[Title 12 CFR ]
[Code of Federal Regulations (annual edition) - January 1, 2000 Edition]
[From the U.S. Government Printing Office]



[[Page 1]]

          
          
                    12


          Parts 220 to 299

                         Revised as of January 1, 2000

Banks and Banking





          Containing a Codification of documents of general 
          applicability and future effect
          As of January 1, 2000
          With Ancillaries
          Published by:
          Office of the Federal Register
          National Archives and Records
          Administration

A Special Edition of the Federal Register



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                     U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2000



               For sale by U.S. Government Printing Office
 Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328



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                            Table of Contents



                                                                    Page
  Explanation.................................................       v

  Title 12:
          Chapter II--Federal Reserve System (Continued)             3
  Finding Aids:
      Table of CFR Titles and Chapters........................     799
      Alphabetical List of Agencies Appearing in the CFR......     817
      List of CFR Sections Affected...........................     827



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                     ----------------------------

                     Cite this Code:  CFR
                     To cite the regulations in 
                       this volume use title, 
                       part and section number. 
                       Thus,  12 CFR 220.1 refers 
                       to title 12, part 220, 
                       section 1.

                     ----------------------------

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                               EXPLANATION

    The Code of Federal Regulations is a codification of the general and 
permanent rules published in the Federal Register by the Executive 
departments and agencies of the Federal Government. The Code is divided 
into 50 titles which represent broad areas subject to Federal 
regulation. Each title is divided into chapters which usually bear the 
name of the issuing agency. Each chapter is further subdivided into 
parts covering specific regulatory areas.
    Each volume of the Code is revised at least once each calendar year 
and issued on a quarterly basis approximately as follows:

Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1

    The appropriate revision date is printed on the cover of each 
volume.

LEGAL STATUS

    The contents of the Federal Register are required to be judicially 
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie 
evidence of the text of the original documents (44 U.S.C. 1510).

HOW TO USE THE CODE OF FEDERAL REGULATIONS

    The Code of Federal Regulations is kept up to date by the individual 
issues of the Federal Register. These two publications must be used 
together to determine the latest version of any given rule.
    To determine whether a Code volume has been amended since its 
revision date (in this case, January 1, 2000), consult the ``List of CFR 
Sections Affected (LSA),'' which is issued monthly, and the ``Cumulative 
List of Parts Affected,'' which appears in the Reader Aids section of 
the daily Federal Register. These two lists will identify the Federal 
Register page number of the latest amendment of any given rule.

EFFECTIVE AND EXPIRATION DATES

    Each volume of the Code contains amendments published in the Federal 
Register since the last revision of that volume of the Code. Source 
citations for the regulations are referred to by volume number and page 
number of the Federal Register and date of publication. Publication 
dates and effective dates are usually not the same and care must be 
exercised by the user in determining the actual effective date. In 
instances where the effective date is beyond the cut-off date for the 
Code a note has been inserted to reflect the future effective date. In 
those instances where a regulation published in the Federal Register 
states a date certain for expiration, an appropriate note will be 
inserted following the text.

OMB CONTROL NUMBERS

    The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires 
Federal agencies to display an OMB control number with their information 
collection request.

[[Page vi]]

Many agencies have begun publishing numerous OMB control numbers as 
amendments to existing regulations in the CFR. These OMB numbers are 
placed as close as possible to the applicable recordkeeping or reporting 
requirements.

OBSOLETE PROVISIONS

    Provisions that become obsolete before the revision date stated on 
the cover of each volume are not carried. Code users may find the text 
of provisions in effect on a given date in the past by using the 
appropriate numerical list of sections affected. For the period before 
January 1, 1986, consult either the List of CFR Sections Affected, 1949-
1963, 1964-1972, or 1973-1985, published in seven separate volumes. For 
the period beginning January 1, 1986, a ``List of CFR Sections 
Affected'' is published at the end of each CFR volume.

CFR INDEXES AND TABULAR GUIDES

    A subject index to the Code of Federal Regulations is contained in a 
separate volume, revised annually as of January 1, entitled CFR Index 
and Finding Aids. This volume contains the Parallel Table of Statutory 
Authorities and Agency Rules (Table I). A list of CFR titles, chapters, 
and parts and an alphabetical list of agencies publishing in the CFR are 
also included in this volume.
    An index to the text of ``Title 3--The President'' is carried within 
that volume.
    The Federal Register Index is issued monthly in cumulative form. 
This index is based on a consolidation of the ``Contents'' entries in 
the daily Federal Register.
    A List of CFR Sections Affected (LSA) is published monthly, keyed to 
the revision dates of the 50 CFR titles.

REPUBLICATION OF MATERIAL

    There are no restrictions on the republication of material appearing 
in the Code of Federal Regulations.

INQUIRIES

    For a legal interpretation or explanation of any regulation in this 
volume, contact the issuing agency. The issuing agency's name appears at 
the top of odd-numbered pages.
    For inquiries concerning CFR reference assistance, call 202-523-5227 
or write to the Director, Office of the Federal Register, National 
Archives and Records Administration, Washington, DC 20408 or e-mail 
info@fedreg.nara.gov.

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ELECTRONIC SERVICES

    The full text of the Code of Federal Regulations, the LSA (List of 
CFR Sections Affected), The United States Government Manual, the Federal 
Register, Public Laws, Weekly Compilation of Presidential Documents and 
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gpoaccess@gpo.gov.

[[Page vii]]

    The Office of the Federal Register also offers a free service on the 
National Archives and Records Administration's (NARA) World Wide Web 
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site also contains links to GPO Access.

                              Raymond A. Mosley,
                                    Director,
                          Office of the Federal Register.

January 1, 2000.



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                               THIS TITLE

    Title 12--Banks and Banking is composed of six volumes. The parts in 
these volumes are arranged in the following order: parts 1-199, 200-219, 
220-299, 300-499, 500-599, and part 600-end. The first volume containing 
parts 1-199 is comprised of chapter I--Comptroller of the Currency, 
Department of the Treasury. The second and third volumes containing 
parts 200-299 are comprised of chapter II--Federal Reserve System. The 
fourth volume containing parts 300-499 is comprised of chapter III--
Federal Deposit Insurance Corporation and chapter IV--Export-Import Bank 
of the United States. The fifth volume containing parts 500-599 is 
comprised of chapter V--Office of Thrift Supervision, Department of the 
Treasury. The sixth volume containing part 600-end is comprised of 
chapter VI--Farm Credit Administration, chapter VII--National Credit 
Union Administration, chapter VIII--Federal Financing Bank, chapter IX--
Federal Housing Finance Board, chapter XI--Federal Financial 
Institutions Examination Council, chapter XIV--Farm Credit System 
Insurance Corporation, chapter XV--Department of the Treasury, chapter 
XVII--Office of Federal Housing Enterprise Oversight, Department of 
Housing and Urban Development and chapter XVIII--Community Development 
Financial Institutions Fund, Department of the Treasury. The contents of 
these volumes represent all of the current regulations codified under 
this title of the CFR as of January 1, 2000.

    Redesignation tables appear in the volumes containing parts 1-199, 
parts 300-499, parts 500-599, and part 600-end.

    For this volume, Shelley C. Featherson was Chief Editor. The Code of 
Federal Regulations publication program is under the direction of 
Frances D. McDonald, assisted by Alomha S. Morris.

[[Page x]]




[[Page 1]]



                       TITLE 12--BANKS AND BANKING




                  (This book contains parts 220 to 299)

  --------------------------------------------------------------------
                                                                    Part

chapter ii--Federal Reserve System (Continued)..............         220


Cross References: Farmers Home Administration: See Agriculture, 7 CFR, 
  chapter XVIII.

  Office of Assistant Secretary for Housing--Federal Housing 
Commissioner, Department of Housing and Urban Development: See Housing 
and Urban Development, 24 CFR, chapter II.

  Fiscal Service: See Money and Finance: Treasury, 31 CFR, chapter II.

  Monetary Offices: See Money and Finance: Treasury, 31 CFR, chapter I.

  Commodity Credit Corporation: See Agriculture, 7 CFR, chapter XIV.

  Small Business Administration: See Business Credit and Assistance, 13 
CFR, chapter I.

  Rural Electrification Administration: See Agriculture, 7 CFR, chapter 
XVII.

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                   CHAPTER II--FEDERAL RESERVE SYSTEM




  --------------------------------------------------------------------

     SUBCHAPTER A--BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Part                                                                Page
220             Credit by brokers and dealers (Regulation T)           5
221             Credit by banks and persons other than 
                    brokers or dealers for the purpose of 
                    purchasing or carrying margin stock 
                    (Regulation U)..........................          34
224             Borrowers of securities credit (Regulation 
                    X)......................................          55
225             Bank holding companies and change in bank 
                    control (Regulation Y)..................          56
226             Truth in lending (Regulation Z).............         193
227             Unfair or deceptive acts or practices 
                    (Regulation AA).........................         432
228             Community reinvestment (Regulation BB)......         435
229             Availability of funds and collection of 
                    checks (Regulation CC)..................         454
230             Truth in savings (Regulation DD)............         560
231             Netting eligibility for financial 
                    institution (Regulation EE).............         594
250             Miscellaneous interpretations...............         595
261             Rules regarding availability of information.         626
261a            Rules regarding access to personal 
                    information under the Privacy Act of 
                    1974....................................         643
261b            Rules regarding public observation of 
                    meetings................................         649
262             Rules of procedure..........................         654
263             Rules of practice for hearings..............         662
264             Employee responsibilities and conduct.......         704
264a            Reserve Bank directors--actions and 
                    responsibilities........................         704
264b            Rules regarding foreign gifts and 
                    decorations.............................         708
265             Rules regarding delegation of authority.....         710
266             Limitations on activities of former members 
                    and employees of the Board..............         728
267             Rules of organization and procedure of the 
                    Consumer Advisory Council...............         729
268             Rules regarding equal opportunity...........         731
269             Policy on labor relations for the Federal 
                    Reserve banks...........................         768

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269a            Definitions.................................         773
269b            Charges of unfair labor practices...........         774
               SUBCHAPTER B--FEDERAL OPEN MARKET COMMITTEE
270             Open market operations of Federal Reserve 
                    banks...................................         784
271             Rules regarding availability of information.         785
272             Rules of procedure..........................         792
281             Statements of policy........................         794
       SUBCHAPTER C--FEDERAL RESERVE SYSTEM LABOR RELATIONS PANEL
290-299         [Reserved]

Supplemental Publications: The Federal Reserve Act, as amended through 
  December 31, 1976, with an Appendix containing provisions of certain 
  other statutes affecting the Federal Reserve System. Rules of 
  Organization and Procedure--Board of Governors of the Federal Reserve 
  System. Regulations of the Board of Governors of the Federal Reserve 
  System. The Federal Reserve System--Purposes and Functions. Annual 
  Report. Federal Reserve Bulletin. Monthly. Federal Reserve Chart Book 
  Quarterly; Historical Chart Book issued in September.

[[Page 5]]





     SUBCHAPTER A--BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM





PART 220--CREDIT BY BROKERS AND DEALERS (REGULATION T)--Table of Contents




Sec.
220.1  Authority, purpose, and scope.
220.2  Definitions.
220.3  General provisions.
220.4  Margin account.
220.5  Special memorandum account.
220.6  Good faith account.
220.7  Broker-dealer credit account.
220.8  Cash account.
220.9  Clearance of securities, options, and futures.
220.10  Borrowing and lending securities.
220.11  Requirements for the list of marginable OTC stocks and the list 
          of foreign margin stocks.
220.12  Supplement: margin requirements.

                             Interpretations

220.101  Transactions of customers who are brokers or dealers.
220.102  [Reserved]
220.103  Borrowing of securities.
220.104  [Reserved]
220.105  Ninety-day rule in special cash account.
220.106-220.107  [Reserved]
220.108  International Bank Securities.
220.109  [Reserved]
220.110  Assistance by Federal credit union to its members.
220.111  Arranging for extensions of credit to be made by a bank.
220.112  [Reserved]
220.113  Necessity for prompt payment and delivery in special cash 
          accounts.
220.114-220.116  [Reserved]
220.117  Exception to 90-day rule in special cash account.
220.118  Time of payment for mutual fund shares purchased in a special 
          cash account.
220.119  Applicability of margin requirements to credit extended to 
          corporation in connection with retirement of stock.
220.120  [Reserved]
220.121  Applicability of margin requirements to joint account between 
          two creditors.
220.122  ``Deep in the money put and call options'' as extensions of 
          credit.
220.123  Partial delayed issue contracts covering nonconvertible bonds.
220.124  Installment sale of tax-shelter programs as ``arranging'' for 
          credit.
220.125-220.126  [Reserved]
220.127  Independent broker/dealers arranging credit in connection with 
          the sale of insurance premium funding programs.
220.128  Treatment of simultaneous long and short positions in the same 
          margin account when put or call options or combinations 
          thereof on such stock are also outstanding in the account.
220.129-220.130  [Reserved]
220.131  Application of the arranging section to broker-dealer 
          activities under SEC Rule 144A.
220.132  Credit to brokers and dealers.

    Authority: 15 U.S.C. 78c, 78g, 78q, and 78w.

    Source: Regulation T, Secs. 220.1 through 220.18 appear at 48 FR 
23165, May 24, 1983, unless otherwise noted.

    Editorial Note: A copy of each form referred to in this part is 
filed as a part of the original document. Copies are available upon 
request to the Board of Governors of the Federal Reserve System or any 
Federal Reserve Bank.



Sec. 220.1  Authority, purpose, and scope.

    (a) Authority and purpose. Regulation T (this part) is issued by the 
Board of Governors of the Federal Reserve System (the Board) pursuant to 
the Securities Exchange Act of 1934 (the Act) (15 U.S.C.78a et seq.). 
Its principal purpose is to regulate extensions of credit by brokers and 
dealers; it also covers related transactions within the Board's 
authority under the Act. It imposes, among other obligations, initial 
margin requirements and payment rules on certain securities 
transactions.
    (b) Scope. (1) This part provides a margin account and four special 
purpose accounts in which to record all financial relations between a 
customer and a creditor. Any transaction not specifically permitted in a 
special purpose account shall be recorded in a margin account.
    (2) This part does not preclude any exchange, national securities 
association, or creditor from imposing additional requirements or taking 
action for its own protection.
    (3) This part does not apply to:
    (i) Financial relations between a customer and a creditor to the 
extent that they comply with a portfolio margining system under rules 
approved or amended by the SEC;

[[Page 6]]

    (ii) Credit extended by a creditor based on a good faith 
determination that the borrower is an exempted borrower;
    (iii) Financial relations between a customer and a broker or dealer 
registered only under section 15C of the Act; and
    (iv) Financial relations between a foreign branch of a creditor and 
a foreign person involving foreign securities.

[Reg. T, 63 FR 2820, Jan. 16, 1998]



Sec. 220.2  Definitions.

    The terms used in this part have the meanings given them in section 
3(a) of the Act or as defined in this section as follows:
    Affiliated corporation means a corporation of which all the common 
stock is owned directly or indirectly by the firm or general partners 
and employees of the firm, or by the corporation or holders of the 
controlling stock and employees of the corporation, and the affiliation 
has been approved by the creditor's examining authority.
    Cash equivalent means securities issued or guaranteed by the United 
States or its agencies, negotiable bank certificates of deposit, bankers 
acceptances issued by banking institutions in the United States and 
payable in the United States, or money market mutual funds.
    Covered option transaction means any transaction involving options 
or warrants in which the customer's risk is limited and all elements of 
the transaction are subject to contemporaneous exercise if:
    (1) The amount at risk is held in the account in cash, cash 
equivalents, or via an escrow receipt; and
    (2) The transaction is eligible for the cash account by the rules of 
the registered national securities exchange authorized to trade the 
option or warrant or by the rules of the creditor's examining authority 
in the case of an unregistered option, provided that all such rules have 
been approved or amended by the SEC.
    Credit balance means the cash amount due the customer in a margin 
account after debiting amounts transferred to the special memorandum 
account.
    Creditor means any broker or dealer (as defined in sections 3(a)(4) 
and 3(a)(5) of the Act), any member of a national securities exchange, 
or any person associated with a broker or dealer (as defined in section 
3(a)(18) of the Act), except for business entities controlling or under 
common control with the creditor.
    Current market value of:
    (1) A security means:
    (i) Throughout the day of the purchase or sale of a security, the 
security's total cost of purchase or the net proceeds of its sale 
including any commissions charged; or
    (ii) At any other time, the closing sale price of the security on 
the preceding business day, as shown by any regularly published 
reporting or quotation service. If there is no closing sale price, the 
creditor may use any reasonable estimate of the market value of the 
security as of the close of business on the preceding business day.
    (2) Any other collateral means a value determined by any reasonable 
method.
    Customer excludes an exempted borrower and includes:
    (1) Any person or persons acting jointly:
    (i) To or for whom a creditor extends, arranges, or maintains any 
credit; or
    (ii) Who would be considered a customer of the creditor according to 
the ordinary usage of the trade;
    (2) Any partner in a firm who would be considered a customer of the 
firm absent the partnership relationship; and
    (3) Any joint venture in which a creditor participates and which 
would be considered a customer of the creditor if the creditor were not 
a participant.
    Debit balance means the cash amount owed to the creditor in a margin 
account after debiting amounts transferred to the special memorandum 
account.
    Delivery against payment, Payment against delivery, or a C.O.D. 
transaction refers to an arrangement under which a creditor and a 
customer agree that the creditor will deliver to, or accept from, the 
customer, or the customer's agent, a security against full payment of 
the purchase price.

[[Page 7]]

    Equity means the total current market value of security positions 
held in the margin account plus any credit balance less the debit 
balance in the margin account.
    Escrow agreement means any agreement issued in connection with a 
call or put option under which a bank or any person designated as a 
control location under paragraph (c) of SEC Rule 15c3-3 (17 CFR 
240.15c3-3(c)), holding the underlying asset or required cash or cash 
equivalents, is obligated to deliver to the creditor (in the case of a 
call option) or accept from the creditor (in the case of a put option) 
the underlying asset or required cash or cash equivalent against payment 
of the exercise price upon exercise of the call or put.
    Examining authority means:
    (1) The national securities exchange or national securities 
association of which a creditor is a member; or
    (2) If a member of more than one self-regulatory organization, the 
organization designated by the SEC as the examining authority for the 
creditor.
    Exempted borrower means a member of a national securities exchange 
or a registered broker or dealer, a substantial portion of whose 
business consists of transactions with persons other than brokers or 
dealers, and includes a borrower who:
    (1) Maintains at least 1000 active accounts on an annual basis for 
persons other than brokers, dealers, and persons associated with a 
broker or dealer;
    (2) Earns at least $10 million in gross revenues on an annual basis 
from transactions with persons other than brokers, dealers, and persons 
associated with a broker or dealer; or
    (3) Earns at least 10 percent of its gross revenues on an annual 
basis from transactions with persons other than brokers, dealers, and 
persons associated with a broker or dealer.
    Exempted securities mutual fund means any security issued by an 
investment company registered under section 8 of the Investment Company 
Act of 1940 (15 U.S.C. 80a-8), provided the company has at least 95 
percent of its assets continuously invested in exempted securities (as 
defined in section 3(a)(12) of the Act).
    Foreign margin stock means a foreign security that is an equity 
security that:
    (1) Appears on the Board's periodically published List of Foreign 
Margin Stocks; or
    (2) Is deemed to have a ``ready market'' under SEC Rule 15c3-1 (17 
CFR 240.15c3-1) or a ``no-action'' position issued thereunder.
    Foreign person means a person other than a United States person as 
defined in section 7(f) of the Act.
    Foreign security means a security issued in a jurisdiction other 
than the United States.
    Good faith with respect to:
    (1) Margin means the amount of margin which a creditor would require 
in exercising sound credit judgment;
    (2) Making a determination or accepting a statement concerning a 
borrower means that the creditor is alert to the circumstances 
surrounding the credit, and if in possession of information that would 
cause a prudent person not to make the determination or accept the 
notice or certification without inquiry, investigates and is satisfied 
that it is correct.
    Margin call means a demand by a creditor to a customer for a deposit 
of additional cash or securities to eliminate or reduce a margin 
deficiency as required under this part.
    Margin deficiency means the amount by which the required margin 
exceeds the equity in the margin account.
    Margin equity security means a margin security that is an equity 
security (as defined in section 3(a)(11) of the Act).
    Margin excess means the amount by which the equity in the margin 
account exceeds the required margin. When the margin excess is 
represented by securities, the current value of the securities is 
subject to the percentages set forth in Sec. 220.12 (the Supplement).
    Margin security means:
    (1) Any security registered or having unlisted trading privileges on 
a national securities exchange;
    (2) After January 1, 1999, any security listed on the Nasdaq Stock 
Market;
    (3) Any non-equity security;
    (4) Any security issued by either an open-end investment company or 
unit investment trust which is registered

[[Page 8]]

under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a-8);
    (5) Any foreign margin stock;
    (6) Any debt security convertible into a margin security;
    (7) Until January 1, 1999, any OTC margin stock; or
    (8) Until January 1, 1999, any OTC security designated as qualified 
for trading in the national market system under a designation plan 
approved by the Securities and Exchange Commission (NMS security).
    Money market mutual fund means any security issued by an investment 
company registered under section 8 of the Investment Company Act of 1940 
(15 U.S.C. 80a-8) that is considered a money market fund under SEC Rule 
2a-7 (17 CFR 270.2a-7).
    Non-equity security means a security that is not an equity security 
(as defined in section 3(a)(11) of the Act).
    Nonexempted security means any security other than an exempted 
security (as defined in section 3(a)(12) of the Act).
    OTC margin stock means any equity security traded over the counter 
that the Board has determined has the degree of national investor 
interest, the depth and breadth of market, the availability of 
information respecting the security and its issuer, and the character 
and permanence of the issuer to warrant being treated like an equity 
security treaded on a national securities exchange. An OTC stock is not 
considered to be an OTC margin stock unless it appears on the Board's 
periodically published list of OTC margin stocks.
    Payment period means the number of business days in the standard 
securities settlement cycle in the United States, as defined in 
paragraph (a) of SEC Rule 15c6-1 (17 CFR 240.15c6-1(a)), plus two 
business days.
    Purpose credit means credit for the purpose of:
    (1) Buying, carrying, or trading in securities; or
    (2) Buying or carrying any part of an investment contract security 
which shall be deemed credit for the purpose of buying or carrying the 
entire security.
    Short call or short put means a call option or a put option that is 
issued, endorsed, or guaranteed in or for an account.
    (1) A short call that is not cash-settled obligates the customer to 
sell the underlying asset at the exercise price upon receipt of a valid 
exercise notice or as otherwise required by the option contract.
    (2) A short put that is not cash-settled obligates the customer to 
purchase the underlying asset at the exercise price upon receipt of a 
valid exercise notice or as otherwise required by the option contract.
    (3) A short call or a short put that is cash-settled obligates the 
customer to pay the holder of an in the money long put or long call who 
has, or has been deemed to have, exercised the option the cash 
difference between the exercise price and the current assigned value of 
the option as established by the option contract.
    Underlying asset means:
    (1) The security or other asset that will be delivered upon exercise 
of an option; or
    (2) In the case of a cash-settled option, the securities or other 
assets which comprise the index or other measure from which the option's 
value is derived.

