortransferred to, an affiliate. This knowledge qualifier isconditioned on the bank maintaining a reasonable Regulation Wcompliance program.
3. Extensions of credit to employees and insiders of affiliatestypically should not be attributed to the affiliate.
4. Floor-plan financing by a nonbank affiliate can create anattributed extension of credit when the bank extends credit to athird party to purchase a good from the floor-plan borrower.
5. Regulation W applies to asset purchases at the time the bankcommits or becomes legally obligated to purchase the asset from theaffiliate.
6. Loan renewals may terminate the attribution of a purchasedloan, but refinancings and restructurings prior to maturity willnot.
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 exemptionfor giving credit for uncollected items is generally limited toitems 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 acovered asset purchase transaction, but cash contributions from theaffiliate should reduce the amount.

Regulation Y – Bank Holding Companies and Change inBank Control

The FAQs on Regulation Y focus on anti-tying, control, andcomplementary authority issues. Notably, one of the FAQs seems toconfirm the longstanding belief that the industry generally mayrely on positions taken in the 2003 Anti-Tying Act proposal (e.g.,what is a traditional banking product) even though it was neverfinalized.2

The FAQs also state that a financial holding company withphysical commodity trading authority may not make or take physicaldelivery of a specific physical commodity solely on the basis thatthe commodity has swaps that are eligible to be traded on a swapexecution facility because the relevant approval orders onlyaddress futures or options on futures that are authorized fortrading on a US futures exchange.

Regulation of CSAs

Section 206 of the 2018 Economic Growth, Regulatory Relief, andConsumer Protection Act allows federal savings associations("FSAs") to elect to operate as CSAs.3A CSA has the same rights andduties as a national bank that has its main office situated in thesame location as the home office of the CSA but retains its FSAcharter and is treated as an FSA for governance purposes. The OCCis the primary federal regulator of CSAs and adopted rulesimplementing Section 206 in 2019.4

The Board is the primary federal regulator of bank and savingsand loan holding companies and regulates aspects of the operationsof banks and savings associations. The Board has not adopted rulesthat implement Section 206, but the FAQs state how the Boardconstrues the portions of the CSA regime that are within itsremit.

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

1. A savings and loan holding company ("SLHC") thatcontrols a CSA is treated as a bank holding company("BHC"), except for the governance purposes enumerated inSection 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 Actand, therefore, would remain supervised as an SLHC only for theenumerated governance purposes.
2. A CSA must become a member of the Federal Reserve System. Thisrequires the CSA to purchase stock of the appropriate FederalReserve Bank.
3. A company that already controls a CSA must file a FR Y-10 withthe Board to report the CSA's election and comply with anyother Board reporting requirements for BHCs. A CSA must submit FormFR 2030a to the appropriate Federal Reserve Bank for the requiredstock purchase under the Federal Reserve Act and comply with anyother Board reporting requirements for national banks. A companyacquiring control of a CSA or a company that controls a CSA mustsubmit an application to the Board under Section 3 of the BankHolding Company Act.
4. A company that controls a CSA may engage only in activitiesthat are permissible for a BHC. A grandfathered unitary SLHCpermanently loses its grandfathered rights following a CSAelection.
5. A CSA must continue to provide notice to the Board prior todeclaring a dividend.

Conclusion

The publication of these and prior FAQs by the Board staffbrings greater transparency to its historical guidance on the Boardregulations to stakeholders who lack back-channel sources ofcommunication with staff. However, because the use of supervisoryguidance to establish new legal requirements raises concernsregarding the administrative rulemaking process, the Board staffwas careful to note that the FAQs are staff interpretations andhave not been approved by the Board, except as otherwise noted.Thus, banking organizations should recognize that while the FAQsare helpful in assessing their compliance requirements, they arenot 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 tothe underlying regulations. Given the obligations imposed oninstitutions by several of those FAQs, such rulemakings may beneeded to avoid due process and Administrative Procedures Actconcerns. However, the Board is not doing the same for the FAQs forCSA, which impose significant requirements on CSAs and companiesthat control CSAs, including the divestiture of BHC-impermissibleactivities. It is unclear why the Board did not previouslyundertake, and apparently is not now contemplating undertaking, arulemaking to implement Section 206 of the Economic Growth,Regulatory Relief, and Consumer Protection Act.

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

Footnotes

1. See Legal Interpretations FAQs of the Board'sRegulations (Dec. 30, 2021), https://www.federalreserve.gov/supervisionreg/legalinterpretations/legal-interpretations-of-the-boards-regulations.htm

2.68 Fed. Reg. 52,024 (Aug. 29, 2003).

3.Pub. L. 115-174 § 206, 132 Stat. 1296,1310-11 (2018) (codified at 12 U.S.C. §1464a).

4.84 Fed. Reg. 23,991 (May 24, 2019) (codifiedat 12 C.F.R. pt. 101).

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