Regulation W
What Is Regulation W?
Regulation W is a U.S. Federal Reserve System (FRS) regulation that limits certain transactions between depository institutions, like banks and their affiliates. Specifically, it draws quantitative lines on covered transactions and requires collateral for certain transactions.
The regulation applies to banks that are members of the Fed, insured state non-member banks, and [insured savings associations](/savings-affiliation insurance-fund). Regulation W was acquainted with consolidate several times of translations and rulemaking under Sections 23A and 23B of the Federal Reserve Act.
Grasping Regulation W
Regulation W, the rule that executes sections 23A and 23B of the Federal Reserve Act, was distributed on Dec. 12, 2002, and happened on April 1, 2003.
Sections 23A and 23B, Regulation W limits the risks to a bank from transactions between the bank and its affiliates. They likewise limit the ability of a depository institution to transfer to its affiliates the subsidy emerging from the institution's access to the federal safety net, which offers benefits, for example, cheaper insured deposits and the discount window. These objectives are achieved by forcing quantitative and qualitative limits on the ability of a bank to stretch out credit to an affiliate or take part in certain different transactions with it.
The Fed noted in January 2003 that Regulation W included 70 years' worth of interpretive guidance concerning statutory requirements "that are genuinely concise however very complex in application." Regulation W is exhaustive in its scope, settling upwards of nine critical issues, including derivative transactions, intraday credit, and financial auxiliaries.
Following Regulation W
Since most large U.S. banks exist inside a diversified holding company structure, the possibility that bank funds might finance to some degree risky purposes exists. Regulation W looks to limit this risk and is conceptually clear, despite the fact that implementation is difficult. Compliance with Regulation W is really difficult for certain banks that are dealing with issues, for example, fast growth in capital market activities or integration of previous acquisitions.
Consenting to Regulation W was complex, even before the regulatory reforms that were organized in the wake of the 2008 financial crisis. The Dodd-Frank Wall Street Reform and Consumer Protection Act — which has been scrutinized by some as being excessively difficult — further fixed Regulation W's requirements.
Since exemptions to Regulation W rules widely gave emergency liquidity to affiliates during the financial crisis, the Fed's ability to grant exemptions on its sole authority was checked under the new rules. For instance, the Federal Deposit Insurance Corporation (FDIC) presently has 60 days to decide if an exemption is justified or whether it could represent an inadmissible risk to its deposit insurance fund and mention any criticisms.
Changes to Regulation W have likewise expanded the concept of what an "affiliate" and is a "covered transaction" under the law. Banking regulators presently expect greater transparency from banks in consenting to Regulation W.
Regulation W expects to safeguard banks and federal deposit insurance funds from undue financial risk.
When Does Regulation W Apply?
Given that Regulation W applies to covered transactions between a bank and its affiliate, two fundamental inquiries should be responded to in deciding if a transaction is subject to this regulation:
- Is the transaction between a bank and an affiliate of the bank?
- Is the transaction a "covered transaction"?
Regulation W defines a bank's affiliates comprehensively including any company that the bank straightforwardly or by implication controls or that is sponsored and prompted by a bank, as well as auxiliaries of the bank.
Covered transactions under Regulation W cover a wide range of transactions, including:
- The extension of credit to an affiliate
- Investment in securities issued by an affiliate
- Asset purchases from an affiliate
- The acceptance of securities issued by an affiliate as collateral for credit
- The issuance of a guarantee or letter of credit for an affiliate
Special Considerations
Under Regulation W, transactions with any affiliate must total something like 10% of a financial institution's capital, and transactions with all affiliates combined must total something like 20% of an institution's capital.
Banks are likewise restricted from purchasing inferior quality assets from their affiliates, for example, bonds with principal and interest payments that are over 30 days past due. In the interim, any extension of credit must be secured by collateral with coverage that reaches somewhere in the range of 100% and 130% of the total transaction amount.
For instance, consider a transaction where the speculative bank BigBanc means to purchase a loan portfolio from its subsidiary SmallBanc. To conform to Regulation W, BigBanc must guarantee that the transaction with SmallBanc doesn't surpass over 10% of its capital and that the loan portfolio isn't viewed as a bad quality asset. The transaction must likewise happen under market terms and conditions.
The Fed screens banks' openings to their affiliates through the FR Y-8 report that gathers data on transactions between an insured depository institution and its affiliates. The report must be put together by banks quarterly, on the last calendar day of each quarter.
Financial institutions that are found to be in violation of Regulation W can be hit with substantial civil punishments. The amount of the not set in stone by several factors, including whether the violation was caused with intent, attempted with wild disregard for the institution's financial safety and adequacy, or brought about a gain by the culprit.
The Bottom Line
Regulation W — added to the Federal Reserve Bank's "alphabet regulations" since it is the 23rd letter of the alphabet and the 23rd regulation — oversees covered transactions between a bank and its affiliates. This is framed in Section 23A of the Federal Reserve Act.
Section 23A defines the sorts of companies that are bank affiliates. It specifies the sorts of transactions covered by this statute. It likewise sets the quantifiable limitations on a bank's covered transactions with any single affiliate; additionally with every collective affiliate. At long last, it frames collateral requirements for specific bank transactions with affiliates.
Features
- Regulation W limits certain sorts of transactions among banks and their affiliates.
- The rules that banks must follow to consent to Regulation W were fixed by post-2008 financial reforms.
- The Dodd-Frank Act expanded the definition of a bank affiliate and the types of transactions Regulation W covers.
FAQ
What Is the Limit of a Transaction With a Single Affiliate?
No transaction with a single affiliate can surpass 10% of an institution's capital.
How Does Regulation W Work?
Regulation W lays out the rulemaking authority granted to the Federal Reserve according to sections 23A and 23B of the Federal Reserve Act. It controls covered transactions, which incorporate the extension of credit to an affiliate, asset purchases from an affiliate, acceptance of securities issued by an affiliate as collateral for credit, and other specifically defined transactions.
Are There Exemptions From Regulation W Requirements?
Indeed, Regulation W permits the Federal Reserve Bank to permit exemptions, however certain exemptions additionally require endorsement from the Federal Deposit Insurance Corporation (FDIC).
What Is the Limit of Transactions With All Affiliates?
All affiliate transactions may not surpass 20% of the institution's held capital.