[Reg. T, 63 FR 2821, Jan. 16, 1998]



Sec. 220.3  General provisions.

    (a) Records. The creditor shall maintain a record for each account 
showing the full details of all transactions.
    (b) Separation of accounts--(1) In general. The requirements of one 
account may not be met by considering items in any other account. If 
withdrawals of cash or securities are permitted under this part, written 
entries shall be made when cash or securities are used for purposes of 
meeting requirements in another account.
    (2) Exceptions. Notwithstanding paragraph (b)(1) of this section:
    (i) For purposes of calculating the required margin for a security 
in a margin account, assets held in the good faith account pursuant to 
Sec. 220.6(e)(1)(i) or (ii) may serve in lieu of margin;
    (ii) Transfers may be effected between the margin account and the 
special memorandum account pursuant to Secs. 220.4 and 220.5.

[[Page 9]]

    (c) Maintenance of credit. Except as prohibited by this part, any 
credit initially extended in compliance with this part may be maintained 
regardless of:
    (1) Reductions in the customer's equity resulting from changes in 
market prices;
    (2) Any security in an account ceasing to be margin or exempted; or
    (3) Any change in the margin requirements prescribed under this 
part.
    (d) Guarantee of accounts. No guarantee of a customer's account 
shall be given any effect for purposes of this part.
    (e) Receipt of funds or securities. (1) A creditor, acting in good 
faith, may accept as immediate payment:
    (i) Cash or any check, draft, or order payable on presentation; or
    (ii) Any security with sight draft attached.
    (2) A creditor may treat a security, check or draft as received upon 
written notification from another creditor that the specified security, 
check, or draft has been sent.
    (3) Upon notification that a check, draft, or order has been 
dishonored or when securities have not been received within a reasonable 
time, the creditor shall take the action required by this part when 
payment or securities are not received on time.
    (4) To temporarily finance a customer's receipt of securities 
pursuant to an employee benefit plan registered on SEC Form S-8 or the 
withholding taxes for an employee stock award plan, a creditor may 
accept, in lieu of the securities, a properly executed exercise notice, 
where applicable, and instructions to the issuer to deliver the stock to 
the creditor. Prior to acceptance, the creditor must verify that the 
issuer will deliver the securities promptly and the customer must 
designate the account into which the securities are to be deposited.
    (f) Exchange of securities. (1) To enable a customer to participate 
in an offer to exchange securities which is made to all holders of an 
issue of securities, a creditor may submit for exchange any securities 
held in a margin account, without regard to the other provisions of this 
part, provided the consideration received is deposited into the account.
    (2) If a nonmargin, nonexempted security is acquired in exchange for 
a margin security, its retention, withdrawal, or sale within 60 days 
following its acquisition shall be treated as if the security is a 
margin security.
    (g) Arranging for loans by others. A creditor may arrange for the 
extension or maintenance of credit to or for any customer by any person, 
provided the creditor does not willfully arrange credit that violates 
parts 221 or 224 of this chapter.
    (h) Innocent mistakes. If any failure to comply with this part 
results from a mistake made in good faith in executing a transaction or 
calculating the amount of margin, the creditor shall not be deemed in 
violation of this part if, promptly after the discovery of the mistake, 
the creditor takes appropriate corrective action.
    (i) Foreign currency. (1) Freely convertible foreign currency may be 
treated at its U.S. dollar equivalent, provided the currency is marked-
to-market daily.
    (2) A creditor may extend credit denominated in any freely 
convertible foreign currency.
    (j) Exempted borrowers. (1) A member of a national securities 
exchange or a registered broker or dealer that has been in existence for 
less than one year may meet the definition of exempted borrower based on 
a six-month period.
    (2) Once a member of a national securities exchange or registered 
broker or dealer ceases to qualify as an exempted borrower, it shall 
notify its lender of this fact before obtaining additional credit. Any 
new extensions of credit to such a borrower, including rollovers, 
renewals, and additional draws on existing lines of credit, are subject 
to the provisions of this part.

[Reg. T, 63 FR 2822, Jan. 16, 1998]



Sec. 220.4  Margin account.

    (a) Margin transactions. (1) All transactions not specifically 
authorized for inclusion in another account shall be recorded in the 
margin account.
    (2) A creditor may establish separate margin accounts for the same 
person to:

[[Page 10]]

    (i) Clear transactions for other creditors where the transactions 
are introduced to the clearing creditor by separate creditors; or
    (ii) Clear transactions through other creditors if the transactions 
are cleared by separate creditors; or
    (iii) Provide one or more accounts over which the creditor or a 
third party investment adviser has investment discretion.
    (b) Required margin--(1) Applicability. The required margin for each 
long or short position in securities is set forth in Sec. 220.12 (the 
Supplement) and is subject to the following exceptions and special 
provisions.
    (2) Short sale against the box. A short sale ``against the box'' 
shall be treated as a long sale for the purpose of computing the equity 
and the required margin.
    (3) When-issued securities. The required margin on a net long or net 
short commitment in a when-issued security is the margin that would be 
required if the security were an issued margin security, plus any 
unrealized loss on the commitment or less any unrealized gain.
    (4) Stock used as cover. (i) When a short position held in the 
account serves in lieu of the required margin for a short put, the 
amount prescribed by paragraph (b)(1) of this section as the amount to 
be added to the required margin in respect of short sales shall be 
increased by any unrealized loss on the position.
    (ii) When a security held in the account serves in lieu of the 
required margin for a short call, the security shall be valued at no 
greater than the exercise price of the short call.
    (5) Accounts of partners. If a partner of the creditor has a margin 
account with the creditor, the creditor shall disregard the partner's 
financial relations with the firm (as shown in the partner's capital and 
ordinary drawing accounts) in calculating the margin or equity of the 
partner's margin account.
    (6) Contribution to joint venture. If a margin account is the 
account of a joint venture in which the creditor participates, any 
interest of the creditor in the joint account in excess of the interest 
which the creditor would have on the basis of its right to share in the 
profits shall be treated as an extension of credit to the joint account 
and shall be margined as such.
    (7) Transfer of accounts. (i) A margin account that is transferred 
from one creditor to another may be treated as if it had been maintained 
by the transferee from the date of its origin, if the transferee 
accepts, in good faith, a signed statement of the transferor (or, if 
that is not practicable, of the customer), that any margin call issued 
under this part has been satisfied.
    (ii) A margin account that is transferred from one customer to 
another as part of a transaction, not undertaken to avoid the 
requirements of this part, may be treated as if it had been maintained 
for the transferee from the date of its origin, if the creditor accepts 
in good faith and keeps with the transferee account a signed statement 
of the transferor describing the circumstances for the transfer.
    (8) Sound credit judgment. In exercising sound credit judgment to 
determine the margin required in good faith pursuant to Sec. 220.12 (the 
Supplement), the creditor shall make its determination for a specified 
security position without regard to the customer's other assets or 
securities positions held in connection with unrelated transactions.
    (c) When additional margin is required--(1) Computing deficiency. 
All transactions on the same day shall be combined to determine whether 
additional margin is required by the creditor. For the purpose of 
computing equity in an account, security positions are established or 
eliminated and a credit or debit created on the trade date of a security 
transaction. Additional margin is required on any day when the day's 
transactions create or increase a margin deficiency in the account and 
shall be for the amount of the margin deficiency so created or 
increased.
    (2) Satisfaction of deficiency. The additional required margin may 
be satisfied by a transfer from the special memorandum account or by a 
deposit of cash, margin securities, exempted securities, or any 
combination thereof.
    (3) Time limits. (i) A margin call shall be satisfied within one 
payment period

[[Page 11]]

after the margin deficiency was created or increased.
    (ii) The payment period may be extended for one or more limited 
periods upon application by the creditor to its examining authority 
unless the examining authority believes that the creditor is not acting 
in good faith or that the creditor has not sufficiently determined that 
exceptional circumstances warrant such action. Applications shall be 
filed and acted upon prior to the end of the payment period or the 
expiration of any subsequent extension.
    (4) Satisfaction restriction. Any transaction, position, or deposit 
that is used to satisfy one requirement under this part shall be 
unavailable to satisfy any other requirement.
    (d) Liquidation in lieu of deposit. If any margin call is not met in 
full within the required time, the creditor shall liquidate securities 
sufficient to meet the margin call or to eliminate any margin deficiency 
existing on the day such liquidation is required, whichever is less. If 
the margin deficiency created or increased is $1000 or less, no action 
need be taken by the creditor.
    (e) Withdrawals of cash or securities. (1) Cash or securities may be 
withdrawn from an account, except if:
    (i) Additional cash or securities are required to be deposited into 
the account for a transaction on the same or a previous day; or
    (ii) The withdrawal, together with other transactions, deposits, and 
withdrawals on the same day, would create or increase a margin 
deficiency.
    (2) Margin excess may be withdrawn or may be transferred to the 
special memorandum account (Sec. 220.5) by making a single entry to that 
account which will represent a debit to the margin account and a credit 
to the special memorandum account.
    (3) If a creditor does not receive a distribution of cash or 
securities which is payable with respect to any security in a margin 
account on the day it is payable and withdrawal would not be permitted 
under this paragraph (e), a withdrawal transaction shall be deemed to 
have occurred on the day the distribution is payable.
    (f) Interest, service charges, etc. (1) Without regard to the other 
provisions of this section, the creditor, in its usual practice, may 
debit the following items to a margin account if they are considered in 
calculating the balance of such account:
    (i) Interest charged on credit maintained in the margin account;
    (ii) Premiums on securities borrowed in connection with short sales 
or to effect delivery;
    (iii) Dividends, interest, or other distributions due on borrowed 
securities;
    (iv) Communication or shipping charges with respect to transactions 
in the margin account; and
    (v) Any other service charges which the creditor may impose.
    (2) A creditor may permit interest, dividends, or other 
distributions credited to a margin account to be withdrawn from the 
account if:
    (i) The withdrawal does not create or increase a margin deficiency 
in the account; or
    (ii) The current market value of any securities withdrawn does not 
exceed 10 percent of the current market value of the security with 
respect to which they were distributed.

[Reg. T, 63 FR 2823, Jan. 16, 1998]



Sec. 220.5  Special memorandum account.

    (a) A special memorandum account (SMA) may be maintained in 
conjunction with a margin account. A single entry amount may be used to 
represent both a credit to the SMA and a debit to the margin account. A 
transfer between the two accounts may be effected by an increase or 
reduction in the entry. When computing the equity in a margin account, 
the single entry amount shall be considered as a debit in the margin 
account. A payment to the customer or on the customer's behalf or a 
transfer to any of the customer's other accounts from the SMA reduces 
the single entry amount.
    (b) The SMA may contain the following entries:
    (1) Dividend and interest payments;
    (2) Cash not required by this part, including cash deposited to meet 
a maintenance margin call or to meet any requirement of a self-
regulatory organization that is not imposed by this part;
    (3) Proceeds of a sale of securities or cash no longer required on 
any expired or liquidated security position that may be withdrawn under 
Sec. 220.4(e); and

[[Page 12]]

    (4) Margin excess transferred from the margin account under 
Sec. 220.4(e)(2).

[Reg. T, 63 FR 2824, Jan. 16, 1998]



Sec. 220.6  Good faith account.

    In a good faith account, a creditor may effect or finance customer 
transactions in accordance with the following provisions:
    (a) Securities entitled to good faith margin--(1) Permissible 
transactions. A creditor may effect and finance transactions involving 
the buying, carrying, or trading of any security entitled to ``good 
faith'' margin as set forth in Sec. 220.12 (the Supplement).
    (2) Required margin. The required margin is set forth in Sec. 220.12 
(the Supplement).
    (3) Satisfaction of margin. Required margin may be satisfied by a 
transfer from the special memorandum account or by a deposit of cash, 
securities entitled to ``good faith'' margin as set forth in Sec. 220.12 
(the Supplement), any other asset that is not a security, or any 
combination thereof. An asset that is not a security shall have a margin 
value determined by the creditor in good faith.
    (b) Arbitrage. A creditor may effect and finance for any customer 
bona fide arbitrage transactions. For the purpose of this section, the 
term ``bona fide arbitrage'' means:
    (1) A purchase or sale of a security in one market together with an 
offsetting sale or purchase of the same security in a different market 
at as nearly the same time as practicable for the purpose of taking 
advantage of a difference in prices in the two markets; or
    (2) A purchase of a security which is, without restriction other 
than the payment of money, exchangeable or convertible within 90 
calendar days of the purchase into a second security together with an 
offsetting sale of the second security at or about the same time, for 
the purpose of taking advantage of a concurrent disparity in the prices 
of the two securities.
    (c) ``Prime broker'' transactions. A creditor may effect 
transactions for a customer as part of a ``prime broker'' arrangement in 
conformity with SEC guidelines.
    (d) Credit to ESOPs. A creditor may extend and maintain credit to 
employee stock ownership plans without regard to the other provisions of 
this part.
    (e) Nonpurpose credit. (1) A creditor may:
    (i) Effect and carry transactions in commodities;
    (ii) Effect and carry transactions in foreign exchange;
    (iii) Extend and maintain secured or unsecured nonpurpose credit, 
subject to the requirements of paragraph (e)(2) of this section.
    (2) Every extension of credit, except as provided in paragraphs 
(e)(1)(i) and (e)(1)(ii) of this section, shall be deemed to be purpose 
credit unless, prior to extending the credit, the creditor accepts in 
good faith from the customer a written statement that it is not purpose 
credit. The statement shall conform to the requirements established by 
the Board.

[Reg. T, 63 FR 2824, Jan. 16, 1998]



Sec. 220.7  Broker-dealer credit account.

    (a) Requirements. In a broker-dealer credit account, a creditor may 
effect or finance transactions in accordance with the following 
provisions.
    (b) Purchase or sale of security against full payment. A creditor 
may purchase any security from or sell any security to another creditor 
or person regulated by a foreign securities authority under a good faith 
agreement to promptly deliver the security against full payment of the 
purchase price.
    (c) Joint back office. A creditor may effect or finance transactions 
of any of its owners if the creditor is a clearing and servicing broker 
or dealer owned jointly or individually by other creditors.
    (d) Capital contribution. A creditor may extend and maintain credit 
to any partner or stockholder of the creditor for the purpose of making 
a capital contribution to, or purchasing stock of, the creditor, 
affiliated corporation or another creditor.
    (e) Emergency and subordinated credit. A creditor may extend and 
maintain, with the approval of the appropriate examining authority:
    (1) Credit to meet the emergency needs of any creditor; or

[[Page 13]]

    (2) Subordinated credit to another creditor for capital purposes, if 
the other creditor:
    (i) Is an affiliated corporation or would not be considered a 
customer of the lender apart from the subordinated loan; or
    (ii) Will not use the proceeds of the loan to increase the amount of 
dealing in securities for the account of the creditor, its firm or 
corporation or an affiliated corporation.
    (f) Omnibus credit (1) A creditor may effect and finance 
transactions for a broker or dealer who is registered with the SEC under 
section 15 of the Act and who gives the creditor written notice that:
    (i) All securities will be for the account of customers of the 
broker or dealer; and
    (ii) Any short sales effected will be short sales made on behalf of 
the customers of the broker or dealer other than partners.
    (2) The written notice required by paragraph (f)(1) of this section 
shall conform to any SEC rule on the hypothecation of customers' 
securities by brokers or dealers.
    (g) Special purpose credit. A creditor may extend the following 
types of credit with good faith margin:
    (1) Credit to finance the purchase or sale of securities for prompt 
delivery, if the credit is to be repaid upon completion of the 
transaction.
    (2) Credit to finance securities in transit or surrendered for 
transfer, if the credit is to be repaid upon completion of the 
transaction.
    (3) Credit to enable a broker or dealer to pay for securities, if 
the credit is to be repaid on the same day it is extended.
    (4) Credit to an exempted borrower.
    (5) Credit to a member of a national securities exchange or 
registered broker or dealer to finance its activities as a market maker 
or specialist.
    (6) Credit to a member of a national securities exchange or 
registered broker or dealer to finance its activities as an underwriter.

[Reg. T, 63 FR 2824, Jan. 16, 1998]



Sec. 220.8  Cash account.

