Background and Summary of Regulation W

Section 23A
Section 23B
Applicability to Insured Depository Institutions and Uninsured Member Banks
Applicability to Financial Subsidiaries
Organization of Regulation W

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Regulation W implements sections 23A and 23B of the Federal Reserve Act (12 USC 371c and 371c-1), which were designed to protect against a depository institution’s suffering losses in transactions with affiliates. These statutory provisions also limit a depository institution’s ability to transfer to its affiliate the subsidy arising from the institution’s access to the federal safety net. Sections 23A and 23B apply to banks that are members of the Federal Reserve System (“member banks”). Other federal law subjects insured nonmember banks and insured thrifts to sections 23A and 23B in the same manner and to the same extent as if they were member banks.

Sections 23A and 23B each explicitly grant the Board broad authority to issue regulations to administer the section (12 USC 371c(f) and 371c-1(e)). However, before 2003, no regulation implemented these provisions. Instead, depository institutions seeking guidance on how to comply with the statute relied on a series of Board interpretations and informal staff guidance. Because institutions increasingly sought guidance on section 23A and 23B issues resulting from the increasing scope of activities conducted by modern financial holding companies and the growing complexities of the U.S. financial markets, the Board issued Regulation W, effective April 1, 2003.

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Section 23A

Section 23A limits the risks to a member bank from transactions with affiliates and limits a member bank’s ability to transfer its federal subsidy to affiliates. It achieves these goals in four ways. First, it limits a member bank’s covered transactions with any single affiliate to no more than 10 percent of the bank’s capital stock and surplus, and transactions with all affiliates combined to no more than 20 percent of the bank’s capital stock and surplus. Covered transactions include—

purchases of assets from an affiliate,
loans or extensions of credit to an affiliate,
purchases of or investments in securities issued by an affiliate,
guarantees on behalf of an affiliate, and
certain other transactions that expose the member bank to an affiliate’s credit or investment risk, including the acceptance of securities issued by an affiliate as collateral and of certain derivative transactions.

A member bank’s affiliates include, among other companies—

any companies that control the bank,
any companies under common control with the bank,
certain investment funds that are advised by the bank or an affiliate of the bank, and
financial subsidiaries of a member bank.

Second, the statute requires all transactions between a member bank and its affiliates to be on terms and conditions that are consistent with safe and sound banking practices. Third, the statute prohibits a member bank from purchasing low-quality assets from its affiliates. Finally, section 23A requires that a member bank’s extensions of credit to affiliates and guarantees on behalf of affiliates be appropriately secured by a statutorily defined amount of collateral.

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Section 23B

Section 23B protects a member bank by requiring that certain transactions between the bank and its affiliates occur on market terms—that is, on terms and under circumstances that are substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with unaffiliated companies. Section 23B applies this restriction to any covered transaction (as defined in section 23A) with an affiliate as well as certain other transactions, such as—

any sale of assets by the member bank to an affiliate,
any payment of money or furnishing of services by the member bank to an affiliate; and
any transaction by the member bank with a third party if an affiliate has a financial interest in the third party or if an affiliate is a participant in the transaction.

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Applicability to Insured Depository Institutions and Uninsured Member Banks

Section 23A was originally enacted as part of the Banking Act of 1933, and its restrictions applied only to member banks. Since 1933, Congress has amended the statute several times, comprehensively in 1982 (Garn-St Germain Depository Institutions Act of 1982, Pub. L. 97-320, § 410; 12 USC 371c). Congress also amended the Federal Deposit Insurance Act in 1966 to apply section 23A to insured nonmember banks (Pub. L. 89-485, §§ 12(c); 12 USC 1828(j)). In addition, Congress revised the Home Owners’ Loan Act in 1989 to apply section 23A to insured savings associations (Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Pub. L. 101-73, § 301; 12 USC 1468(a)). Congress enacted section 23B of the Federal Reserve Act as part of the Competitive Equality Banking Act of 1987 (Pub. L. 100-86, § 102; 12 USC 371c-1) and has subsequently expanded its scope to cover the same set of depository institutions as are covered by section 23A. Consequently, sections 23A and 23B now apply to all insured depository institutions and uninsured member banks.

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Applicability to Financial Subsidiaries

The GLB Act amended the Federal Reserve Act in 1999 so that sections 23A and 23B would apply to transactions between a bank and its financial subsidiaries. Section 23A, as amended by the GLB Act, defines a financial subsidiary as any subsidiary of a bank that would be a financial subsidiary of a national bank under section 5136A of the Revised Statutes of the United States. Section 5136A of the Revised Statutes generally defines a financial subsidiary as a subsidiary of an insured depository institution that engages in activities that are not permissible for national banks to engage in directly (unless national banks are authorized by the express terms of a federal statute to own or control the subsidiary) (12 USC 24a(g)). The GLB Act provides that a financial subsidiary of a bank, unlike most other subsidiaries of a bank, is considered an affiliate of the bank for purposes of sections 23A and 23B. The GLB Act also establishes certain special rules under section 23A for financial subsidiaries.

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Organization of Regulation W

Regulation W provides users with a single, comprehensive tool for complying with and analyzing issues arising under sections 23A and 23B. Subpart A provides a comprehensive glossary of the terms used in the regulation and the statute. Subpart B sets out the principal restrictions and requirements imposed by section 23A. Subpart C discusses the appropriate valuation and timing principles for covered transactions. Subpart D discusses the appropriate treatment under section 23A for transactions with financial subsidiaries, bank-affiliate derivative transactions, and certain bank-affiliate merger and acquisition transactions. Subpart E sets forth available exemptions from certain of the requirements of section 23A. Subpart F lays out the operative provisions of section 23B. Subpart G discusses the application of sections 23A and 23B and the rule to U.S. branches and agencies of foreign banks. Subpart H contains the Board’s miscellaneous interpretations of the statute.

The regulation also includes examples illustrating how several of the rule’s provisions would apply in particular circumstances. The examples included in the rule are considered part of the rule, and compliance with an applicable example would constitute compliance with the rule. Each example included in the rule illustrates only the scope and application of the particular issue addressed by the example and not any other issue that may arise under the rule.