A Closer Look Into Regulation W

By Paul Frey and Donna Thompson

This article touches upon some common oversights and violations cited in recent reports related to financial institutions’ transactions with affiliates. The transactions discussed below are not meant to be an all-inclusive list of Regulation W violations. The Bank Holding Company Inspection Manual Section 2020.0 provides detailed explanations of the various sections of Regulation W and serves as a good resource. If you are unsure of whether a transaction is covered under Regulation W, we encourage you to reach out to your relationship team from this Reserve Bank.

Sections 23A and 23B of the Federal Reserve Act (the “Act”), implemented by Regulation W of the Federal Reserve System (12 CFR 223), govern most intercompany transactions. Violations of Regulation W generally stem from not understanding the limitations on intercompany transactions within a consolidated organization. While not all intercompany transactions are covered by Regulation W, all need to be identified and reviewed to ensure compliance. The subsidiary bank must be a party to the transaction for the transaction to be covered under Regulation W.

Management should have a policy addressing intercompany transactions, particularly those common to the organization, and clearly identifying the affiliates within the corporate structure. In this connection, an affiliate, as defined in the regulation, could be a sponsored and advised company (such as a real estate investment trust), a partnership associated with the bank, entities with common ownership or other less common possibilities.

In its simplest form, Regulation W establishes terms and guidelines for financial transactions between banks and their nonbank affiliates. It applies to all federally insured depository institutions. Regulation W sets quantitative limits and establishes collateral requirements on extensions of credit by a bank to affiliates. In particular, a bank may not engage in covered transactions with any one affiliate in excess of 10 percent of the bank’s capital and surplus, and covered transactions with all affiliates may not total more than 20 percent of the bank’s capital and surplus. These restrictions are also designed to protect the bank from the misuse of its resources as well as from potential losses in transactions with affiliates.

Generally speaking, the common provisions of Section 23A of the Act require transactions between banks and their affiliates meet certain stipulations. The provisions of Section 23B of the Act require transactions to be conducted on an arm’s-length basis (i.e., no less favorable to the bank than for outside third parties). The parent company or an affiliate of the bank can provide services and transactions on terms more favorable than those for unaffiliated entities. In this context, the parent company or nonbank affiliate would be acting as a source of strength to its affiliated bank. Ultimately, this is what Regulation W is meant to uphold.

Extensions of Credit

A credit transaction with an affiliate, such as a loan by the bank to an affiliate or an overdrawn checking account, must be secured by the appropriate amount of collateral required at the time of the transaction [see Section 223.14 paragraph (b)] and must be on market terms or no less favorable to the bank than for a similar transaction to an unaffiliated entity.

Example 1: The bank subsidiary and parent company share certain expenses. The bank pays 100 percent of these and records a “receivable” representing the bank holding company’s pro rata share of the expenses. The parent reimburses the bank on an ad hoc basis, rather than in relationship to when the expense was incurred. As a result, the receivable due from the parent company is considered an extension of credit under Regulation W Section 223.3(i) and must be reported as a covered transaction on Federal Reserve System Form FR Y-8, The Bank Holding Company Report of Insured Depository Institutions’ Section 23A Transactions with Affiliates (Form FR Y-8). In this case, the transaction was not collateralized and violates Regulation W Section 223.14(a). Since the terms were favorable to the parent company and the bank would not be paying expenses of an unaffiliated third party without prompt reimbursement, the transaction also violates Section 223.5(a), which describes transactions with affiliates that must comply with Section 23B of the Act’s market terms requirements. 

Example 2: The parent company overdraws its checking account with the subsidiary bank in an amount of $15,000.  The overdraft constitutes an extension of credit under Regulation W Section 223.3(i) and must be reported as a covered transaction on Form FR Y-8. The extension of credit was not collateralized at the time of the overdraft and violates Regulation W Section 223.14(a). Since there was no overdraft agreement, this is also viewed as an interest-free extension of credit to the parent company, which violates Section 223.5(a) on market term requirements. 

Example 3: An unsecured advance is made by the subsidiary bank to the parent company to provide funds for repaying or servicing parent company obligations. This transaction is considered an unsecured extension of credit and violates the applicable sections of 23A and 23B described in the prior example. The transaction also must be reported as a covered transaction on Form FR Y-8.

Example 4: The subsidiary bank of a holding company makes a loan to an individual who pledges his or her investment of stock of the parent bank holding company (corporation) as collateral for the loan. This transaction constitutes a covered transaction under Section 223.3(h)(4) and must be reported on Form FR Y-8; however, additional collateral is not required.

These examples demonstrate how an unsecured extension of credit can arise in the normal course of operations. In Example 1, the shared portion of the parent company’s expenses must be repaid to the subsidiary bank immediately, including reimbursement at a market rate of interest for the duration of the extension of credit.  Alternatively, the extension of credit could be immediately collateralized with sufficient qualifying collateral under a formal agreement with interest assessed and paid at a market rate from the date of inception. In the other examples, management must ensure that sufficient collateral is in place at the time the transactions occur.

Simple monitoring routines and awareness can prevent inadvertent oversights. In some cases, it also may be appropriate to have a blanket pledge of parent company assets in place to provide sufficient collateral to cover an extension of credit. Nevertheless, any extension of credit must be reasonably warranted and should not serve to drain the bank of resources or otherwise disadvantage it. The parent company must always serve as a source of strength to its subsidiary bank(s), not vice versa.