    (a) Permissible transactions. In a cash account, a creditor, may:
    (1) Buy for or sell to any customer any security or other asset if:
    (i) There are sufficient funds in the account; or
    (ii) The creditor accepts in good faith the customer's agreement 
that the customer will promptly make full cash payment for the security 
or asset before selling it and does not contemplate selling it prior to 
making such payment;
    (2) Buy from or sell for any customer any security or other asset 
if:
    (i) The security is held in the account; or
    (ii) The creditor accepts in good faith the customer's statement 
that the security is owned by the customer or the customer's principal, 
and that it will be promptly deposited in the account;
    (3) Issue, endorse, or guarantee, or sell an option for any customer 
as part of a covered option transaction; and
    (4) Use an escrow agreement in lieu of the cash, cash equivalents or 
underlying asset position if:
    (i) In the case of a short call or a short put, the creditor is 
advised by the customer that the required securities, assets or cash are 
held by a person authorized to issue an escrow agreement and the 
creditor independently verifies that the appropriate escrow agreement 
will be delivered by the person promptly; or
    (ii) In the case of a call issued, endorsed, guaranteed, or sold on 
the same day the underlying asset is purchased in the account and the 
underlying asset is to be delivered to a person authorized to issue an 
escrow agreement, the creditor verifies that the appropriate escrow 
agreement will be delivered by the person promptly.
    (b) Time periods for payment; cancellation or liquidation. (1) Full 
cash payment. A creditor shall obtain full cash payment for customer 
purchases:
    (i) Within one payment period of the date:
    (A) Any nonexempted security was purchased;
    (B) Any when-issued security was made available by the issuer for 
delivery to purchasers;
    (C) Any ``when distributed'' security was distributed under a 
published plan;

[[Page 14]]

    (D) A security owned by the customer has matured or has been 
redeemed and a new refunding security of the same issuer has been 
purchased by the customer, provided:
    (1) The customer purchased the new security no more than 35 calendar 
days prior to the date of maturity or redemption of the old security;
    (2) The customer is entitled to the proceeds of the redemption; and
    (3) The delayed payment does not exceed 103 percent of the proceeds 
of the old security.
    (ii) In the case of the purchase of a foreign security, within one 
payment period of the trade date or within one day after the date on 
which settlement is required to occur by the rules of the foreign 
securities market, provided this period does not exceed the maximum time 
permitted by this part for delivery against payment transactions.
    (2) Delivery against payment. If a creditor purchases for or sells 
to a customer a security in a delivery against payment transaction, the 
creditor shall have up to 35 calendar days to obtain payment if delivery 
of the security is delayed due to the mechanics of the transaction and 
is not related to the customer's willingness or ability to pay.
    (3) Shipment of securities, extension. If any shipment of securities 
is incidental to consummation of a transaction, a creditor may extend 
the payment period by the number of days required for shipment, but not 
by more than one additional payment period.
    (4) Cancellation; liquidation; minimum amount. A creditor shall 
promptly cancel or otherwise liquidate a transaction or any part of a 
transaction for which the customer has not made full cash payment within 
the required time. A creditor may, at its option, disregard any sum due 
from the customer not exceeding $1000.
    (c) 90 day freeze. (1) If a nonexempted security in the account is 
sold or delivered to another broker or dealer without having been 
previously paid for in full by the customer, the privilege of delaying 
payment beyond the trade date shall be withdrawn for 90 calendar days 
following the date of sale of the security. Cancellation of the 
transaction other than to correct an error shall constitute a sale.
    (2) The 90 day freeze shall not apply if:
    (i) Within the period specified in paragraph (b)(1) of this section, 
full payment is received or any check or draft in payment has cleared 
and the proceeds from the sale are not withdrawn prior to such payment 
or check clearance; or
    (ii) The purchased security was delivered to another broker or 
dealer for deposit in a cash account which holds sufficient funds to pay 
for the security. The creditor may rely on a written statement accepted 
in good faith from the other broker or dealer that sufficient funds are 
held in the other cash account.
    (d) Extension of time periods; transfers. (1) Unless the creditor's 
examining authority believes that the creditor is not acting in good 
faith or that the creditor has not sufficiently determined that 
exceptional circumstances warrant such action, it may upon application 
by the creditor:
    (i) Extend any period specified in paragraph (b) of this section;
    (ii) Authorize transfer to another account of any transaction 
involving the purchase of a margin or exempted security; or
    (iii) Grant a waiver from the 90 day freeze.
    (2) Applications shall be filed and acted upon prior to the end of 
the payment period, or in the case of the purchase of a foreign security 
within the period specified in paragraph (b)(1)(ii) of this section, or 
the expiration of any subsequent extension.

[Reg. T, 63 FR 2825, Jan. 16, 1998]



Sec. 220.9  Clearance of securities, options, and futures.

    (a) Credit for clearance of securities. The provisions of this part 
shall not apply to the extension or maintenance of any credit that is 
not for more than one day if it is incidental to the clearance of 
transactions in securities directly between members of a national 
securities exchange or association or through any clearing agency 
registered with the SEC.
    (b) Deposit of securities with a clearing agency. The provisions of 
this part

[[Page 15]]

shall not apply to the deposit of securities with an option or futures 
clearing agency for the purpose of meeting the deposit requirements of 
the agency if:
    (1) The clearing agency:
    (i) Issues, guarantees performance on, or clears transactions in, 
any security (including options on any security, certificate of deposit, 
securities index or foreign currency); or
    (ii) Guarantees performance of contracts for the purchase or sale of 
a commodity for future delivery or options on such contracts;
    (2) The clearing agency is registered with the Securities and 
Exchange Commission or is the clearing agency for a contract market 
regulated by the Commodity Futures Trading Commission; and
    (3) The deposit consists of any margin security and complies with 
the rules of the clearing agency that have been approved by the 
Securities and Exchange Commission or the Commodity Futures Trading 
Commission.

[Reg. T, 63 FR 2826, Jan. 16, 1998]



Sec. 220.10  Borrowing and lending securities.

    (a) Without regard to the other provisions of this part, a creditor 
may borrow or lend securities for the purpose of making delivery of the 
securities in the case of short sales, failure to receive securities 
required to be delivered, or other similar situations. If a creditor 
reasonably anticipates a short sale or fail transaction, such borrowing 
may be made up to one standard settlement cycle in advance of trade 
date.
    (b) A creditor may lend foreign securities to a foreign person (or 
borrow such securities for the purpose of relending them to a foreign 
person) for any purpose lawful in the country in which they are to be 
used.
    (c) A creditor that is an exempted borrower may lend securities 
without regard to the other provisions of this part and a creditor may 
borrow securities from an exempted borrower without regard to the other 
provisions of this part.

[Reg. T, 63 FR 2826, Jan. 16, 1998]



Sec. 220.11  Requirements for the list of marginable OTC stocks and the list of foreign margin stocks.

    (a) Requirements for inclusion on the list of marginable OTC stocks. 
Except as provided in paragraph (f) of this section, OTC margin stock 
shall meet the following requirements:
    (1) Four or more dealers stand willing to, and do in fact, make a 
market in such stock and regularly submit bona fide bids and offers to 
an automated quotations system for their own accounts;
    (2) The minimum average bid price of such stock, as determined by 
the Board, is at least $5 per share;
    (3) The stock is registered under section 12 of the Act, is issued 
by an insurance company subject to section 12(g)(2)(G) of the Act, is 
issued by a closed-end investment management company subject to 
registration pursuant to section 8 of the Investment Company Act of 1940 
(15 U.S.C. 80a-8), is an American Depository Receipt (ADR) of a foreign 
issuer whose securities are registered under section 12 of the Act, or 
is a stock of an issuer required to file reports under section 15(d) of 
the Act;
    (4) Daily quotations for both bid and asked prices for the stock are 
continously available to the general public;
    (5) The stock has been publicly traded for at least six months;
    (6) The issuer has at least $4 million of capital, surplus, and 
undivided profits;
    (7) There are 400,000 or more shares of such stock outstanding in 
addition to shares held beneficially by officers, directors or 
beneficial owners of more than 10 percent of the stock;
    (8) There are 1,200 or more holders of record, as defined in SEC 
Rule 12g5-1 (17 CFR 240.12g5-1), of the stock who are not officers, 
directors or beneficial owners of 10 percent or more of the stock, or 
the average daily trading volume of such stock as determined by the 
Board, is at least 500 shares; and
    (9) The issuer or a predecessor in interest has been in existence 
for at least three years.
    (b) Requirements for continued inclusion on the list of marginable 
OTC stocks. Except as provided in paragraph (f) of

[[Page 16]]

this section, OTC margin stock shall meet the following requirements:
    (1) Three or more dealers stand willing to, and do in fact, make a 
market in such stock and regularly submit bona fide bids and offers to 
an automated quotations system for their own accounts;
    (2) The minimum average bid price of such stocks, as determined by 
the Board, is at least $2 per share;
    (3) The stock is registered as specified in paragraph (a)(3) of this 
section;
    (4) Daily quotations for both bid and asked prices for the stock are 
continuously available to the general public; ;
    (5) The issuer has at least $1 million of capital, surplus, and 
undivided profits;
    (6) There are 300,000 or more shares of such stock outstanding in 
addition to shares held beneficially by officers, directors, or 
beneficial owners of more than 10 percent of the stock; and
    (7) There continue to be 800 or more holders of record, as defined 
in SEC Rule 12g5-1 (17 CFR 240.12g5-1), of the stock who are not 
officers, directors, or beneficial owners of 10 percent or more of the 
stock, or the average daily trading volume of such stock, as determined 
by the Board, is at least 300 shares.
    (c) Requirements for inclusion on the list of foreign margin stocks. 
Except as provided in paragraph (f) of this section, a foreign security 
shall meet the following requirements before being placed on the List of 
Foreign Margin Stocks:
    (1) The security is an equity security that is listed for trading on 
or through the facilities of a foreign securities exchange or a 
recognized foreign securities market and has been trading on such 
exchange or market for at least six months;
    (2) Daily quotations for both bid and asked or last sale prices for 
the security provided by the foreign securities exchange or foreign 
securities market on which the security is traded are continuously 
available to creditors in the United States pursuant to an electronic 
quotation system;
    (3) The aggregate market value of shares, the ownership of which is 
unrestricted, is not less than $1 billion;
    (4) The average weekly trading volume of such security during the 
preceding six months is either at least 200,000 shares or $1 million; 
and
    (5) The issuer or a predecessor in interest has been in existence 
for at least five years.
    (d) Requirements for continued inclusion on the list of foreign 
margin stocks. Except as provided in paragraph (f) of this section, a 
foreign security shall meet the following requirements to remain on the 
List of Foreign Margin Stocks:
    (1) The security continues to meet the requirements specified in 
paragraphs (c) (1) and (2) of this section;
    (2) The aggregate market value of shares, the ownership of which is 
unrestricted, is not less than $500 million; and
    (3) The average weekly trading volume of such security during the 
preceding six months is either at least 100,000 shares or $500,000.
    (e) Removal from the list. The Board shall periodically remove from 
the lists any stock that:
    (1) Ceases to exist or of which the issuer ceases to exist; or
    (2) No longer substantially meets the provisions of paragraphs (b) 
or (d) of this section or the definition of OTC margin stock.
    (f) Discretionary authority of Board. Without regard to other 
paragraphs of this section, the Board may add to, or omit or remove from 
the list of marginable OTC stocks and the list of foreign margin stocks 
an equity security, if in the judgment of the Board, such action is 
necessary or appropriate in the public interest.
    (g) Unlawful representations. It shall be unlawful for any creditor 
to make, or cause to be made, any representation to the effect that the 
inclusion of a security on the list of marginable OTC stocks or the list 
of foreign margin stocks is evidence that the Board or the SEC has in 
any way passed upon the merits of, or given approval to, such security 
or any transactions therein. Any statement in an advertisement or other 
similar communication containing a reference to the Board in connection 
with the lists or

[[Page 17]]

stocks on those lists shall be an unlawful representation.

[Reg. T, 63 FR 2826, Jan. 16, 1998]



Sec. 220.12  Supplement: margin requirements.

    The required margin for each security position held in a margin 
account shall be as follows:
    (a) Margin equity security, except for an exempted security, money 
market mutual fund or exempted securities mutual fund, warrant on a 
securities index or foreign currency or a long position in an option: 50 
percent of the current market value of the security or the percentage 
set by the regulatory authority where the trade occurs, whichever is 
greater.
    (b) Exempted security, non-equity security, money market mutual fund 
or exempted securities mutual fund: The margin required by the creditor 
in good faith or the percentage set by the regulatory authority where 
the trade occurs, whichever is greater.
    (c) Short sale of a nonexempted security, except for a non-equity 
security:
    (1) 150 percent of the current market value of the security; or
    (2) 100 percent of the current market value if a security 
exchangeable or convertible within 90 calendar days without restriction 
other than the payment of money into the security sold short is held in 
the account, provided that any long call to be used as margin in 
connection with a short sale of the underlying security is an American-
style option issued by a registered clearing corporation and listed or 
traded on a registered national securities exchange with an exercise 
price that does not exceed the price at which the underlying security 
was sold short.
    (d) Short sale of an exempted security or non-equity security: 100 
percent of the current market value of the security plus the margin 
required by the creditor in good faith.
    (e) Nonmargin, nonexempted equity security: 100 percent of the 
current market value.
    (f) Put or call on a security, certificate of deposit, securities 
index or foreign currency or a warrant on a securities index or foreign 
currency:
    (1) In the case of puts and calls issued by a registered clearing 
corporation and listed or traded on a registered national securities 
exchange or a registered securities association and registered warrants 
on a securities index or foreign currency, the amount, or other position 
specified by the rules of the registered national securities exchange or 
the registered securities association authorized to trade the option or 
warrant, provided that all such rules have been approved or amended by 
the SEC; or
    (2) In the case of all other puts and calls, the amount, or other 
position, specified by the maintenance rules of the creditor's examining 
authority.

[Reg. T, 63 FR 2827, Jan. 16, 1998]

                             Interpretations



Sec. 220.101  Transactions of customers who are brokers or dealers.

    The Board has recently considered certain questions regarding 
transactions of customers who are brokers or dealers.
    (a) The first question was whether delivery and payment under 
Sec. 220.4(f)(3) must be exactly simultaneous (such as in sight draft 
shipments), or whether it is sufficient if the broker-dealer customer, 
``as promptly as practicable in accordance with the ordinary usage of 
the trade,'' mails or otherwise delivers to the creditor a check in 
settlement of the transaction, the check being accompanied by 
instructions for transfer or delivery of the security. The Board ruled 
that the latter method of setting the transaction is permissible.
    (b) The second question was, in effect, whether the limitations of 
Sec. 220.4(c)(8) apply to the account of a customer who is himself a 
broker or dealer. The answer is that the provision applies to any 
``special cash account,'' regardless of the type of customer.
    (c) The third question was, in effect, whether a purchase and a sale 
of an unissued security under Sec. 220.4(f)(3) may be offset against 
each other, or whether each must be settled separately by what would 
amount to delivery of the security to settle one transaction and its 
redelivery to settle the other. The answer is that it is permissible to 
offset the transactions against each other

[[Page 18]]

without physical delivery and redelivery of the security.

[11 FR 14155, Dec. 7, 1946]



Sec. 220.102  [Reserved]



Sec. 220.103  Borrowing of securities.

    (a) The Board of Governors has been asked for a ruling as to whether 
Sec. 220.6(h), which deals with borrowing and lending of securities, 
applies to a borrower of securities if the lender is a private 
individual, as contrasted with a member of a national securities 
exchange or a broker or dealer.
    (b) Section 220.6(h) does not require that the lender of the 
securities in such a case be a member of a national securities exchange 
or a broker or dealer. Therefore, a borrowing of securities may be able 
to qualify under the provision even though the lender is a private 
individual, and this is true whether the security is registered on a 
national securities exchange or is unregistered. In borrowing securities 
from a private individual under Sec. 220.6(h), however, it becomes 
especially important to bear in mind two limitations that are contained 
in the section.
    (c) The first limitation is that the section applies only if the 
broker borrows the securities for the purpose specified in the 
provision, that is, ``for the purpose of making delivery of such 
securities in the case of short sales, failure to receive securities he 
is required to deliver, or other similar cases''. The present language 
of the provision does not require that the delivery for which the 
securities are borrowed must be on a transaction which the borrower has 
himself made, either as agent or as principal; he may borrow under the 
provision in order to relend to someone else for the latter person to 
make such a delivery. However, the borrowing must be related to an 
actual delivery of the type specified--a delivery in connection with a 
specific transaction that has already occurred or is in immediate 
prospect. The provision does not authorize a broker to borrow securities 
(or make the related deposit) merely in order that he or some other 
broker may have the securities ``on hand'' or may anticipate some need 
that may or may not arise in the future.
    (d) The ruling in the 1940 Federal Reserve Bulletin, at page 647, is 
an example of a borrowing which, on the facts as given, did not meet the 
requirement. There, the broker wished to borrow stocks with the 
understanding that he ``would offer to lend this stock in the `loan 
crowd' on a national securities exchange.'' There was no assurance that 
the stocks would be used for the purpose specified in Sec. 220.6(h); 
they might be, or they might merely be held idle while the person 
lending the stocks had the use of the funds deposited against them. The 
ruling held in effect that since the borrowing could not qualify under 
Sec. 220.6(h) it must comply with other applicable provisions of the 
regulation.
    (e) The second requirement is that the deposit of cash against the 
borrowed securities must be ``bona fide.'' This requirement naturally 
cannot be spelled out in detail, but it requires at least that the 
purpose of the broker in making the deposit should be to obtain the 
securities for the specified purpose, and that he should not use the 
arrangement as a means of accommodating a customer who is seeking to 
obtain more funds than he could get in a general account.
    (f) The Board recognizes that even with these requirements there is 
still some possibility that the provision may be misapplied. The Board 
is reluctant to impose additional burdens on legitimate transactions by 
tightening the provision. If there should be evidence of abuses 
developing under the provision, however, it would become necessary to 
consider making it more restricted.

[12 FR 5278, Aug. 2, 1947]



Sec. 220.104  [Reserved]



Sec. 220.105  Ninety-day rule in special cash account.

    (a) Section 220.4(c)(8) places a limitation on a special cash 
account if a security other than an exempted security has been purchased 
in the account and ``without having been previously paid for in full by 
the customer * * * has been * * * delivered out to any broker or 
dealer.'' The limitation is that during the succeeding 90 days the 
customer may not purchase a security in

[[Page 19]]

the account other than an exempted security unless funds sufficient for 
the purpose are held in the account. In other words, the privilege of 
delayed payment in such an account is withdrawn during the 90-day 
period.
    (b) The Board recently considered a question as to whether the 
following situation makes an account subject to the 90-day 
disqualification: A customer purchases registered security ABC in a 
special cash account. The broker executes the order in good faith as a 
bona fide cash transaction, expecting to obtain full cash payment 
promptly. The next day, the customer sells registered security XYZ in 
the account, promising to deposit it promptly in the account. The 
proceeds of the sale are equal to or greater than the cost of security 
ABC. After both sale and purchase have been made, the customer requests 
the broker to deliver security ABC to a different broker, to receive 
security XYZ from that broker at about the same time, and to settle with 
the other broker--such settlement to be made either by paying the cost 
of security XYZ to the other broker and receiving from him the cost of 
security ABC, or by merely settling any difference between these 
amounts.
    (c) The Board expressed the view that the account becomes subject to 
the 90-day disqualification in Sec. 220.4(c)(8). In the instant case, 
unlike that described at 1940 Federal Reserve Bulletin 772, the security 
sold is not held in the account and is not to be deposited in it 
unconditionally. It is to be obtained only against the delivery to the 
other broker of the security which had been purchased. Hence payment can 
not be said to have been made prior to such delivery; the purchased 
security has been delivered out to a broker without previously having 
been paid for in full, and the account becomes subject to the 90-day 
disqualification.

[13 FR 2368, May 1, 1948]



Secs. 220.106-220.107  [Reserved]



Sec. 220.108  International Bank Securities.

    (a) Section 2 of the Act of June 29, 1949 (Pub. L. 142--81st 
Congress), amended the Bretton Woods Agreements Act by adding a new 
section numbered 15 providing, in part, that--

    Any securities issued by International Bank for Reconstruction and 
Development (including any guaranty by the bank, whether or not limited 
in scope), and any securities guaranteed by the bank as to both 
principal and interest, shall be deemed to be exempted securities within 
the meaning of * * * paragraph (a)(12) of section 3 of the [Securities 
Exchange] Act of June 6, 1934, as amended (15 U.S.C. 78c). * * *.

    (b) In response to inquiries with respect to the applicability of 
the margin requirements of this part to securities issued or guaranteed 
by the International Bank for Reconstruction and Development, the Board 
has replied that, as a result of this enactment, securities issued by 
the Bank are now classified as exempted securities under Sec. 220.2(e). 
Such securities are now in the same category under this part as are 
United States Government, State and municipal bonds. Accordingly, the 
specific percentage limitations prescribed by this part with respect to 
maximum loan value and margin requirements are no longer applicable 
thereto.

[14 FR 5505, Sept. 7, 1949]



Sec. 220.109  [Reserved]



Sec. 220.110  Assistance by Federal credit union to its members.

