Regulation W - United States
It came into force in 1933. Regulation W deals with financial relationships between member banks and affiliates. It is a part of
the Federal Reserve Act. Though it has been in existence since 1933, due to the regulatory reforms coming out of the recent financial crisis (2007),
banks are being forced to revisit their Regulation W compliance closely. The following gives a brief overview of the regulation and its impact.
What does Regulation W affect?
Regulation W establishes limitations on transactions between member banks and their affiliates. The regulation applies to all federally insured
depository institutions, from national to state banks, and from trust companies to insured savings associations.
What does Affiliate mean?
Affiliate includes, but is not limited to, the following.
Note: The subsidiary of an affiliate is also considered an affiliate. Also, it is not important for the affiliate to be a legal person.
It can be an individual person, trust, partnership or any other form of organisation.
- The parent company of any bank;
- Companies under common control (holding companies), which can be indirect or via trust
- Financial subsidiaries; and
- Subsidiaries of affiliates
Thus, the following entities could also come under the scope of the term affiliate.
- Advised funds
- Certain companies sponsored by a bank - such as a real estate investment trust (REIT)
- Partnership firm
- Investment banking firms, etc.
What are the main sections under Regulation W?
There are two main sections under this regulation, namely Section 23A and Section 23B.
The following is covered under Section 23A
- Section 23A requires transactions between banks and their affiliates to meet certain criteria.
- Section 23B applies to all covered transactions and sets-forth further requirements.
The following is covered under Section 23B
- Explicit and specific collateral requirements when banks extend credit to their affiliates.
All transactions should be fully collateralized (must be at least 100%)
- Prohibition of the transfer or sale of “low quality” assets from affiliate to banks; and
- Adherence to the “Quantitative Limits”
- Transactions between banks and their affiliates shall not exceed 20% of the bank’s capital and surplus; and
- Transactions between banks and a single affiliate shall not exceed 10% of the bank’s capital and surplus.
- Covered transactions must be kept at “arm’s length”, meaning the transactions must be on terms that are the same or as
favourite to the bank as comparable transactions involving non-affiliates; and
- In the absence of comparable transactions, the transactions must be on terms that would be offered to non-affiliates.
- Prohibition of certain types of advertisements, purchases and underwriting
What does Attribution under the regulation mean?
The following is the extract on attribution under the regulation.
“A member bank must treat any of its transactions with any person as a transaction with an Affiliate to the extent that the proceeds
of the transaction are used for the benefit of, or transferred to, an Affiliate”.
This means that the rule treats transactions between banks and third parties as extensions of credit from banks to affiliates to the extent
that the third party utilizes the proceeds to benefit an affiliate. For example, if the bank provides a loan to a third party and the
third party extends credit to one of the bank’s affiliate then the transaction is viewed as if the bank has provided direct credit
to the affiliate. The transactions between the third party and the affiliate need not be just a loan, it can be investment, guarantee, etc.
Covered transactions under the regulation
A covered transaction under the regulation includes.
- Extension of credit to an affiliate
- Purchase of assets from an affiliate
- Providing guarantees to affiliates
- Bank’s acceptance of affiliate securities such as stocks, bonds, collateral for a loan, etc.
Exemptions under Regulation W?
Transactions in liquid assets, municipal securities and intraday extensions of credit are not covered under this regulation.
Penalties for non-compliance to the regulation
The Federal Reserve has the capacity to levy penalties upto $1 million per day for non-compliance of the regulation.
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