Management and Service Fee Arrangements and Corporate Expenses

Regulation W also covers fees and payments assessed by parent companies on their banking subsidiaries. Of primary concern are excessive or unjustifiable management or service fees and any other unwarranted payments or practices that potentially divert bank resources to the parent company or a nonbank affiliate. According to Regulation W Section 223.51 (which implements Section 23B of the Act), a subsidiary bank may not engage in transactions with affiliates unless the transactions are on terms and conditions that are substantially the same, or at least as favorable to the subsidiary bank as those prevailing at the time for comparable transactions with or involving nonaffiliates.  Section 223.52 covers the payment of money or the furnishing of a service to an affiliate under contract, lease or otherwise.

Example 1: Bank holding companies frequently allocate overhead expenses, among other fees, to subsidiary banks.  Bank holding company expenses incurred to serve the needs of the subsidiary banks can be allocated to the subsidiary bank(s) that benefit from the services provided in proportion to the benefit received from the service;  however, allocating all bank holding expenses to bank subsidiaries is not permitted.   

Example 2: A parent company has been assessing the bank subsidiary rent on a storage facility without a lease agreement in place. Management could not provide documentation to validate that the rent assessed is based on a fair market rental rate. Without a lease agreement in place, these transactions could be considered unsecured extensions of credit and a violation of the regulation. Moreover, management must immediately document fair market terms for the leased premises and execute a formal lease agreement between the parent company and subsidiary bank.

If management or other service fees are being assessed, financial institutions should execute service contracts to govern these types of activities, including documentation and support for the methodology used to determine the fees and the amounts charged versus what is available in the market place. Management should ensure that the bank is being appropriately compensated for the use of its resources and charged on market terms that are substantially the same, or at least as favorable to the bank as those prevailing (at the time) for comparable transactions with or involving other nonaffiliated customers. As the parent does have some expenses related to its existence as a corporate entity, it would not be appropriate to allocate all of its expenses to the subsidiary bank(s).

Purchase of Assets

Financial institutions should track all instances of asset purchases from affiliates to ascertain reporting requirements and application to the quantitative limits. In general, a bank cannot purchase a low-quality asset, as defined in the regulation, from an affiliate, including a sister bank, unless the exemption is met as described in Example 2 below.

Example 1: Bank A purchases a building from the parent company, which represents over 26 percent of the bank’s capital and surplus. Section 23A limits any covered transaction with an affiliate to 10 percent of the bank’s capital and surplus and all transactions in aggregate with affiliates to 20 percent of the bank’s capital and surplus. This would be a violation of Regulation W Section 223.11.

Example 2: A bank participates a portion of a loan to its parent company. Subsequently, the subsidiary bank repurchases the loan participation back from its parent company. The transaction is covered under Regulation W Section 223.3(h) and must be tracked for purposes of calculating the limit for all covered transactions. Similarly, if the loan is subsequently rated special mention or worse on nonaccrual status, or the terms are renegotiated due to the deteriorating financial condition of the obligor, the asset would then be considered “low quality” and could not be repurchased by the bank subsidiary. There is an exception to these general rules: If there is a repurchase agreement in place at the time of origination, the bank qualifies for an exemption from the quantitative limits, collateral requirements and low-quality asset prohibition under Regulation W Section 223.42(h).

Tax Allocation in a Holding Company Structure

A holding company and its depository institution subsidiaries file federal taxes on a consolidated basis; however, each depository institution is viewed as — and reports as — a separate legal and accounting entity for regulatory purposes. Accordingly, each depository institution’s applicable income taxes, reflecting either an expense or benefit, should be recorded as if the institution had filed on a separate entity basis. Furthermore, the amount and timing of payments or refunds should be no less favorable to the bank subsidiary than if it were a separate taxpayer.  Any practice that is not consistent with this policy statement may be viewed as an unsafe and unsound practice prompting regulatory corrective action. (Note: Filing of state taxes may be required on a separate entity basis depending on state law).

A holding company and its subsidiary institutions are encouraged to enter into a written and comprehensive tax allocation agreement tailored to their specific circumstances. The agreement should be approved by the respective boards of directors. Although each agreement will be different, tax allocation agreements usually address certain issues common to consolidated groups. Therefore, such an agreement should:

  • Require a subsidiary depository institution to compute its income taxes (both current and deferred) on a separate entity basis.
  • Discuss the amount and timing of the institution’s payments for current tax expense, including estimated tax payments.
  • Discuss reimbursements to an institution when it has a loss for tax purposes.
  • Prohibit the payment or other transfer of deferred taxes by the institution to another member of the consolidated group.

The recent review of examination reports revealed that, in many cases, violations of Regulation W arose resulting from a lack of awareness or understanding by management. In other cases, it appears that the financial strain experienced by affiliates, in many cases caused by restrictions on bank subsidiary dividends under enforcement action or otherwise, resulted in unsecured extensions of credit by the banking subsidiary to the affiliate. Violations of Regulation W should be immediately remedied and may have to be undone or restructured in order to assure compliance.

Ultimately, management is expected to be knowledgeable about the requirements under Regulation W. Financial institutions should develop policies and procedures to govern compliance with appropriate sections of the Act and should describe transactions that are permitted among entities within the corporate structure and the applicable terms and requirements thereof.

Paul Frey is a supervisory examiner with the Charlotte branch of the Federal Reserve Bank of Richmond. He can be reached at

Donna Thompson is a supervisory examiner with the Federal Reserve Bank of Richmond. She can be reached at

The analyses and conclusions set forth in this publication are those of the authors and do not necessarily indicate concurrence by the Board of Governors, the Federal Reserve Banks, or the members of their staffs. Although we strive to make the information in this publication as accurate as possible, it is made available for educational and informational purposes only. Accordingly, for purposes of determining compliance with any legal requirement, the statements and views expressed in this publication do not constitute an interpretation of any laws, rule or regulation by the Board or by the officials or employees of the Federal Reserve System.

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