    (a) An inquiry was presented recently concerning the application of 
this part or part 221 of this subchapter, to a plan proposed by a 
Federal credit union to aid its members in purchasing stock of a 
corporation whose subsidiary apparently was the employer of all the 
credit union's members.
    (b) From the information submitted, the plan appeared to contemplate 
that the Federal credit union would accept orders from its members for 
registered common stock of the parent corporation in multiples of 5 
shares; that whenever orders had been so received for a total of 100 
shares, the credit union, as agent for such members, would execute the 
orders through a brokerage firm with membership on a national securities 
exchange; that the brokerage firm would deliver certificates for the 
stock, registered in the names of the individual purchasers, to the 
credit union against payment by

[[Page 20]]

the credit union; that the credit union would prorate the total amount 
so paid, including the brokerage fee, among the individual purchasers 
according to the number of shares purchased by them; and that a savings 
in brokerage fee resulting from the 100-lot purchases would be passed on 
by the credit union to the individual purchasers of the stock. However, 
amounts of the stock less than 100 shares would be purchased by the 
credit union through the brokerage firm for any members willing to 
forego such savings.
    (c) It appeared further that the Federal credit union members for 
whom stock was so purchased would reimburse the credit union (1) by cash 
payment, (2) by the proceeds of withdrawn shares of the credit union, 
(3) by the proceeds of an installment loan from the credit union 
collateraled by the stock purchased, or by (4) by a combination of two 
or more of the above methods. To assist the collection of any such loan, 
the employer of the credit union members would provide payroll 
deductions. Apparently, sales by the credit union of any of the stock 
purchased by one of its members would occur only in satisfaction of a 
delinquent loan balance. In no case did it appear that the credit union 
would make a charge for arranging the execution of transactions in the 
stock for its members.
    (d) The Board was of the view that, from the facts as presented, it 
did not appear that the Federal credit union should be regarded as the 
type of institution to which part 221 of this subchapter, in its present 
form, applied.
    (e) With respect to this part, the question was whether the 
activities of the Federal credit union under the proposal, or otherwise, 
might be such as to bring it within the meaning of the terms ``broker'' 
or ``dealer'' as used in the part and the Securities Exchange Act of 
1934. The Board observed that this, of course, was a question of fact 
that necessarily depended upon the circumstances of the particular case, 
including the manner in which the arrangement in question might be 
carried out in practice.
    (f) On the basis of the information submitted, however, it did not 
appear to the Board that the Federal credit union should be regarded as 
being subject to this part as a ``broker or dealer who transacts a 
business in securities through the medium of'' a member firm solely 
because of its activities as contemplated by the proposal in question. 
The Board stated that the part rather clearly would not apply if there 
appeared to be nothing other than loans by the credit union to its 
members to finance purchases made directly by them of stock of the 
parent corporation of the employer of the member-borrowers. The 
additional fact that the credit union, as agent, would purchase such 
stock for its members (even though all such purchases might not be 
financed by credit union loans) was not viewed by the Board as 
sufficient to make the regulation applicable where, as from the facts 
presented, it did not appear that the credit union in any case was to 
make any charge or receive any compensation for assisting in such 
purchases or that the credit union otherwise was engaged in securities 
activities. However, the Board stated that matters of this kind must be 
examined closely for any variations that might suggest the 
inapplicability of the foregoing.

[18 FR 4592, Aug. 5, 1953]



Sec. 220.111  Arranging for extensions of credit to be made by a bank.

    (a) The Board has recently had occasion to express opinions 
regarding the requirements which apply when a person subject to this 
part (for convenience, called here simply a broker) arranges for a bank 
to extend credit.
    (b) The matter is treated generally in Sec. 220.7(a) and is also 
subject to the general rule of law that any person who aids or abets a 
violation of law by another is himself guilty of a violation. It may be 
stated as a general principle that any person who arranges for credit to 
be extended by someone else has a responsibility so to conduct his 
activities as not to be a participant in a violation of this part, which 
applies to brokers, or part 221 of this subchapter, which applies to 
banks.
    (c) More specifically, in arranging an extension of credit that may 
be subject to part 221 of this subchapter, a broker must act in good 
faith and, therefore,

[[Page 21]]

must question the accuracy of any non-purpose statement (i.e., a 
statement that the loan is not for the purpose of purchasing or carrying 
registered stocks) given in connection with the loan where the 
circumstances are such that the broker from any source knows or has 
reason to know that the statement is incomplete or otherwise inaccurate 
as to the true purpose of the credit. The requirement of ``good faith'' 
is of vital importance. While the application of the requirement will 
necessarily vary with the facts of the particular case, the broker, like 
the bank for whom the loan is arranged to be made, must be alert to the 
circumstances surrounding the loan. Thus, for example, if a broker or 
dealer is to deliver registered stocks to secure the loan or is to 
receive the proceeds of the loan, the broker arranging the loan and the 
bank making it would be put on notice that the loan would probably be 
subject to part 221 of this subchapter. In any such circumstances they 
could not in good faith accept or rely upon a statement to the contrary 
without obtaining a reliable and satisfactory explanation of the 
situation. The foregoing, of course, applies the principles contained in 
Sec. 221.101 of this subchapter.
    (d) In addition, when a broker is approached by another broker to 
arrange extensions of credit for customers of the approaching broker, 
the broker approached has a responsibility not to arrange any extension 
of credit which the approaching broker could not himself arrange. 
Accordingly, in such cases the statutes and regulations forbid the 
approached broker to arrange extensions of credit on unregistered 
securities for the purpose of purchasing or carrying either registered 
or unregistered securities. The approaching broker would also be 
violating the applicable requirements if he initiated or otherwise 
participated in any such forbidden transactions.
    (e) The expression of views, set forth in this section, to the 
effect that certain specific transactions are forbidden, of course, 
should not in any way be understood to indicate approval of any other 
transactions which are not mentioned.

[18 FR 5505, Sept. 15, 1953]



Sec. 220.112  [Reserved]



Sec. 220.113  Necessity for prompt payment and delivery in special cash accounts.

    (a) The Board of Governors recently received an inquiry concerning 
whether purchases of securities by certain municipal employees' 
retirement or pension systems on the basis of arrangements for delayed 
delivery and payment, might properly be effected by a creditor subject 
to this part in a special cash account under Sec. 220.4(c).
    (b) It appears that in a typical case the supervisors of the 
retirement system meet only once or twice each month, at which times 
decisions are made to purchase any securities wished to be acquired for 
the system. Although the securities are available for prompt delivery by 
the broker-dealer firm selected to effect the system's purchase, it is 
arranged in advance with the firm that the system will not accept 
delivery and pay for the securities before some date more than seven 
business days after the date on which the securities are purchased. 
Apparently, such an arrangement is occasioned by the monthly or 
semimonthly meetings of the system's supervisors. It was indicated that 
a retirement system of this kind may be supervised by officials who 
administer it as an incidental part of their regular duties, and that 
meetings requiring joint action by two or more supervisors may be 
necessary under the system's rules and procedures to authorize issuance 
of checks in payment for the securities purchased. It was indicated also 
that the purchases do not involve exempted securities, securities of the 
kind covered by Sec. 220.4(c)(3), or any shipment of securities as 
described in Sec. 220.4(c).
    (c) This part provides that a creditor subject thereto may not 
effect for a customer a purchase in a special cash account under 
Sec. 220.4(c) unless the use of the account meets the limitations of 
Sec. 220.4(a) and the purchase constitutes a ``bona fide cash 
transaction'' which complies with the eligibility requirements of 
Sec. 220.4(c)(1)(i). One such requirement is that the purchase be made 
``in reliance upon an agreement accepted by the creditor (broker-dealer) 
in good faith'' that the customer

[[Page 22]]

will ``promptly make full cash payment for the security, if funds 
sufficient for the purpose are not already in the account; and, subject 
to certain exceptions, Sec. 220.4(c)(2) provides that the creditor shall 
promptly cancel or liquidate the transaction if payment is not made by 
the customer within seven business days after the date of purchase. As 
indicated in the Board's interpretation at 1940 Federal Reserve Bulletin 
1172, a necessary part of the customer's undertaking pursuant to 
Sec. 220.4(c)(1)(i) is that he ``should have the necessary means of 
payment readily available when he purchases a security in the special 
cash account. He should expect to pay for it immediately or in any event 
within the period (of not more than a very few days) that is as long as 
is usually required to carry through the ordinary securities 
transaction.''
    (d) The arrangements for delayed delivery and payment in the case 
presented to the Board and outlined above clearly would be inconsistent 
with the requirement of Sec. 220.4(c)(1)(i) that the purchase be made in 
reliance upon an agreement accepted by the creditor in good faith that 
the customer will ``promptly'' make full cash payment for the security. 
Accordingly, the Board said that transactions of the kind in question 
would not qualify as a ``bona fide cash transaction'' and, therefore, 
could not properly be effected in a special cash account, unless a 
contrary conclusion would be justified by the exception in 
Sec. 220.4(c)(5).
    (e) Section 220.4(c)(5) provides that if the creditor, ``acting in 
good faith in accordance with'' Sec. 220.4(c)(1), purchases a security 
for a customer ``with the understanding that he is to deliver the 
security promptly to the customer, and the full cash payment is to be 
made promptly by the customer is to be made against such delivery'', the 
creditor may at his option treat the transaction as one to which the 
period applicable under Sec. 220.4(c)(2) is not the seven days therein 
specified but 35 days after the date of such purchase. It will be 
observed that the application of Sec. 220.4 (c)(5) is specifically 
conditioned on the creditor acting in good faith in accordance with 
Sec. 220.4(c)(1). As noted above, the existence of the arrangements for 
delayed delivery and payment in the case presented would prevent this 
condition from being met, since the customer could not be regarded as 
having agreed to make full cash payment ``promptly''. Furthermore, such 
arrangements clearly would be inconsistent with the requirement of 
Sec. 220.4(c)(5) that the creditor ``deliver the security promptly to 
the customer''.
    (f) Section 220.4(c)(5) was discussed in the Board's published 
interpretation, referred to above, which states that ``it is not the 
purpose of (Sec. 220.4 (c)(5)) to allow additional time to customers for 
making payment. The `prompt delivery' described in (Sec. 220.4 (c)(5)) 
is delivery which is to be made as soon as the broker or dealer can 
reasonably make it in view of the mechanics of the securities business 
and the bona fide usages of the trade. The provision merely recognizes 
the fact that in certain circumstances it is an established bona fide 
practice in the trade to obtain payment against delivery of the security 
to the customer, and the further fact that the mechanics of the trade, 
unrelated to the customer's readiness to pay, may sometimes delay such 
delivery to the customer''.
    (g) In the case presented, it appears that the only reason for the 
delay is related solely to the customer's readiness to pay and is in no 
way attributable to the mechanics of the securities business. 
Accordingly, it is the Board's view that the exception in 
Sec. 220.4(c)(5) should not be regarded as permitting the transactions 
in question to be effected in a special cash account.

[22 FR 5954, July 27, 1957]



Secs. 220.114-220.116  [Reserved]



Sec. 220.117  Exception to 90-day rule in special cash account.

    (a) The Board of Governors has recently interpreted certain of the 
provisions of Sec. 220.4(c)(8), with respect to the withdrawal of 
proceeds of a sale of stock in a ``special cash account'' when the stock 
has been sold out of the account prior to payment for its purchase.
    (b) The specific factual situation presented may be summarized as 
follows:


[[Page 23]]


    Customer purchased stock in a special cash account with a member 
firm on Day 1. On Day 3 customer sold the same stock at a profit. On Day 
8 customer delivered his check for the cost of the purchase to the 
creditor (member firm). On Day 9 the creditor mailed to the customer a 
check for the proceeds of the sale.

    (c) Section 220.4(c)(8) prohibits a creditor, as a general rule, 
from effecting a purchase of a security in a customer's special cash 
account if any security has been purchased in that account during the 
preceding 90 days and has then been sold in the account or delivered out 
to any broker or dealer without having been previously paid for in full 
by the customer. One exception to this general rule reads as follows:

    * * * The creditor may disregard for the purposes of this 
subparagraph (Sec. 220.4(c) (8)) a sale without prior payment provided 
full cash payment is received within the period described by 
subparagraph (2) of this paragraph (seven days after the date of 
purchase) and the customer has not withdrawn the proceeds of sale on or 
before the day on which such payment (and also final payment of any 
check received in that connection) is received. * * *

    (d) Final payment of customer's check: (1) The first question is: 
When is the creditor to be regarded as having received ``final payment 
of any check received'' in connection with the purchase?
    (2) The clear purpose of Sec. 220.4(c) (8) is to prevent the use of 
the proceeds of sale of a stock by a customer to pay for its purchase--
i.e., to prevent him from trading on the creditor's funds by being able 
to deposit the sale proceeds prior to presentment of his own check to 
the drawee bank. Thus, when a customer undertakes to pay for a purchase 
by check, that check does not constitute payment for the purchase, 
within the language and intent of the above-quoted exception in 
Sec. 220.4(c)(8), until it has been honored by the drawee bank, 
indicating the sufficiency of his account to pay the check.
    (3) The phrase ``final payment of any check'' is interpreted as 
above notwithstanding Sec. 220.6(f), which provides that:

    For the purposes of this part (Regulation T), a creditor may, at his 
option (1) treat the receipt in good faith of any check or draft drawn 
on a bank which in the ordinary course of business is payable on 
presentation, * * * as receipt of payment of the amount of such check, 
draft or order; * * *

This is a general provision substantially the same as language found in 
section 4(f) of Regulation T as originally promulgated in 1934. The 
language of the subject exception to the 90-day rule of 
Sec. 220.4(c)(8), i.e., the exception based expressly on final ``payment 
of any check,'' was added to the regulation in 1949 by an amendment 
directed at a specific type of situation. Because the exception is a 
special, more recent provision, and because Sec. 220.6(f), if 
controlling, would permit the exception to undermine, to some extent, 
the effectiveness of the 90-day rule, sound principles of construction 
require that the phrase ``final payment of any check'' be given its 
literal and intended effect.
    (4) There is no fixed period of time from the moment of receipt by 
the payee, or of deposit, within which it is certain that any check will 
be paid by the drawee bank. Therefore, in the rare case where the 
operation of the subject exception to Sec. 220.4(c)(8) is necessary to 
avoid application of the 90-day rule, a creditor should ascertain (from 
his bank of deposit or otherwise) the fact of payment of a customer's 
check given for the purchase. Having so determined the day of final 
payment, the creditor can permit withdrawal on any subsequent day.
    (e) Mailing as ``withdrawal'': (1) Also presented is the question 
whether the mailing to the customer of the creditor's check for the sale 
proceeds constitutes a withdrawal of such proceeds by the customer at 
the time of mailing so that, if the check for the sale proceeds is 
mailed on or before the day on which the customer's check for the 
purchase is finally paid, the 90-day rule applies. It may be that a 
check mailed one day will not ordinarily be received by the customer 
until the next. The Board is of the view, however, that when the check 
for sale proceeds is issued and released into the mails, the proceeds 
are to be regarded as withdrawn by the customer; a more liberal 
interpretation would open a way for circumvention. Accordingly, the 
creditor's check should not be mailed nor the sale proceeds otherwise 
released to

[[Page 24]]

the customer ``on or before the day'' on which payment for the purchase, 
including final payment of any check given for such payment, is received 
by the creditor, as determined in accordance with the principles stated 
herein.
    (2) Applying the above principles to the schedule of transactions 
described in the second paragraph of this interpretation, the mailing of 
the creditor's check on ``Day 9'' would be consistent with the subject 
exception to Sec. 220.4(c)(8), as interpreted herein, only if the 
customer's check was paid by the drawee bank on ``Day 8''.

[27 FR 3511, Apr. 12, 1962]



Sec. 220.118  Time of payment for mutual fund shares purchased in a special cash account.

    (a) The Board has recently considered the question whether, in 
connection with the purchase of mutual fund shares in a ``special cash 
account'' under the provisions of this part 220, the 7-day period with 
respect to liquidation for nonpayment is that described in 
Sec. 220.4(c)(2) or that described in Sec. 220.4(c)(3).
    (b) Section 220.4(c)(2) provides as follows:

    In case a customer purchases a security (other than an exempted 
security) in the special cash account and does not make full cash 
payment for the security within 7 days after the date on which the 
security is so purchased, the creditor shall, except as provided in 
subparagraphs (3)-(7) of this paragraph, promptly cancel or otherwise 
liquidate the transaction or the unsettled portion thereof.


Section 220.4(c)(3), one of the exceptions referred to, provides in 
relevant part as follows:

    If the security when so purchased is an unissued security, the 
period applicable to the transaction under subparagraph (2) of this 
paragraph shall be 7 days after the date on which the security is made 
available by the issuer for delivery to purchasers.

    (c) In the case presented, the shares of the mutual fund (open-end 
investment company) are technically not issued at the time they are sold 
by the underwriter and distributor. Several days may elapse from the 
date of sale before a certificate can be delivered by the transfer 
agent. The specific inquiry to the Board was, in effect, whether the 7-
day period after which a purchase transaction must be liquidated or 
cancelled for nonpayment should run, in the case of mutual fund shares, 
from the time when a certificate for the purchased shares is available 
for delivery to the purchaser, instead of from the date of the purchase.
    (d) Under the general rule of Sec. 220.4 (c)(2) that is applicable 
to purchases of outstanding securities, the 7-day period runs from the 
date of purchase without regard to the time required for the mechanical 
acts of transfer of ownership and delivery of a certificate. This rule 
is based on the principles governing the use of special cash accounts in 
accordance with which, in the absence of special circumstances, payment 
is to be made promptly upon the purchase of securities.
    (e) The purpose of Sec. 220.4(c)(3) is to recognize the fact that, 
when an issue of securities is to be issued at some fixed future date, a 
security that is a part of such issue can be purchased on a ``when-
issued'' basis and that payment may reasonably be delayed until after 
such date of issue, subject to other basic conditions for transactions 
in a special cash account. Thus, unissued securities should be regarded 
as ``made available for delivery to purchasers'' on the date when they 
are substantially as available as outstanding securities are available 
upon purchase, and this would ordinarily be the designated date of 
issuance or, in the case of a stock dividend, the ``payment date''. In 
any case, the time required for the mechanics of transfer and delivery 
of a certificate is not material under Sec. 220.4(c)(3) any more than it 
is under Sec. 220.4(c)(2).
    (f) Mutual fund shares are essentially available upon purchase to 
the same extent as outstanding securities. The mechanics of their 
issuance and of the delivery of certificates are not significantly 
different from the mechanics of transfer and delivery of certificates 
for shares of outstanding securities, and the issuance of mutual fund 
shares is not a future event in a sense that would warrant the extension 
of the time for payment beyond that afforded in the case of outstanding 
securities. Consequently, the Board has concluded

[[Page 25]]

that a purchase of mutual fund shares is not a purchase of an ``unissued 
security'' to which Sec. 220.4(c)(3) applies, but is a transaction to 
which Sec. 220.4(c)(2) applies.

[27 FR 10885, Nov. 8, 1962]



Sec. 220.119  Applicability of margin requirements to credit extended to corporation in connection with retirement of stock.

    (a) The Board of Governors has been asked whether part 220 was 
violated when a dealer in securities transferred to a corporation 4,161 
shares of the stock of such corporation for a consideration of $33,288, 
of which only 10 percent was paid in cash.
    (b) If the transaction was of a kind that must be included in the 
corporation's ``general account'' with the dealer (Sec. 220.3), it would 
involve an excessive extension of credit in violation of Sec. 220.3 
(b)(1). However, the transaction would be permissible if the transaction 
came within the scope of Sec. 220.4(f)(8), which permits a ``creditor'' 
(such as the dealer) to ``Extend and maintain credit to or for any 
customer without collateral or on any collateral whatever for any 
purpose other than purchasing or carrying or trading in securities.'' 
Accordingly, the crucial question is whether the corporation, in this 
transaction, was ``purchasing'' the 4,161 shares of its stock, within 
the meaning of that term as used in this part.
    (c) Upon first examination, it might seem apparent that the 
transaction was a purchase by the corporation. From the viewpoint of the 
dealer the transaction was a sale, and ordinarily, at least a sale by 
one party connotes a purchase by the other. Furthermore, other indicia 
of a sale/purchase transaction were present, such as a transfer of 
property for a pecuniary consideration. However, when the underlying 
objectives of the margin regulations are considered, it appears that 
they do not encompass a transaction of this nature, where securities are 
transferred on credit to the issuer thereof for the purpose of 
retirement.
    (d) Section 7(a) of the Securities Exchange Act of 1934 requires the 
Board of Governors to prescribe margin regulations ``For the purpose of 
preventing the excessive use of credit for the purchase or carrying of 
securities.'' Accordingly, the provisions of this part are not intended 
to prevent the use of credit where the transaction will not have the 
effect of increasing the volume of credit in the securities markets.
    (e) It appears that the instant transaction would have no such 
effect. When the transaction was completed, the equity interest of the 
dealer was transmuted into a dollar-obligation interest; in lieu of its 
status as a stockholder of the corporation, the dealer became a creditor 
of that corporation. The corporation did not become the owner of any 
securities acquired through the use of credit; its outstanding stock was 
simply reduced by 4,161 shares.
    (f) The meaning of ``sale'' and ``purchase'' in the Securities 
Exchange Act has been considered by the Federal courts in a series of 
decisions dealing with corporate ``insiders'' profits under section 
16(b) of that Act. Although the statutory purpose sought to be 
effectuated in those cases is quite different from the purpose of the 
margin regulations, the decisions in question support the propriety of 
not regarding a transaction as a ``purchase'' where this accords with 
the probable legislative intent, even though, literally, the statutory 
definition seems to include the particular transaction. See Roberts v. 
Eaton (CA 2 1954) 212 F. 2d 82, and cases and other authorities there 
cited. The governing principle, of course, is to effectuate the purpose 
embodied in the statutory or regulatory provision being interpreted, 
even where that purpose may conflict with the literal words. U.S. v. 
Amer. Trucking Ass'ns, 310 U.S. 534, 543 (1940); 2 Sutherland, Statutory 
Construction (3d ed. 1943) ch. 45.
    (g) There can be little doubt that an extension of credit to a 
corporation to enable it to retire debt securities would not be for the 
purpose of ``purchasing * * * securities'' and therefore would come 
within Sec. 220.4(f)(8), regardless of whether the retirement was 
obligatory (e.g., at maturity) or was a voluntary ``call'' by the 
issuer. This is true, it is difficult to see any valid distinction, for 
this purpose, between (1) voluntary retirement of an indebtedness 
security and (2) voluntary retirement of an equity security.

[[Page 26]]

    (h) For the reasons indicated above, it is the opinion of the Board 
of Governors that the extension of credit here involved is not of the 
kind which the margin requirements are intended to regulate and that the 
transaction described does not involve an unlawful extension of credit 
as far as this part is concerned.
    (i) The foregoing interpretation relates, of course, only to cases 
of the type described. It should not be regarded as governing any other 
situations; for example, the interpretation does not deal with cases 
where securities are being transferred to someone other than the issuer, 
or to the issuer for a purpose other than immediate retirement. Whether 
the margin requirements are inapplicable to any such situations would 
depend upon the relevant facts of actual cases presented.

[27 FR 12346, Dec. 13, 1962]



Sec. 220.120  [Reserved]



Sec. 220.121  Applicability of margin requirements to joint account between two creditors.

    (a) The Board has recently been asked whether extensions of credit 
in a joint account between two brokerage firms, a member of a national 
securities exchange (``Firm X'') and a member of the National 
Association of Securities Dealers (``Firm Y'') are subject to the margin 
requirements of this part (Regulation T). It is understood that similar 
joint accounts are not uncommon, and it appears that the margin 
requirements of the regulation are not consistently applied to 
extensions of credit in the accounts.
    (b) When the account in question was opened, Firm Y deposited $5,000 
with Firm X and has made no further deposit in the account, except for 
the monthly settlement described below. Both firms have the privilege of 
buying and selling specified securities in the account, but it appears 
that Firm X initiates most of the transactions therein. Trading volume 
may run from half a million to a million dollars a month. Firm X carries 
the ``official'' ledger of the account and sends Firm Y a monthly 
statement with a complete record of all transactions effected during the 
month. Settlement is then made in accordance with the agreement between 
the two firms, which provides that profits and losses shall be shared 
equally on a fifty-fifty basis. However, all transactions are confirmed 
and reconfirmed between the two on a daily basis.
    (c) Section 220.3(a) provides that

    All financial relations between a creditor and a customer, whether 
recorded in one record or in more than one record, shall be included in 
and be deemed to be part of the customer's general account with the 
creditor, * * *.


and Sec. 220.2(c) defines the term ``customer'' to include

    * * * any person, or any group of persons acting jointly, * * * to 
or for whom a creditor is extending or maintaining any credit * * *


In the course of a normal month's operations, both Firm X and Firm Y are 
at one time or another extending credit to the joint account, since both 
make purchases for the account that are not ``settled'' until the 
month's end. Consequently, the account would be a ``customer'' within 
the above definition.
    (d) Section 220.6(b) provides, with respect to the account of a 
joint adventure in which a creditor participates, that

    * * * the adjusted debit balance of the account shall include, in 
addition to the items specified in Sec. 220.3(d), any amount by which 
the creditor's contribution to the joint adventure exceeds the 
contribution which he would have made if he had contributed merely in 
proportion to his right to share in the profits of the joint adventure.


In addition, the final paragraph of Sec. 220.2(c) states that the 
definition of ``customer''

    * * * includes any joint adventure in which a creditor participates 
and which would be considered a customer of the creditor if the creditor 
were not a participant.

    (e) The above provisions clearly evince the Board's intent that the 
regulation shall cover trading accounts in which a creditor 
participates. If additional confirmation were needed, it is supplied by 
the fact that the Board found it needful specifically to exempt from 
ordinary margin requirements

[[Page 27]]

credit extended to certain joint accounts in which a creditor 
participates. These include the account in which transactions of odd-lot 
dealers may be financed under Sec. 220.4(f) (4), and the specialist's 
account under Sec. 220.4(g). Accordingly, the Board concluded that the 
joint account between Firm X and Firm Y is a ``customer'' within the 
meaning of the regulation, and that extensions of credit in the account 
are subject to margin requirements.

[31 FR 7169, May 17, 1966]



Sec. 220.122  ``Deep in the money put and call options'' as extensions of credit.

    (a) The Board of Governors has been asked to determine whether the 
business of selling instruments described as ``deep in the money put and 
call options'' would involve an extension of credit for the purposes of 
the Board's regulations governing margin requirements for securities 
transactions. Most of such options would be of the ``call'' type, such 
as the following proposal that was presented to the Board for its 
consideration:

    If X stock is selling at $100 per share, the customer would pay 
about $3,250 for a contract to purchase 100 shares of X at $70 per share 
within a 30-day period. The contract would be guaranteed by an exchange 
member, as are standard ``puts'' and ``calls''. When the contract is 
made with the customer, the seller, who will also be the writer of the 
contract, will immediately purchase 100 shares of X at $100 per share 
through the guarantor member firm in a margin account. If the customer 
exercises the option, the shares will be delivered to him; if the option 
is not exercised, the writer will sell the shares in the margin account 
to close out the transaction. As a practical matter, it is anticipated 
that the customer will exercise the option in almost every case.

    (b) An ordinary ``put'' is an option given to a person to sell to 
the writer of the put a specified amount of securities at a stated price 
within a certain time. A ``call'' is an option given to a person to buy 
from the writer a specified amount of securities at a stated price 
within a certain time. To be freely saleable, options must be indorsed, 
or guaranteed, by a member firm of the exchange on which the security is 
registered. The guarantor charges a fee for this service.
    (c) The option embodied in the normal put or call is exercisable 
either at the market price of the security at the time the option is 
written, or some ``points away'' from the market. The price of a normal 
option is modest by comparison with the margin required to take a 
position. Writers of normal options are persons who are satisfied with 
the current price of a security, and are prepared to purchase or sell at 
that price, with the small profit provided by the fee. Moreover, since a 
large proportion of all options are never exercised, a person who 
customarily writes normal options can anticipate that the fee would be 
clear profit in many cases, and he will not be obligated to buy or sell 
the stock in question.
    (d) The stock exchanges require that the writer of an option deposit 
and maintain in his margin account with the indorser 30 percent of the 
current market price in the case of a call (unless he has a long 
position in the stock) and 25 percent in the case of a put (unless he 
has a short position in the stock). Many indorsing firms in fact require 
larger deposits. Under Sec. 220.3(a) of Regulation T, all financial 
relations between a broker and his customer must be included in the 
customer's general account, unless specifically eligible for one of the 
special accounts authorized by Sec. 220.4. Accordingly, the writer, as a 
customer of the member firm, must make a deposit, which is included in 
his general account.
    (e) In order to prevent the deposit from being available against 
other margin purchases, and in effect counted twice, Sec. 220.3(d)(5) 
requires that in computing the customer's adjusted debit balance, there 
shall be included ``the amount of any margin customarily required by the 
creditor in connection with his endorsement or guarantee of any put, 
call, or other option''. No other margin deposit is required in 
connection with a normal put or call option under Regulation T.
    (f) Turning to the ``deep in the money'' proposed option contract 
described above, the price paid by the buyer can be divided into (1) a 
deposit of 30 percent of the current market

[[Page 28]]

value of the stock, and (2) an additional fixed charge, or fee. To the 
extent that the price of the stock rose during the 30 ensuing days the 
proposed instrument would produce results similar to those in the case 
of an ordinary profitable call, and the contract right would be 
exercised. But even if the price fell, unlike the situation with a 
normal option, the buyer would still be virtually certain to exercise 
his right to purchase before it expired, in order to minimize his loss. 
The result would be that the buyer would not have a genuine choice 
whether or not to buy. Rather, the instrument would have made it 
possible for him, in effect, to purchase stock as of the time the 
contract was written by depositing 30 percent of the stock's current 
market price.
    (g) It was suggested that the proposed contract is not unusual, 
since there are examples of ordinary options selling at up to 28 percent 
of current market value. However, such examples are of options running 
for 12 months, and reflect expectations of changes in the price of the 
stock over that period. The 30-day contracts discussed above are not 
comparable to such 12-month options, because instances of true 
expectations of price changes of this magnitude over a 30-day period 
would be exceedingly rare. And a contract that does not reflect such 
true expectations of price change, plus a reasonable fee for the 
services of the writer, is not an option in the accepted meaning of the 
term.
    (h) Because of the virtual certainty that the contract right would 
be exercised under the proposal described above, the writer would buy 
the stock in a margin account with an indorsing firm immediately on 
writing the contract. The indorsing firm would extend credit in the 
amount of 20 percent of the current market price of the stock, the 
maximum permitted by the current Sec. 220.8 (supplement to Regulation 
T). The writer would deposit the 30 percent supplied by the buyer, and 
furnish the remaining 50 percent out of his own working capital. His 
account with the indorsing firm would thus be appropriately margined.
    (i) As to the buyer, however, the writer would function as a broker. 
In effect, he would purchase the stock for the account, or use, of the 
buyer, on what might be described as a deferred payment arrangement. 
Like an ordinary broker, the writer of the contract described above 
would put up funds to pay for the difference between the price of 
securities the customer wished to purchase and the customer's own 
contribution. His only risk would be that the price of the securities 
would decline in excess of the customer's contribution. True, he would 
be locked in, and could not liquidate the customer's collateral for 30 
days even if the market price should fall in excess of 30 percent, but 
the risk of such a decline is extremely slight.
    (j) Like any other broker who extends credit in a margin account, 
the writer who was in the business of writing and selling such a 
contract would be satisfied with a fixed predetermined amount of return 
on his venture, since he would realize only the fee charged. Unlike a 
writer of ordinary puts and calls, he would not receive a substantial 
part of his income from fees on unexercised contract rights. The 
similarity of his activities to those of a broker, and the dissimilarity 
to a writer of ordinary options, would be underscored by the fact that 
his fee would be a fixed predetermined amount of return similar to an 
interest charge, rather than a fee arrived at individually for each 
transaction according to the volatility of the stock and other 
individual considerations.
    (k) The buyer's general account with the writer would in effect 
reflect a debit for the purchase price of the stock and, on the credit 
side, a deposit of cash in the amount of 30 percent of that price, plus 
an extension of credit for the remaining 70 percent, rather than the 
maximum permissible 20 percent.
    (l) For the reasons stated above, the Board concluded that the 
proposed contracts would involve extensions of credit by the writer as 
broker in an amount exceeding that permitted by the current supplement 
to Regulation T. Accordingly, the writing of such contracts by a 
brokerage firm is presently prohibited by such regulation, and any 
brokerage firm that endorses such a contract would be arranging for

[[Page 29]]

credit in an amount greater than the firm itself could extend, a 
practice that is prohibited by Sec. 220.7(a).

[35 FR 3280, Feb. 21, 1970]



Sec. 220.123  Partial delayed issue contracts covering nonconvertible bonds.

    (a) During recent years, it has become customary for portions of new 
issues of nonconvertible bonds and preferred stocks to be sold subject 
to partial delayed issue contracts, which have customarily been referred 
to in the industry as ``delayed delivery'' contracts, and the Board of 
Governors has been asked for its views as to whether such transactions 
involve any violations of the Board's margin regulations.
    (b) The practice of issuing a portion of a debt (or equivalent) 
security issue at a date subsequent to the main underwriting has arisen 
where market conditions made it difficult or impossible, in a number of 
instances, to place an entire issue simultaneously. In instances of this 
kind, institutional investors (e.g., insurance companies or pension 
funds) whose cash flow is such that they expect to have funds available 
some months in the future, have been willing to subscribe to a portion, 
to be issued to them at a future date. The issuer has been willing to 
agree to issue the securities in two or more stages because it did not 
immediately need the proceeds to be realized from the deferred portion, 
because it could not raise funds on better terms, or because it 
preferred to have a certain portion of the issue taken down by an 
investor of this type.
    (c) In the case of such a delayed issue contract, the underwriter is 
authorized to solicit from institutional customers offers to purchase 
from the issuer, pursuant to contracts of the kind described above, and 
the agreement becomes binding at the underwriters' closing, subject to 
specified conditions. When securities are issued pursuant to the 
agreement, the purchase price includes accrued interest or dividends, 
and until they are issued to it, the purchaser does not, in the case of 
bonds, have rights under the trust indenture, or, in the case of 
preferred stocks, voting rights.
    (d) Securities sold pursuant to such arrangements are high quality 
debt issues (or their equivalent). The purchasers buy with a view to 
investment and do not resell or otherwise dispose of the contract prior 
to its completion. Delayed issue arrangements are not acceptable to 
issuers unless a substantial portion of an issue, not less than 10 
percent, is involved.
    (e) Sections 3(a) (13) and (14) of the Securities Exchange Act of 
1934 provide that an agreement to purchase is equivalent to a purchase, 
and an agreement to sell to a sale. The Board has hitherto expressed the 
view that credit is extended at the time when there is a firm agreement 
to extend such credit (1968 Federal Reserve Bulletin 328; 12 CFR 
207.101; para. 6800 Published Interpretations of the Board of 
Governors). Accordingly, in instances of the kind described above, the 
issuer may be regarded as extending credit to the institutional 
purchaser at the time of the underwriters' closing, when the obligations 
of both become fixed.
    (f) Section 220.7(a) of the Board's Regulation T (12 CFR 220.7(a)), 
with an exception not applicable here, forbids a creditor subject to 
that regulation to arrange for credit on terms on which the creditor 
could not itself extend the credit. Sections 220.4(c) (1) and (2) (12 
CFR 220.4(c) (1) and (2)) provide that a creditor may not sell 
securities to a customer except in good faith reliance upon an agreement 
that the customer will promptly, and in no event in more than 7 full 
business days, make full cash payment for the securities. Since the 
underwriters in question are creditors subject to the regulation, unless 
some specific exception applies, they are forbidden to arrange for the 
credit described above. This result follows because payment is not made 
until more than 7 full business days have passed from the time the 
credit is extended.
    (g) However, Sec. 220.4(c)(3) provides that:

    If the security when so purchased is an unissued security, the 
period applicable to the transaction under subparagraph (2) of this 
paragraph shall be 7 days after the date on which the security is made 
available by the issuer for delivery to purchasers.


[[Page 30]]


    (h) In interpreting Sec. 220.4(c)(3), the Board has stated that the 
purpose of the provision:

    * * * is to recognize the fact that, when an issue of securities is 
to be issued at some future fixed date, a security that is part of such 
issue can be purchased on a ``when-issued'' basis and that payment may 
reasonably be delayed until after such date of issue, subject to other 
basic conditions for transactions in a special cash account. (1962 
Federal Reserve Bulletin 1427; 12 CFR 220.118; para. 5996, Published 
Interpretations of the Board of Governors.)


In that situation, the Board distinguished the case of mutual fund 
shares, which technically are not issued until the certificate can be 
delivered by the transfer agent. The Board held that mutual fund shares 
must be regarded as issued at the time of purchase because they are:

    * * * essentially available upon purchase to the same extent as 
outstanding securities. The mechanics of their issuance and of the 
delivery of certificates are not significantly different from the 
mechanics of transfer and delivery of certificates for shares of 
outstanding securities, and the issuance of mutual fund shares is not a 
future event in the sense that would warrant the extension of the time 
for payment beyond that afforded in the case of outstanding securities. 
(ibid.)


The issuance of debt securities subject to delayed issue contracts, by 
contrast with that of mutual fund shares, which are in a status of 
continual underwriting, is a specific single event taking place at a 
future date fixed by the issuer with a view to its need for funds and 
the availability of those funds under current market conditions.
    (i) For the reasons stated above the Board concluded that the 
nonconvertible debt and preferred stock subject to delayed issue 
contracts of the kind described above should not be regarded as having 
been issued until delivered, pursuant to the agreement, to the 
institutional purchaser. This interpretation does not apply, of course, 
to fact situations different from that described in this section.

[36 FR 2777, Feb. 10, 1971]



Sec. 220.124  Installment sale of tax-shelter programs as ``arranging'' for credit.

    (a) The Board has been asked whether the sale by brokers and dealers 
of tax-shelter programs containing a provision that payment for the 
program may be made in installments would constitute ``arranging'' for 
credit in violation of this part 220. For the purposes of this 
interpretation, the term ``tax-shelter program'' means a program which 
is required to be registered pursuant to section 5 of the Securities Act 
of 1933 (15 U.S.C. section 77e), in which tax benefits, such as the 
ability to deduct substantial amounts of depreciation or oil exploration 
expenses, are made available to a person investing in the program. The 
programs may take various legal forms and can relate to a variety of 
industries including, but not limited to, oil and gas exploration 
programs, real estate syndications (except real estate investment 
trusts), citrus grove developments and cattle programs.
    (b) The most common type of tax-shelter program takes the form of a 
limited partnership. In the case of the programs under consideration, 
the investor would commit himself to purchase and the partnership would 
commit itself to sell the interests. The investor would be entitled to 
the benefits, and become subject to the risks of ownership at the time 
the contract is made, although the full purchase price is not then 
required to be paid. The balance of the purchase price after the 
downpayment usually is payable in installments which range from 1 to 10 
years depending on the program. Thus, the partnership would be extending 
credit to the purchaser until the time when the latter's contractual 
obligation has been fulfilled and the final payment made.
    (c) With an exception not applicable here, Sec. 220.7(a) of 
Regulation T provides that:

    A creditor [broker or dealer] may arrange for the extension or 
maintenance of credit to or for any customer of such creditor by any 
person upon the same terms and conditions as those upon which the 
creditor, under the provisions of this part, may himself extend

[[Page 31]]

or maintain such credit to such customer, but only such terms and 
conditions * * *

    (d) In the case of credit for the purpose of purchasing or carrying 
securities (purpose credit), Sec. 220.8 of the regulation (the 
Supplement to Regulation T) does not permit any loan value to be given 
securities that are not registered on a national securities exchange, 
included on the Board's OTC Margin List, or exempted by statute from the 
regulation.
    (e) The courts have consistently held investment programs such as 
those described above to be ``securities'' for purpose of both the 
Securities Act of 1933 and the Securities Exchange Act of 1934. The 
courts have also held that the two statutes are to be construed 
together. Tax-shelter programs, accordingly, are securities for purposes 
of Regulation T. They also are not registered on a national securities 
exchange, included on the Board's OTC Margin List, or exempted by 
statute from the regulation.
    (f) Accordingly, the Board concludes that the sale by a broker/
dealer of tax-shelter programs containing a provision that payment for 
the program may be made in installments would constitute ``arranging'' 
for the extension of credit to purchase or carry securities in violation 
of the prohibitions of Secs. 220.7(a) and 220.8 of Regulation T.

[37 FR 6568, Mar. 31, 1972]



Sec. 220.125-220.126  [Reserved]



Sec. 220.127  Independent broker/dealers arranging credit in connection with the sale of insurance premium funding programs.

    (a) The Board's September 5, 1972, clarifying amendment to 
Sec. 220.4(k) set forth that creditors who arrange credit for the 
acquisition of mutual fund shares and insurance are also permitted to 
sell mutual fund shares without insurance under the provisions of the 
special cash account. It should be understood, of course, that such 
account provides a relatively short credit period of up to 7 business 
days even with so-called cash transactions. This amendment was in 
accordance with the Board's understanding in 1969, when the insurance 
premium funding provisions were adopted in Sec. 220.4(k), that firms 
engaged in a general securities business would not also be engaged in 
the sale and arranging of credit in connection with such insurance 
premium funding programs.
    (b) The 1972 amendment eliminated from Sec. 220.4(k) the requirement 
that, to be eligible for the provisions of the section, a creditor had 
to be the issuer, or a subsidiary or affiliate of the issuer, of 
programs which combine the acquisition of both mutual fund shares and 
insurance. Thus the amendment permits an independent broker/dealer to 
sell such a program and to arrange for financing in that connection. In 
reaching such decision, the Board again relied upon the earlier 
understanding that independent broker/dealers who would sell such 
programs would not be engaged in transacting a general securities 
business.
    (c) In response to a specific view recently expressed, the Board 
agrees that under Regulation T:

    * * * a broker/dealer dealing in special insurance premium funding 
products can only extend credit in connection with such products or in 
connection with the sale of shares of registered investment companies 
under the cash accounts * * * (and) cannot engage in the general 
securities business or sell any securities other than shares * * * (in) 
registered investment companies through a cash account or any other 
manner involving the extension of credit.

    (d) There is a way, of course, as has been indicated, that an 
independent broker/dealer might be able to sell other than shares of 
registered investment companies without creating any conflict with the 
regulation. Such sales could be executed on a ``funds on hand'' basis 
and in the case of payment by check, would have to include the 
collection of such check. It is understood from industry sources, 
however, that few if any independent broker/dealers engage solely in a 
``fund on hand'' type of operation.

[38 FR 11066, May 4, 1973]

[[Page 32]]



Sec. 220.128  Treatment of simultaneous long and short positions in the same margin account when put or call options or combinations thereof on such stock are 
          also outstanding in the account.

    (a) The Board was recently asked whether under Regulation T, 
``Credit by Brokers and Dealers'' (12 CFR part 220), if there are 
simultaneous long and short positions in the same security in the same 
margin account (often referred to as a short sale ``against the box''), 
such positions may be used to supply the place of the deposit of margin 
ordinarily required in connection with the guarantee by a creditor of a 
put or call option or combination thereof on such stock.
    (b) The applicable provisions of regulation T are Sec. 220.3(d)(3) 
and (5) and Sec. 220.3(g)(4) and (5) which provide as follows:

    (d) * * * the adjusted debit balance of a general account * * * 
shall be calculated by taking the sum of the following items:

                                * * * * *

    (3) The current market value of any securities (other than unissued 
securities) sold short in the general account plus, for each security 
(other than an exempted security), such amount as the board shall 
prescribe from time to time in Sec. 220.8(d) (the supplement to 
regulation T) as the margin required for such short sales, except that 
such amount so prescribed in such Sec. 220.8(d) need not be included 
when there are held in the general account * * * the same securities or 
securities exchangeable or convertible within 90 calendar days, without 
restriction other than the payment of money, into such securities sold 
short;

                                * * * * *

    (5) The amount of any margin customarily required by the creditor in 
connection with his endorsement or guarantee of any put, call, or other 
option;

                                * * * * *

    (g) * * * (4) Any transaction which serves to meet the requirements 
of paragraph (e) of this section or otherwise serves to permit any 
offsetting transaction in an account shall, to that extent, be 
unavailable to permit any other transaction in such account.
    (5) For the purposes of this part (regulation T), if a security has 
maximum loan value under paragraph (c)(1) of this section in a general 
account, or under Sec. 220.4(j) in a special convertible debt security 
account, a sale of the same security (even though not the same 
certificate) in such account shall be deemed to be a long sale and shall 
not be deemed to be or treated as a short sale.

    (c) Rule 431 of the New York Stock Exchange requires that a creditor 
obtain a minimum deposit of 25 percent of the current market value of 
the optioned stock in connection with his issuance or guarantee of a 
put, and at least 30 percent in the case of a call (and that such 
position be ``marked to the market''), but permits a short position in 
the stock to serve in lieu of the required deposit in the case of a put 
and a long position to serve in the case of a call. Thus, where the 
appropriate position is held in an account, that position may serve as 
the margin required by Sec. 220.3(d)(5).
    (d) In a short sale ``against the box,'' however, the customer is 
both long and short the same security. He may have established either 
position, properly margined, prior to taking the other, or he may have 
deposited fully paid securities in his margin account on the same day he 
makes a short sale of such securities. In either case, he will have 
directed his broker to borrow securities elsewhere in order to make 
delivery on the short sale rather than using his long position for this 
purpose (see also 17 CFR 240.3b-3).
    (e) Generally speaking, a customer makes a short sale ``against the 
box'' for tax reasons. Regulation T, however, provides in Sec. 220.3(g) 
that the two positions must be ``netted out'' for the purposes of the 
calculations required by the regulation. Thus, the board concludes that 
neither position would be available to serve as the deposit of margin 
required in connection with the endorsement by the creditor of an 
option.
    (f) A similar conclusion obtains under Sec. 220.3(d)(3). That 
section provides, in essence, that the margin otherwise required in 
connection with a short sale need not be included in the account if the 
customer has in the account a long position in the same security. In 
Sec. 220.3(g) (4), however, it is provided that ``[A]ny transaction 
which

[[Page 33]]

* * * serves to permit any offsetting transaction in an account shall, 
to that extent, be unavailable to permit any other transaction in such 
account.'' Thus, if a customer has, for example, a long position in a 
security and that long position has been used to supply the margin 
required in connection with a short sale of the same security, then the 
long position is unavailable to serve as the margin required in 
connection with the creditor's endorsement of a call option on such 
security.
    (g) A situation was also described in which a customer has purported 
to establish simultaneous offsetting long and short positions by 
executing a ``cross'' or wash sale of the security on the same day. In 
this situation, no change in the beneficial ownership of stock has taken 
place. Since there is no actual ``contra'' party to either transaction, 
and no stock has been borrowed or delivered to accomplish the short 
sale, such fictitious positions would have no value for purposes of the 
Board's margin regulations. Indeed, the adoption of such a scheme in 
connection with an overall strategy involving the issuance, endorsement, 
or guarantee of put or call options or combinations thereof appears to 
be manipulative and may have been employed for the purpose of 
circumventing the requirements of the regulations.

[38 FR 12098, May 9, 1973]



Secs. 220.129-220.130  [Reserved]



Sec. 220.131  Application of the arranging section to broker-dealer activities under SEC Rule 144A.

    (a) The Board has been asked whether the purchase by a broker-dealer 
of debt securities for resale in reliance on Rule 144A of the Securities 
and Exchange Commission (17 CFR 230.144A) \1\ may be considered an 
arranging of credit permitted as an ``investment banking service'' under 
Sec. 220.13(a) of Regulation T.
---------------------------------------------------------------------------

    \1\ Rule 144A, 17 CFR 230.144A, was originally published in the 
Federal Register at 55 FR 17933, April 30, 1990.
---------------------------------------------------------------------------

    (b) SEC Rule 144A provides a safe harbor exemption from the 
registration requirements of the Securities Act of 1933 for resales of 
restricted securities to qualified institutional buyers, as defined in 
the rule. In general, a qualified institutional buyer is an 
institutional investor that in the aggregate owns and invests on a 
discretionary basis at least $100 million in securities of issuers that 
are not affiliated with the buyer. Registered broker-dealers need only 
own and invest on a discretionary basis at least $10 million of 
securities in order to purchase as principal under the rule. Section 
4(2) of the Securities Act of 1933 provides an exemption from the 
registration requirements for ``transactions by an issuer not involving 
any public offering.'' Securities acquired in a transaction under 
section 4(2) cannot be resold without registration under the Act or an 
exemption therefrom. Rule 144A provides a safe harbor exemption for 
resales of such securities. Accordingly, broker-dealers that previously 
acted only as agents in intermediating between issuers and purchasers of 
privately-placed securities, due to the lack of such a safe harbor, now 
may purchase privately-placed securities from issuers as principal and 
resell such securities to ``qualified institutional buyers'' under Rule 
144A.
    (c) The Board has consistently treated the purchase of a privately-
placed debt security as an extension of credit subject to the margin 
regulations. If the issuer uses the proceeds to buy securities, the 
purchase of the privately-placed debt security by a creditor represents 
an extension of ``purpose credit'' to the issuer. Section 7(c) of the 
Securities Exchange Act of 1934 prohibits the extension of purpose 
credit by a creditor if the credit is unsecured, secured by collateral 
other than securities, or secured by any security (other than an 
exempted security) in contravention of Federal Reserve regulations. If a 
debt security sold pursuant to Rule 144A represents purpose credit and 
is not properly collateralized by securities, the statute and Regulation 
T can be viewed as preventing the broker-dealer from taking the security 
into inventory in spite of the fact that the broker-dealer intends to 
immediately resell the debt security.
    (d) Under Sec. 220.13 of Regulation T, a creditor may arrange credit 
it cannot itself extend if the arrangement is an

[[Page 34]]

``investment banking service'' and the credit does not violate 
Regulations G and U. Investment banking services are defined to include, 
but not be limited to, ``underwritings, private placements, and advice 
and other services in connection with exchange offers, mergers, or 
acquisitions, except for underwritings that involve the public 
distribution of an equity security with installment or other deferred-
payment provisions.'' To comply with Regulations G and U where the 
proceeds of debt securities sold under Rule 144A may be used to purchase 
or carry margin stock and the debt securities are secured in whole or in 
part, directly or indirectly by margin stock (see 12 CFR 207.2(f), 
207.112, and 221.2(g)), the margin requirements of the regulations must 
be met.
    (e) The SEC's objective in adopting Rule 144A is to achieve ``a more 
liquid and efficient institutional resale market for unregistered 
securities.'' To further this objective, the Board believes it is 
appropriate for Regulation T purposes to characterize the participation 
of broker-dealers in this unique and limited market as an ``investment 
banking service.'' The Board is therefore of the view that the purchase 
by a creditor of debt securities for resale pursuant to SEC Rule 144A 
may be considered an investment banking service under the arranging 
section of Regulation T. The market-making activities of broker-dealers 
who hold themselves out to other institutions as willing to buy and sell 
Rule 144A securities on a regular and continuous basis may also be 
considered an arranging of credit permissible under Sec. 220.13(a) of 
Regulation T.

[Reg. T, 55 FR 29566, July 20, 1990]



Sec. 220.132  Credit to brokers and dealers.

    For text of this interpretation, see Sec. 207.114 of this 
subchapter.

[Reg. T, 61 FR 60167, Nov. 26, 1996]



PART 221--CREDIT BY BANKS AND PERSONS OTHER THAN BROKERS OR DEALERS FOR THE PURPOSE OF PURCHASING OR CARRYING MARGIN STOCK (REGULATION U)--Table of Contents




Sec.
221.1  Authority, purpose, and scope.
221.2  Definitions.
221.3  General requirements.
221.4  Employee stock option, purchase, and ownership plans.
221.5  Special purpose loans to brokers and dealers.
221.6  Exempted transactions.
221.7  Supplement: Maximum loan value of margin stock and other 
          collateral.

                             Interpretations

221.101  Determination and effect of purpose of loan.
221.102  Application to committed credit where funds are disbursed 
          thereafter.
221.103  Loans to brokers or dealers.
221.104  Federal credit unions.
221.105  Arranging for extensions of credit to be made by a bank.
221.106  Reliance in ``good faith'' on statement of purpose of loan.
221.107  Arranging loan to purchase open-end investment company shares.
221.108  Effect of registration of stock subsequent to making of loan.
221.109  Loan to open-end investment company.
221.110  Questions arising under this part.
221.111  Contribution to joint venture as extension of credit when the 
          contribution is disproportionate to the contributor's share in 
          the venture's profits or losses.
221.112  Loans by bank in capacity as trustee.
221.113  Loan which is secured indirectly by stock.
221.114  Bank loans to purchase stock of American Telephone and 
          Telegraph Company under Employees' Stock Plan.
221.115  Accepting a purpose statement through the mail without benefit 
          of face-to-face interview.
221.116  Bank loans to replenish working capital used to purchase mutual 
          fund shares.
221.117  When bank in ``good faith'' has not relied on stock as 
          collateral.
221.118  Bank arranging for extension of credit by corporation.
221.119  Applicability of plan-lender provisions to financing of stock 
          options and

[[Page 35]]

          stock purchase rights qualified or restricted under Internal 
          Revenue Code.
221.120  Allocation of stock collateral to purpose and nonpurpose 
          credits to same customer.
221.121  Extension of credit in certain stock option and stock purchase 
          plans.
221.122  Applicability of margin requirements to credit in connection 
          with Insurance Premium Funding Programs.
221.123  Combined credit for exercising employee stock options and 
          paying income taxes incurred as a result of such exercise.
221.124  Purchase of debt securities to finance corporate takeovers.
221.125  Credit to brokers and dealers.

    Authority: 15 U.S.C. 78c, 78g, 78q, and 78w.

    Source: Reg. U, 63 FR 2827, Jan. 16, 1998, unless otherwise noted.



Sec. 221.1  Authority, purpose, and scope.

    (a) Authority. Regulation U (this part) is issued by the Board of 
Governors of the Federal Reserve System (the Board) pursuant to the 
Securities Exchange Act of 1934 (the Act) (15 U.S.C. 78a et seq.).
    (b) Purpose and scope. (1) This part imposes credit restrictions 
upon persons other than brokers or dealers (hereinafter lenders) that 
extend credit for the purpose of buying or carrying margin stock if the 
credit is secured directly or indirectly by margin stock. Lenders 
include ``banks'' (as defined in Sec. 221.2) and other persons who are 
required to register with the Board under Sec. 221.3(b). Lenders may not 
extend more than the maximum loan value of the collateral securing such 
credit, as set by the Board in Sec. 221.7 (the Supplement).
    (2) This part does not apply to clearing agencies regulated by the 
Securities and Exchange Commission or the Commodity Futures Trading 
Commission that accept deposits of margin stock in connection with:
    (i) The issuance of, or guarantee of, or the clearance of 
transactions in, any security (including options on any security, 
certificate of deposit, securities index or foreign currency); or
    (ii) The guarantee of contracts for the purchase or sale of a 
commodity for future delivery or options on such contracts.
    (3) This part does not apply to credit extended to an exempted 
borrower.
    (c) Availability of forms. The forms referenced in this part are 
available from the Federal Reserve Banks.



Sec. 221.2  Definitions.

    The terms used in this part have the meanings given them in section 
3(a) of the Act or as defined in this section as follows:
    Affiliate means:
    (1) For banks:
    (i) Any bank holding company of which a bank is a subsidiary within 
the meaning of the Bank Holding Company Act of 1956, as amended (12 
U.S.C. 1841(d));
    (ii) Any other subsidiary of such bank holding company; and
    (iii) Any other corporation, business trust, association, or other 
similar organization that is an affiliate as defined in section 2(b) of 
the Banking Act of 1933 (12 U.S.C. 221a(c));
    (2) For nonbank lenders, affiliate means any person who, directly or 
indirectly, through one or more intermediaries, controls, or is 
controlled by, or is under common control with the lender.
    Bank. (1) Bank. Has the meaning given to it in section 3(a)(6) of 
the Act (15 U.S.C. 78c(a)(6)) and includes:
    (i) Any subsidiary of a bank;
    (ii) Any corporation organized under section 25(a) of the Federal 
Reserve Act (12 U.S.C. 611); and
    (iii) Any agency or branch of a foreign bank located within the 
United States.
    (2) Bank does not include:
    (i) Any savings and loan association;
    (ii) Any credit union;
    (iii) Any lending institution that is an instrumentality or agency 
of the United States; or
    (iv) Any member of a national securities exchange.
    Carrying credit is credit that enables a customer to maintain, 
reduce, or retire indebtedness originally incurred to purchase a 
security that is currently a margin stock.
    Current market value of:
    (1) A security means:
    (i) If quotations are available, the closing sale price of the 
security on the preceding business day, as appearing on any regularly 
published reporting or quotation service; or

[[Page 36]]

    (ii) If there is no closing sale price, the lender may use any 
reasonable estimate of the market value of the security as of the close 
of business on the preceding business day; or
    (iii) If the credit is used to finance the purchase of the security, 
the total cost of purchase, which may include any commissions charged.
    (2) Any other collateral means a value determined by any reasonable 
method.
    Customer excludes an exempted borrower and includes any person or 
persons acting jointly, to or for whom a lender extends or maintains 
credit.
    Examining authority means:
    (1) The national securities exchange or national securities 
association of which a broker or dealer is a member; or
    (2) If a member of more than one self-regulatory organization, the 
organization designated by the Securities and Exchange Commission as the 
examining authority for the broker or dealer.
    Exempted borrower means a member of a national securities exchange 
or a registered broker or dealer, a substantial portion of whose 
business consists of transactions with persons other than brokers or 
dealers, and includes a borrower who:
    (1) Maintains at least 1000 active accounts on an annual basis for 
persons other than brokers, dealers, and persons associated with a 
broker or dealer;
    (2) Earns at least $10 million in gross revenues on an annual basis 
from transactions with persons other than brokers, dealers, and persons 
associated with a broker or dealer; or
    (3) Earns at least 10 percent of its gross revenues on an annual 
basis from transactions with persons other than brokers, dealers, and 
persons associated with a broker-dealer.
    Good faith with respect to:
    (1) The loan value of collateral means that amount (not exceeding 
100 per cent of the current market value of the collateral) which a 
lender, exercising sound credit judgment, would lend, without regard to 
the customer's other assets held as collateral in connection with 
unrelated transactions.
    (2) Making a determination or accepting a statement concerning a 
borrower means that the lender or its duly authorized representative is 
alert to the circumstances surrounding the credit, and if in possession 
of information that would cause a prudent person not to make the 
determination or accept the notice or certification without inquiry, 
investigates and is satisfied that it is correct;
    In the ordinary course of business means occurring or reasonably 
expected to occur in carrying out or furthering any business purpose, or 
in the case of an individual, in the course of any activity for profit 
or the management or preservation of property.
    Indirectly secured. (1) Includes any arrangement with the customer 
under which:
    (i) The customer's right or ability to sell, pledge, or otherwise 
dispose of margin stock owned by the customer is in any way restricted 
while the credit remains outstanding; or
    (ii) The exercise of such right is or may be cause for accelerating 
the maturity of the credit.
    (2) Does not include such an arrangement if:
    (i) After applying the proceeds of the credit, not more than 25 
percent of the value (as determined by any reasonable method) of the 
assets subject to the arrangement is represented by margin stock;
    (ii) It is a lending arrangement that permits accelerating the 
maturity of the credit as a result of a default or renegotiation of 
another credit to the customer by another lender that is not an 
affiliate of the lender;
    (iii) The lender holds the margin stock only in the capacity of 
custodian, depositary, or trustee, or under similar circumstances, and, 
in good faith, has not relied upon the margin stock as collateral; or
    (iv) The lender, in good faith, has not relied upon the margin stock 
as collateral in extending or maintaining the particular credit.
    Lender means:
    (1) Any bank; or
    (2) Any person subject to the registration requirements of this 
part.
    Margin stock means:
    (1) Any equity security registered or having unlisted trading 
privileges on a national securities exchange;

[[Page 37]]

    (2) Any OTC security designated as qualified for trading in the 
National Market System under a designation plan approved by the 
Securities and Exchange Commission (NMS security);
    (3) Any debt security convertible into a margin stock or carrying a 
warrant or right to subscribe to or purchase a margin stock;
    (4) Any warrant or right to subscribe to or purchase a margin stock; 
or
    (5) Any security issued by an investment company registered under 
section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a-8), other 
than:
    (i) A company licensed under the Small Business Investment Company 
Act of 1958, as amended (15 U.S.C. 661); or
    (ii) A company which has at least 95 percent of its assets 
continuously invested in exempted securities (as defined in 15 U.S.C. 
78c(a)(12)); or
    (iii) A company which issues face-amount certificates as defined in 
15 U.S.C. 80a-2(a)(15), but only with respect of such securities; or
    (iv) A company which is considered a money market fund under SEC 
Rule 2a-7 (17 CFR 270.2a-7).
    Maximum loan value is the percentage of current market value 
assigned by the Board under Sec. 221.7 (the Supplement) to specified 
types of collateral. The maximum loan value of margin stock is stated as 
a percentage of its current market value. Puts, calls and combinations 
thereof that do not qualify as margin stock have no loan value. All 
other collateral has good faith loan value.
    Nonbank lender means any person subject to the registration 
requirements of this part.
    Purpose credit is any credit for the purpose, whether immediate, 
incidental, or ultimate, of buying or carrying margin stock.



Sec. 221.3  General requirements.

    (a) Extending, maintaining, and arranging credit--(1) Extending 
credit. No lender, except a plan-lender, as defined in Sec. 221.4(a), 
shall extend any purpose credit, secured directly or indirectly by 
margin stock, in an amount that exceeds the maximum loan value of the 
collateral securing the credit.
    (2) Maintaining credit. A lender may continue to maintain any credit 
initially extended in compliance with this part, regardless of:
    (i) Reduction in the customer's equity resulting from change in 
market prices;
    (ii) Change in the maximum loan value prescribed by this part; or
    (iii) Change in the status of the security (from nonmargin to 
margin) securing an existing purpose credit.
    (3) Arranging credit. No lender may arrange for the extension or 
maintenance of any purpose credit, except upon the same terms and 
conditions under which the lender itself may extend or maintain purpose 
credit under this part.
    (b) Registration of nonbank lenders; termination of registration; 
annual report--(1) Registration. Every person other than a person 
subject to part 220 of this chapter or a bank who, in the ordinary 
course of business, extends or maintains credit secured, directly or 
indirectly, by any margin stock shall register on Federal Reserve Form 
FR G-1 (OMB control number 7100-0011) within 30 days after the end of 
any calendar quarter during which:
    (i) The amount of credit extended equals $200,000 or more; or
    (ii) The amount of credit outstanding at any time during that 
calendar quarter equals $500,000 or more.
    (2) Deregistration. A registered nonbank lender may apply to 
terminate its registration, by filing Federal Reserve Form FR G-2 (OMB 
control number 7100-0011), if the lender has not, during the preceding 
six calendar months, had more than $200,000 of such credit outstanding. 
Registration shall be deemed terminated when the application is approved 
by the Board.
    (3) Annual report. Every registered nonbank lender shall, within 30 
days following June 30 of every year, file Form FR G-4 (OMB control 
number 7100-0011).
    (4) Where to register and file applications and reports. 
Registration statements, applications to terminate registration, and 
annual reports shall be filed with the Federal Reserve Bank of the 
district in which the principal office of the lender is located.

[[Page 38]]

    (c) Purpose statement--(1) General rule--(i) Banks. Except for 
credit extended under paragraph (c)(2) of this section, whenever a bank 
extends credit secured directly or indirectly by any margin stock, in an 
amount exceeding $100,000, the bank shall require its customer to 
execute Form FR U-1 (OMB No. 7100-0115), which shall be signed and 
accepted by a duly authorized officer of the bank acting in good faith.
    (ii) Nonbank lenders. Except for credit extended under paragraph 
(c)(2) of this section or Sec. 221.4, whenever a nonbank lender extends 
credit secured directly or indirectly by any margin stock, the nonbank 
lender shall require its customer to execute Form FR G-3 (OMB control 
number 7100-0018), which shall be signed and accepted by a duly 
authorized representative of the nonbank lender acting in good faith.
    (2) Purpose statement for revolving-credit or multiple-draw 
agreements or financing of securities purchases on a payment-against-
delivery basis--(i) Banks. If a bank extends credit, secured directly or 
indirectly by any margin stock, in an amount exceeding $100,000, under a 
revolving-credit or other multiple-draw agreement, Form FR U-1 must be 
executed at the time the credit arrangement is originally established 
and must be amended as described in paragraph (c)(2)(iv) of this section 
for each disbursement if all of the collateral for the agreement is not 
pledged at the time the agreement is originally established.
    (ii) Nonbank lenders. If a nonbank lender extends credit, secured 
directly or indirectly by any margin stock, under a revolving-credit or 
other multiple-draw agreement, Form FR G-3 must be executed at the time 
the credit arrangement is originally established and must be amended as 
described in paragraph (c)(2)(iv) of this section for each disbursement 
if all of the collateral for the agreement is not pledged at the time 
the agreement is originally established.
    (iii) Collateral. If a purpose statement executed at the time the 
credit arrangement is initially made indicates that the purpose is to 
purchase or carry margin stock, the credit will be deemed in compliance 
with this part if:
    (A) The maximum loan value of the collateral at least equals the 
aggregate amount of funds actually disbursed; or
    (B) At the end of any day on which credit is extended under the 
agreement, the lender calls for additional collateral sufficient to 
bring the credit into compliance with Sec. 221.7 (the Supplement).
    (iv) Amendment of purpose statement. For any purpose credit 
disbursed under the agreement, the lender shall obtain and attach to the 
executed Form FR U-1 or FR G-3 a current list of collateral which 
adequately supports all credit extended under the agreement.
    (d) Single credit rule. (1) All purpose credit extended to a 
customer shall be treated as a single credit, and all the collateral 
securing such credit shall be considered in determining whether or not 
the credit complies with this part, except that syndicated loans need 
not be aggregated with other unrelated purpose credit extended by the 
same lender.
    (2) A lender that has extended purpose credit secured by margin 
stock may not subsequently extend unsecured purpose credit to the same 
customer unless the combined credit does not exceed the maximum loan 
value of the collateral securing the prior credit.
    (3) If a lender extended unsecured purpose credit to a customer 
prior to the extension of purpose credit secured by margin stock, the 
credits shall be combined and treated as a single credit solely for the 
purposes of the withdrawal and substitution provision of paragraph (f) 
of this section.
    (4) If a lender extends purpose credit secured by any margin stock 
and non-purpose credit to the same customer, the lender shall treat the 
credits as two separate loans and may not rely upon the required 
collateral securing the purpose credit for the nonpurpose credit.
    (e) Exempted borrowers. (1) An exempted borrower that has been in 
existence for less than one year may meet the definition of exempted 
borrower based on a six-month period.
    (2) Once a member of a national securities exchange or registered 
broker or dealer ceases to qualify as an exempted borrower, it shall 
notify its lenders of this fact. Any new extensions of credit

[[Page 39]]

to such a borrower, including rollovers, renewals, and additional draws 
on existing lines of credit, are subject to the provisions of this part.
    (f) Withdrawals and substitutions. (1) A lender may permit any 
withdrawal or substitution of cash or collateral by the customer if the 
withdrawal or substitution would not:
    (i) Cause the credit to exceed the maximum loan value of the 
collateral; or
    (ii) Increase the amount by which the credit exceeds the maximum 
loan value of the collateral.
    (2) For purposes of this section, the maximum loan value of the 
collateral on the day of the withdrawal or substitution shall be used.
    (g) Exchange offers. To enable a customer to participate in a 
reorganization, recapitalization or exchange offer that is made to 
holders of an issue of margin stock, a lender may permit substitution of 
the securities received. A nonmargin, nonexempted security acquired in 
exchange for a margin stock shall be treated as if it is margin stock 
for a period of 60 days following the exchange.
    (h) Renewals and extensions of maturity. A renewal or extension of 
maturity of a credit need not be considered a new extension of credit if 
the amount of the credit is increased only by the addition of interest, 
service charges, or taxes with respect to the credit.
    (i) Transfers of credit. (1) A transfer of a credit between 
customers or between lenders shall not be considered a new extension of 
credit if:
    (i) The original credit was extended by a lender in compliance with 
this part or by a lender subject to part 207 of this chapter in effect 
prior to April 1, 1998, (See part 207 appearing in the 12 CFR parts 200 
to 219 edition revised as of January 1, 1997), in a manner that would 
have complied with this part;
    (ii) The transfer is not made to evade this part;
    (iii) The amount of credit is not increased; and
    (iv) The collateral for the credit is not changed.
    (2) Any transfer between customers at the same lender shall be 
accompanied by a statement by the transferor customer describing the 
circumstances giving rise to the transfer and shall be accepted and 
signed by a representative of the lender acting in good faith. The 
lender shall keep such statement with its records of the transferee 
account.
    (3) When a transfer is made between lenders, the transferee shall 
obtain a copy of the Form FR U-1 or Form FR G-3 originally filed with 
the transferor and retain the copy with its records of the transferee 
account. If no form was originally filed with the transferor, the 
transferee may accept in good faith a statement from the transferor 
describing the purpose of the loan and the collateral securing it.
    (j) Action for lender's protection. Nothing in this part shall 
require a bank to waive or forego any lien or prevent a bank from taking 
any action it deems necessary in good faith for its protection.
    (k) Mistakes in good faith. A mistake in good faith in connection 
with the extension or maintenance of credit shall not be a violation of 
this part.



Sec. 221.4  Employee stock option, purchase, and ownership plans.

    (a) Plan-lender; eligible plan. (1) Plan-lender means any 
corporation, (including a wholly-owned subsidiary, or a lender that is a 
thrift organization whose membership is limited to employees and former 
employees of the corporation, its subsidiaries or affiliates) that 
extends or maintains credit to finance the acquisition of margin stock 
of the corporation, its subsidiaries or affiliates under an eligible 
plan.
    (2) Eligible plan. An eligible plan means any employee stock option, 
purchase, or ownership plan adopted by a corporation and approved by its 
stockholders that provides for the purchase of margin stock of the 
corporation, its subsidiaries, or affiliates.
    (b) Credit to exercise rights under or finance an eligible plan. (1) 
If a plan-lender extends or maintains credit under an eligible plan, any 
margin stock that directly or indirectly secured that credit shall have 
good faith loan value.
    (2) Credit extended under this section shall be treated separately 
from credit extended under any other section of this part except 
Sec. 221.3(b)(1) and (b)(3).

[[Page 40]]

    (c) Credit to ESOPs. A nonbank lender may extend and maintain 
purpose credit without regard to the provisions of this part, except for 
Sec. 221.3(b)(1) and (b)(3), if such credit is extended to an employee 
stock ownership plan (ESOP) qualified under section 401 of the Internal 
Revenue Code, as amended (26 U.S.C. 401).



Sec. 221.5  Special purpose loans to brokers and dealers.

    (a) Special purpose loans. A lender may extend and maintain purpose 
credit to brokers and dealers without regard to the limitations set 
forth in Secs. 221.3 and 221.7, if the credit is for any of the specific 
purposes and meets the conditions set forth in paragraph (c) of this 
section.
    (b) Written notice. Prior to extending credit for more than a day 
under this section, the lender shall obtain and accept in good faith a 
written notice or certification from the borrower as to the purposes of 
the loan. The written notice or certification shall be evidence of 
continued eligibility for the special credit provisions until the 
borrower notifies the lender that it is no longer eligible or the lender 
has information that would cause a reasonable person to question whether 
the credit is being used for the purpose specified.
    (c) Types of special purpose credit. The types of credit that may be 
extended and maintained on a good faith basis are as follows:
    (1) Hypothecation loans. Credit secured by hypothecated customer 
securities that, according to written notice received from the broker or 
dealer, may be hypothecated by the broker or dealer under Securities and 
Exchange Commission (SEC) rules.
    (2) Temporary advances in payment-against-delivery transactions. 
Credit to finance the purchase or sale of securities for prompt 
delivery, if the credit is to be repaid upon completion of the 
transaction.
    (3) Loans for securities in transit or transfer. Credit to finance 
securities in transit or surrendered for transfer, if the credit is to 
be repaid upon completion of the transaction.
    (4) Intra-day loans. Credit to enable a broker or dealer to pay for 
securities, if the credit is to be repaid on the same day it is 
extended.
    (5) Arbitrage loans. Credit to finance proprietary or customer bona 
fide arbitrage transactions. For the purpose of this section bona fide 
arbitrage means:
    (i) Purchase or sale of a security in one market, together with an 
offsetting sale or purchase of the same security in a different market 
at nearly the same time as practicable, for the purpose of taking 
advantage of a difference in prices in the two markets; or
    (ii) Purchase of a security that is, without restriction other than 
the payment of money, exchangeable or convertible within 90 calendar 
days of the purchase into a second security, together with an offsetting 
sale of the second security at or about the same time, for the purpose 
of taking advantage of a concurrent disparity in the price of the two 
securities.
    (6) Market maker and specialist loans. Credit to a member of a 
national securities exchange or registered broker or dealer to finance 
its activities as a market maker or specialist.
    (7) Underwriter loans. Credit to a member of a national securities 
exchange or registered broker or dealer to finance its activities as an 
underwriter.
    (8) Emergency loans. Credit that is essential to meet emergency 
needs of the broker-dealer business arising from exceptional 
circumstances.
    (9) Capital contribution loans. Capital contribution loans include:
    (i) Credit that Board has exempted by order upon a finding that the 
exemption is necessary or appropriate in the public interest or for the 
protection of investors, provided the Securities Investor Protection 
Corporation certifies to the Board that the exemption is appropriate; or
    (ii) Credit to a customer for the purpose of making a subordinated 
loan or capital contribution to a broker or dealer in conformity with 
the SEC's net capital rules and the rules of the broker's or dealer's 
examining authority, provided:
    (A) The customer reduces the credit by the amount of any reduction 
in the loan or contribution to the broker or dealer; and

[[Page 41]]

    (B) The credit is not used to purchase securities issued by the 
broker or dealer in a public distribution.
    (10) Credit to clearing brokers or dealers. Credit to a member of a 
national securities exchange or registered broker or dealer whose 
nonproprietary business is limited to financing and carrying the 
accounts of registered market makers.



Sec. 221.6  Exempted transactions.

    A bank may extend and maintain purpose credit without regard to the 
provisions of this part if such credit is extended:
    (a) To any bank;
    (b) To any foreign banking institution;
    (c) Outside the United States;
    (d) To an employee stock ownership plan (ESOP) qualified under 
section 401 of the Internal Revenue Code (26 U.S.C. 401);
    (e) To any plan lender as defined in Sec. 221.4(a) to finance an 
eligible plan as defined in Sec. 221.4(b), provided the bank has no 
recourse to any securities purchased pursuant to the plan;
    (f) To any customer, other than a broker or dealer, to temporarily 
finance the purchase or sale of securities for prompt delivery, if the 
credit is to be repaid in the ordinary course of business upon 
completion of the transaction and is not extended to enable the customer 
to pay for securities purchased in an account subject to part 220 of 
this chapter;
    (g) Against securities in transit, if the credit is not extended to 
enable the customer to pay for securities purchased in an account 
subject to part 220 of this chapter; or
    (h) To enable a customer to meet emergency expenses not reasonably 
foreseeable, and if the extension of credit is supported by a statement 
executed by the customer and accepted and signed by an officer of the 
bank acting in good faith. For this purpose, emergency expenses include 
expenses arising from circumstances such as the death or disability of 
the customer, or some other change in circumstances involving extreme 
hardship, not reasonably foreseeable at the time the credit was 
extended. The opportunity to realize monetary gain or to avoid loss is 
not a ``change in circumstances'' for this purpose.



Sec. 221.7  Supplement: Maximum loan value of margin stock and other collateral.

    (a) Maximum loan value of margin stock. The maximum loan value of 
any margin stock is fifty per cent of its current market value.
    (b) Maximum loan value of nonmargin stock and all other collateral. 
The maximum loan value of nonmargin stock and all other collateral 
except puts, calls, or combinations thereof is their good faith loan 
value.
    (c) Maximum loan value of options. Except for options that qualify 
as margin stock, puts, calls, and combinations thereof have no loan 
value.

                             Interpretations



Sec. 221.101  Determination and effect of purpose of loan.

    (a) Under this part the original purpose of a loan is controlling. 
In other words, if a loan originally is not for the purpose of 
purchasing or carrying margin stock, changes in the collateral for the 
loan do not change its exempted character.
    (b) However, a so-called increase in the loan is necessarily on an 
entirely different basis. So far as the purpose of the credit is 
concerned, it is a new loan, and the question of whether or not it is 
subject to this part must be determined accordingly.
    (c) Certain facts should also be mentioned regarding the 
determination of the purpose of a loan. Section 221.3(c) provides in 
that whenever a lender is required to have its customer execute a 
``Statement of Purpose for an Extension of Credit Secured by Margin 
Stock,'' the statement must be accepted by the lender ``acting in good 
faith.'' The requirement of ``good faith'' is of vital importance here. 
Its application will necessarily vary with the facts of the particular 
case, but it is clear that the bank must be alert to the circumstances 
surrounding the loan. For example, if the loan is to be made to a 
customer who is not a broker or dealer in securities, but such a broker 
or dealer is to deliver margin stock to secure the loan or is to receive 
the proceeds of

[[Page 42]]

the loan, the bank would be put on notice that the loan would probably 
be subject to this part. It could not accept in good faith a statement 
to the contrary without obtaining a reliable and satisfactory 
explanation of the situation.
    (d) Furthermore, the purpose of a loan means just that. It cannot be 
altered by some temporary application of the proceeds. For example, if a 
borrower is to purchase Government securities with the proceeds of a 
loan, but is soon thereafter to sell such securities and replace them 
with margin stock, the loan is clearly for the purpose of purchasing or 
carrying margin stock.



Sec. 221.102  Application to committed credit where funds are disbursed thereafter.

    The Board has concluded that the date a commitment to extend credit 
becomes binding should be regarded as the date when the credit is 
extended, since:
    (a) On that date the parties should be aware of law and facts 
surrounding the transaction; and
    (b) Generally, the date of contract is controlling for purposes of 
margin regulations and Federal securities law, regardless of the 
delivery of cash or securities.



Sec. 221.103  Loans to brokers or dealers.

    Questions have arisen as to the adequacy of statements received by 
lending banks under Sec. 221.3(c), ``Purpose Statement,'' in the case of 
loans to brokers or dealers secured by margin stock where the proceeds 
of the loans are to be used to finance customer transactions involving 
the purchasing or carrying of margin stock. While some such loans may 
qualify for exemption under Secs. 221.1(b)(2), 221.4, 221.5 or 221.6, 
unless they do qualify for such an exemption they are subject to this 
part. For example, if a loan so secured is made to a broker to furnish 
cash working capital for the conduct of his brokerage business (i.e., 
for purchasing and carrying securities for the account of customers), 
the maximum loan value prescribed in Sec. 221.7 (the Supplement) would 
be applicable unless the loan should be of a kind exempted under this 
part. This result would not be affected by the fact that the margin 
stock given as security for the loan was or included margin stock owned 
by the brokerage firm. In view of the foregoing, the statement referred 
to in Sec. 221.3(c) which the lending bank must accept in good faith in 
determining the purpose of the loan would be inadequate if the form of 
statement accepted or used by the bank failed to call for answers which 
would indicate whether or not the loan was of the kind discussed 
elsewhere in this section.



Sec. 221.104  Federal credit unions.

    For text of the interpretation on Federal credit unions, see 12 CFR 
220.110.



Sec. 221.105  Arranging for extensions of credit to be made by a bank.

    For text of the interpretation on Arranging for extensions of credit 
to be made by a bank, see 12 CFR 220.111.



Sec. 221.106  Reliance in ``good faith'' on statement of purpose of loan.

    (a) Certain situations have arisen from time to time under this part 
wherein it appeared doubtful that, in the circumstances, the lending 
banks may have been entitled to rely upon the statements accepted by 
them in determining whether the purposes of certain loans were such as 
to cause the loans to be not subject to the part.
    (b) The use by a lending bank of a statement in determining the 
purpose of a particular loan is, of course, provided for by 
Sec. 221.3(c). However, under that paragraph a lending bank may accept 
such statement only if it is ``acting in good faith.'' As the Board 
stated in the interpretation contained in Sec. 221.101, the 
``requirement of `good faith' is of vital importance''; and, to fulfill 
such requirement, ``it is clear that the bank must be alert to the 
circumstances surrounding the loan.''
    (c) Obviously, such a statement would not be accepted by the bank in 
``good faith'' if at the time the loan was made the bank had knowledge, 
from any source, of facts or circumstances which were contrary to the 
natural purport of the statement, or which were sufficient reasonably to 
put the bank on notice of the questionable

[[Page 43]]

reliability or completeness of the statement.
    (d) Furthermore, the same requirement of ``good faith'' is to be 
applied whether the statement accepted by the bank is signed by the 
borrower or by an officer of the bank. In either case, ``good faith'' 
requires the exercise of special diligence in any instance in which the 
borrower is not personally known to the bank or to the officer who 
processes the loan.
    (e) The interpretation set forth in Sec. 221.101 contains an example 
of the application of the ``good faith'' test. There it was stated that 
``if the loan is to be made to a customer who is not a broker or dealer 
in securities, but such a broker or dealer is to deliver margin stock to 
secure the loan or is to receive the proceeds of the loan, the bank 
would be put on notice that the loan would probably be subject to this 
part. It could not accept in good faith a statement to the contrary 
without obtaining a reliable and satisfactory explanation of the 
situation''.
    (f) Moreover, and as also stated by the interpretation contained in 
Sec. 221.101, the purpose of a loan, of course, ``cannot be altered by 
some temporary application of the proceeds. For example, if a borrower 
is to purchase Government securities with the proceeds of a loan, but is 
soon thereafter to sell such securities and replace them with margin 
stock, the loan is clearly for the purpose of purchasing or carrying 
margin stock''. The purpose of a loan therefore, should not be 
determined upon a narrow analysis of the immediate use to which the 
proceeds of the loan are put. Accordingly, a bank acting in ``good 
faith'' should carefully scrutinize cases in which there is any 
indication that the borrower is concealing the true purpose of the loan, 
and there would be reason for special vigilance if margin stock is 
substituted for bonds or nonmargin stock soon after the loan is made, or 
on more than one occasion.
    (g) Similarly, the fact that a loan made on the borrower's signature 
only, for example, becomes secured by margin stock shortly after the 
disbursement of the loan usually would afford reasonable grounds for 
questioning the bank's apparent reliance upon merely a statement that 
the purpose of the loan was not to purchase or carry margin stock.
    (h) The examples in this section are, of course, by no means 
exhaustive. They simply illustrate the fundamental fact that no 
statement accepted by a lender is of any value for the purposes of this 
part unless the lender accepting the statement is ``acting in good 
faith'', and that ``good faith'' requires, among other things, 
reasonable diligence to learn the truth.



Sec. 221.107  Arranging loan to purchase open-end investment company shares.

    For text of the interpretation on Arranging loan to purchase open-
end investment company shares, see 12 CFR 220.112.



Sec. 221.108  Effect of registration of stock subsequent to making of loan.

    (a) The Board recently was asked whether a loan by a bank to enable 
the borrower to purchase a newly issued nonmargin stock during the 
initial over-the-counter trading period prior to the stock becoming 
registered (listed) on a national securities exchange would be subject 
to this part. The Board replied that, until such stock qualifies as 
margin stock, this would not be applicable to such a loan.
    (b) The Board has now been asked what the position of the lending 
bank would be under this part if, after the date on which the stock 
should become registered, such bank continued to hold a loan of the kind 
just described. It is assumed that the loan was in an amount greater 
than the maximum loan value for the collateral specified in this part.
    (c) If the stock should become registered, the loan would then be 
for the purpose of purchasing or carrying a margin stock, and, if 
secured directly or indirectly by any margin stock, would be subject to 
this part as from the date the stock was registered. Under this part, 
this does not mean that the bank would have to obtain reduction of the 
loan in order to reduce it to an amount no more than the specified 
maximum loan value. It does mean, however, that so long as the loan 
balance exceeded the specified

[[Page 44]]

maximum loan value, the bank could not permit any withdrawals or 
substitutions of collateral that would increase such excess; nor could 
the bank increase the amount of the loan balance unless there was 
provided additional collateral having a maximum loan value at least 
equal to the amount of the increase. In other words, as from the date 
the stock should become a margin stock, the loan would be subject to 
this part in exactly the same way, for example, as a loan subject to 
this part that became under-margined because of a decline in the current 
market value of the loan collateral or because of a decrease by the 
Board in the maximum loan value of the loan collateral.



Sec. 221.109  Loan to open-end investment company.

    In response to a question regarding a possible loan by a bank to an 
open-end investment company that customarily purchases stocks registered 
on a national securities exchange, the Board stated that in view of the 
general nature and operations of such a company, any loan by a bank to 
such a company should be presumed to be subject to this part as a loan 
for the purpose of purchasing or carrying margin stock. This would not 
be altered by the fact that the open-end company had used, or proposed 
to use, its own funds or proceeds of the loan to redeem some of its own 
shares, since mere application of the proceeds of a loan to some other 
use cannot prevent the ultimate purpose of a loan from being to purchase 
or carry registered stocks.



Sec. 221.110  Questions arising under this part.

    (a) This part governs ``any purpose credit'' extended by a lender 
``secured directly or indirectly by margin stock'' and defines ``purpose 
credit'' as ``any credit for the purpose, whether immediate, incidental, 
or ultimate, of buying or carrying margin stock, `` with certain 
exceptions, and provides that the maximum loan value of such margin 
stock shall be a fixed percentage ``of its current market value.''
    (b) The Board of Governors has had occasion to consider the 
application of the language in paragraph (a) of this section to the two 
following questions:
    (1) Loan secured by stock. First, is a loan to purchase or carry 
margin stock subject to this part where made in unsecured form, if 
margin stock is subsequently deposited as security with the lender, and 
surrounding circumstances indicate that the parties originally 
contemplated that the loan should be so secured? The Board answered that 
in a case of this kind, the loan would be subject to this part, for the 
following reasons:
    (i) The Board has long held, in the closely related purpose area, 
that the original purpose of a loan should not be determined upon a 
narrow analysis of the technical circumstances under which a loan is 
made. Instead, the fundamental purpose of the loan is considered to be 
controlling. Indeed, ``the fact that a loan made on the borrower's 
signature only, for example, becomes secured by registered stock shortly 
after the disbursement of the loan'' affords reasonable grounds for 
questioning whether the bank was entitled to rely upon the borrower's 
statement as to the purpose of the loan. 1953 Fed. Res. Bull. 951 (See, 
Sec. 221.106).
    (ii) Where security is involved, standards of interpretation should 
be equally searching. If, for example, the original agreement between 
borrower and lender contemplated that the loan should be secured by 
margin stock, and such stock is in fact delivered to the bank when 
available, the transaction must be regarded as fundamentally a secured 
loan. This view is strengthened by the fact that this part applies to a 
loan ``secured directly or indirectly by margin stock.''
    (2) Loan to acquire controlling shares. (i) The second question is 
whether this part governs a margin stock-secured loan made for the 
business purpose of purchasing a controlling interest in a corporation, 
or whether such a loan would be exempt on the ground that this part is 
directed solely toward purchases of stock for speculative or investment 
purposes. The Board answered that a margin stock-secured loan for the 
purpose of purchasing or carrying margin stock is subject to this part, 
regardless of the reason for which the purchase is made.

[[Page 45]]

    (ii) The answer is required, in the Board's view, since the language 
of this part is explicitly inclusive, covering ``any purpose credit, 
secured directly or indirectly by margin stock.'' Moreover, the 
withdrawal in 1945 of the original section 2(e) of this part, which 
exempted ``any loan for the purpose of purchasing a stock from or 
through a person who is not a member of a national securities exchange . 
. .'' plainly implies that transactions of the sort described are now 
subject to the general prohibition of Sec. 221.3(a).



Sec. 221.111  Contribution to joint venture as extension of credit when the contribution is disproportionate to the contributor's share in the venture's profits 
          or losses.

    (a) The Board considered the question whether a joint venture, 
structured so that the amount of capital contribution to the venture 
would be disproportionate to the right of participation in profits or 
losses, constitutes an ``extension of credit'' for the purpose of this 
part.
    (b) An individual and a corporation plan to establish a joint 
venture to engage in the business of buying and selling securities, 
including margin stock. The individual would contribute 20 percent of 
the capital and receive 80 percent of the profits or losses; the 
corporate share would be the reverse. In computing profits or losses, 
each participant would first receive interest at the rate of 8 percent 
on his respective capital contribution. Although purchases and sales 
would be mutually agreed upon, the corporation could liquidate the joint 
portfolio if the individual's share of the losses equaled or exceeded 
his 20 percent contribution to the venture. The corporation would hold 
the securities, and upon termination of the venture, the assets would 
first be applied to repayment of capital contributions.
    (c) In general, the relationship of joint venture is created when 
two or more persons combine their money, property, or time in the 
conduct of some particular line of trade or some particular business and 
agree to share jointly, or in proportion to capital contributed, the 
profits and losses of the undertaking.
    (d) The incidents of the joint venture described in paragraph (b) of 
this section, however, closely parallel those of an extension of margin 
credit, with the corporation as lender and the individual as borrower. 
The corporation supplies 80 percent of the purchase price of securities 
in exchange for a net return of 8 percent of the amount advanced plus 20 
percent of any gain. Like a lender of securities credit, the corporation 
is insulated against loss by retaining the right to liquidate the 
collateral before the securities decline in price below the amount of 
its contribution. Conversely, the individual--like a customer who 
borrows to purchase securities--puts up only 20 percent of their cost, 
is entitled to the principal portion of any appreciation in their value, 
bears the principal risk of loss should that value decline, and does not 
stand to gain or lose except through a change in value of the securities 
purchased.
    (e) The Board is of the opinion that where the right of an 
individual to share in profits and losses of such a joint venture is 
disproportionate to his contribution to the venture:
    (1) The joint venture involves an extension of credit by the 
corporation to the individual;
    (2) The extension of credit is to purchase or carry margin stock, 
and is collateralized by such margin stock; and
    (3) If the corporation is not a broker or dealer subject to 
Regulation T (12 CFR part 220), the credit is of the kind described by 
Sec. 221.3(a).



Sec. 221.112  Loans by bank in capacity as trustee.

    (a) The Board's advice has been requested whether a bank's 
activities in connection with the administration of an employees' 
savings plan are subject to this part.
    (b) Under the plan, any regular, full-time employee may participate 
by authorizing the sponsoring company to deduct a percentage of his 
salary and wages and transmit the same to the bank as trustee. Voluntary 
contributions by the company are allocated among the participants. A 
participant may direct that funds held for him be invested by the 
trustee in insurance,

[[Page 46]]

annuity contracts, Series E Bonds, or in one or more of three specified 
securities which are listed on a stock exchange. Loans to purchase the 
stocks may be made to participants from funds of the trust, subject to 
approval of the administrative committee, which is composed of five 
participants, and of the trustee. The bank's right to approve is said to 
be restricted to the mechanics of making the loan, the purpose being to 
avoid cumbersome procedures.
    (c) Loans are secured by the credit balance of the borrowing 
participants in the savings fund, including stock, but excluding (in 
practice) insurance and annuity contracts and government securities. 
Additional stocks may be, but, in practice, have not been pledged as 
collateral for loans. Loans are not made, under the plan, from bank 
funds, and participants do not borrow from the bank upon assignment of 
the participants' accounts in the trust.
    (d) It is urged that loans under the plan are not subject to this 
part because a loan should not be considered as having been made by a 
bank where the bank acts solely in its capacity of trustee, without 
exercise of any discretion.
    (e) The Board reviewed this question upon at least one other 
occasion, and full consideration has again been given to the matter. 
After considering the arguments on both sides, the Board has reaffirmed 
its earlier view that, in conformity with an interpretation not 
published in the Code of Federal Regulations which was published at page 
874 of the 1946 Federal Reserve Bulletin (See 12 CFR 261.10(f) for 
information on how to obtain Board publications.), this part applies to 
the activities of a bank when it is acting in its capacity as trustee. 
Although the bank in that case had at best a limited discretion with 
respect to loans made by it in its capacity as trustee, the Board 
concluded that this fact did not affect the application of the 
regulation to such loans.



Sec. 221.113  Loan which is secured indirectly by stock.

    (a) A question has been presented to the Board as to whether a loan 
by a bank to a mutual investment fund is ``secured * * * indirectly by 
margin stock'' within the meaning of Sec. 221.(3)(a), so that the loan 
should be treated as subject to this part.
    (b) Briefly, the facts are as follows. Fund X, an open-end 
investment company, entered into a loan agreement with Bank Y, which was 
(and still is) custodian of the securities which comprise the portfolio 
of Fund X. The agreement includes the following terms, which are 
material to the question before the Board:
    (1) Fund X agrees to have an ``asset coverage'' (as defined in the 
agreements) of 400 percent of all its borrowings, including the proposed 
borrowing, at the time when it takes down any part of the loan.
    (2) Fund X agrees to maintain an ``asset coverage'' of at least 300 
percent of its borrowings at all times.
    (3) Fund X agrees not to amend its custody agreement with Bank Y, or 
to substitute another custodian without Bank Y's consent.
    (4) Fund X agrees not to mortgage, pledge, or otherwise encumber any 
of its assets elsewhere than with Bank Y.
    (c) In Sec. 221.109 the Board stated that because of ``the general 
nature and operations of such a company'', any ``loan by a bank to an 
open-end investment company that customarily purchases margin stock * * 
* should be presumed to be subject to this part as a loan for the 
purpose of purchasing or carrying margin stock'' (purpose credit). The 
Board's interpretation went on to say that: ``this would not be altered 
by the fact that the open-end company had used, or proposed to use, its 
own funds or proceeds of the loan to redeem some of its own shares * * 
*.''
    (d) Accordingly, the loan by Bank Y to Fund X was and is a ``purpose 
credit''. However, a loan by a bank is not subject to this part unless: 
it is a purpose credit; and it is ``secured directly or indirectly by 
margin stock''. In the present case, the loan is not ``secured 
directly'' by stock in the ordinary sense, since the portfolio of Fund X 
is not pledged to secure the credit from Bank Y. But the word 
``indirectly'' must signify some form of security arrangement other than 
the ``direct'' security which arises from the ordinary ``transaction 
that gives recourse

[[Page 47]]

against a particular chattel or land or against a third party on an 
obligation'' described in the American Law Institute's Restatement of 
the Law of Security, page 1. Otherwise the word ``indirectly'' would be 
superfluous, and a regulation, like a statute, must be construed if 
possible to give meaning to every word.
    (e) The Board has indicated its view that any arrangement under 
which margin stock is more readily available as security to the lending 
bank than to other creditors of the borrower may amount to indirect 
security within the meaning of this part. In an interpretation published 
at Sec. 221.110 it stated: ``The Board has long held, in the * * * 
purpose area, that the original purpose of a loan should not be 
determined upon a narrow analysis of the technical circumstances under 
which a loan is made * * * . Where security is involved, standards of 
interpretation should be equally searching.'' In its pamphlet issued for 
the benefit and guidance of banks and bank examiners, entitled 
``Questions and Answers Illustrating Application of Regulation U'', the 
Board said: ``In determining whether a loan is ``indirectly'' secured, 
it should be borne in mind that the reason the Board has thus far 
refrained * * * from regulating loans not secured by stock has been to 
simplify operations under the regulation. This objective of simplifying 
operations does not apply to loans in which arrangements are made to 
retain the substance of stock collateral while sacrificing only the 
form''.
    (f) A wide variety of arrangements as to collateral can be made 
between bank and borrower which will serve, to some extent, to protect 
the interest of the bank in seeing that the loan is repaid, without 
giving the bank a conventional direct ``security'' interest in the 
collateral. Among such arrangements which have come to the Board's 
attention are the following:
    (1) The borrower may deposit margin stock in the custody of the 
bank. An arrangement of this kind may not, it is true, place the bank in 
the position of a secured creditor in case of bankruptcy, or even of 
conflicting claims, but it is likely effectively to strengthen the 
bank's position. The definition of indirectly secured in Sec. 221.2, 
which provides that a loan is not indirectly secured if the lender 
``holds the margin stock only in the capacity of custodian, depositary 
or trustee, or under similar circumstances, and, in good faith has not 
relied upon the margin stock as collateral,'' does not exempt a deposit 
of this kind from the impact of the regulation unless it is clear that 
the bank ``has not relied'' upon the margin stock deposited with it.
    (2) A borrower may not deposit his margin stock with the bank, but 
agree not to pledge or encumber his assets elsewhere while the loan is 
outstanding. Such an agreement may be difficult to police, yet it serves 
to some extent to protect the interest of the bank if only because the 
future credit standing and business reputation of the borrower will 
depend upon his keeping his word. If the assets covered by such an 
agreement include margin stock, then, the credit is ``indirectly 
secured'' by the margin stock within the meaning of this part.
    (3) The borrower may deposit margin stock with a third party who 
agrees to hold the stock until the loan has been paid off. Here, even 
though the parties may purport to provide that the stock is not 
``security'' for the loan (for example, by agreeing that the stock may 
not be sold and the proceeds applied to the debt if the borrower fails 
to pay), the mere fact that the stock is out of the borrower's control 
for the duration of the loan serves to some extent to protect the bank.
    (g) The three instances described in paragraph (f) of this section 
are merely illustrative. Other methods, or combinations of methods, may 
serve a similar purpose. The conclusion that any given arrangement makes 
a credit ``indirectly secured'' by margin stock may, but need not, be 
reinforced by facts such as that the stock in question was purchased 
with proceeds of the loan, that the lender suggests or insists upon the 
arrangement, or that the loan would probably be subject to criticism by 
supervisory authorities were it not for the protective arrangement.
    (h) Accordingly, the Board concludes that the loan by Bank Y to Fund 
X is indirectly secured by the portfolio of the fund and must be treated 
by the bank as a regulated loan.

[[Page 48]]



Sec. 221.114  Bank loans to purchase stock of American Telephone and Telegraph Company under Employees' Stock Plan.

    (a) The Board of Governors interpreted this part in connection with 
proposed loans by a bank to persons who are purchasing shares of stock 
of American Telephone and Telegraph Company pursuant to its Employees' 
Stock Plan.
    (b) According to the current offering under the Plan, an employee of 
the AT&T system may purchase shares through regular deductions from his 
pay over a period of 24 months. At the end of that period, a certificate 
for the appropriate number of shares will be issued to the participating 
employee by AT&T. Each employee is entitled to purchase, as a maximum, 
shares that will cost him approximately three-fourths of his annual base 
pay. Since the program extends over two years, it follows that the 
payroll deductions for this purpose may be in the neighborhood of 38 
percent of base pay and a larger percentage of ``take-home pay.'' 
Deductions of this magnitude are in excess of the saving rate of many 
employees.
    (c) Certain AT&T employees, who wish to take advantage of the 
current offering under the Plan, are the owners of shares of AT&T stock 
that they purchased under previous offerings. A bank proposed to receive 
such stock as collateral for a ``living expenses'' loan that will be 
advanced to the employee in monthly installments over the 24-month 
period, each installment being in the amount of the employee's monthly 
payroll deduction under the Plan. The aggregate amount of the advances 
over the 24-month period would be substantially greater than the maximum 
loan value of the collateral as prescribed in Sec. 221.7 (the 
Supplement).
    (d) In the opinion of the Board of Governors, a loan of the kind 
described would violate this part if it exceeded the maximum loan value 
of the collateral. The regulation applies to any margin stock-secured 
loan for the purpose of purchasing or carrying margin stock 
(Sec. 221.3(a)). Although the proposed loan would purport to be for 
living expenses, it seems quite clear, in view of the relationship of 
the loan to the Employees' Stock Plan, that its actual purpose would be 
to enable the borrower to purchase AT&T stock, which is margin stock. At 
the end of the 24-month period the borrower would acquire a certain 
number of shares of that stock and would be indebted to the lending bank 
in an amount approximately equal to the amount he would pay for such 
shares. In these circumstances, the loan by the bank must be regarded as 
a loan ``for the purpose of purchasing'' the stock, and therefore it is 
subject to the limitations prescribed by this part. This conclusion 
follows from the provisions of this part, and it may also be observed 
that a contrary conclusion could largely defeat the basic purpose of the 
margin regulations.
    (e) Accordingly, the Board concluded that a loan of the kind 
described may not be made in an amount exceeding the maximum loan value 
of the collateral, as prescribed by the current Sec. 221.7 (the 
Supplement).



Sec. 221.115  Accepting a purpose statement through the mail without benefit of face-to-face interview.

    (a) The Board has been asked whether the acceptance of a purpose 
statement submitted through the mail by a lender subject to the 
provisions of this part will meet the good faith requirement of 
Sec. 221.3(c). Section 221.3(c) states that in connection with any 
credit secured by collateral which includes any margin stock, a nonbank 
lender must obtain a purpose statement executed by the borrower and 
accepted by the lender in good faith. Such acceptance requires that the 
lender be alert to the circumstances surrounding the credit and if 
further information suggests inquiry, he must investigate and be 
satisfied that the statement is truthful.
    (b) The lender is a subsidiary of a holding company which also has 
another subsidiary which serves as underwriter and investment advisor to 
various mutual funds. The sole business of the lender will be to make 
``non-purpose'' consumer loans to shareholders of the mutual funds, such 
loans to be collateralized by the fund shares. Most mutual funds shares 
are margin stock for purposes of this part. Solicitation and acceptance 
of these consumer

[[Page 49]]

loans will be done principally through the mail and the lender wishes to 
obtain the required purpose statement by mail rather than by a face-to-
face interview. Personal interviews are not practicable for the lender 
because shareholders of the funds are scattered throughout the country. 
In order to provide the same safeguards inherent in face-to-face 
interviews, the lender has developed certain procedures designed to 
satisfy the good faith acceptance requirement of this part.
    (c) The purpose statement will be supplemented with several 
additional questions relevant to the prospective borrower's investment 
activities such as purchases of any security within the last 6 months, 
dollar amount, and obligations to purchase or pay for previous 
purchases; present plans to purchase securities in the near future, 
participations in securities purchase plans, list of unpaid debts, and 
present income level. Some questions have been modified to facilitate 
understanding but no questions have been deleted. If additional inquiry 
is indicated by the answers on the form, a loan officer of the lender 
will interview the borrower by telephone to make sure the loan is ``non-
purpose''. Whenever the loan exceeds the ``maximum loan value'' of the 
collateral for a regulated loan, a telephone interview will be done as a 
matter of course.
    (d) One of the stated purposes of Regulation X (12 CFR part 224) was 
to prevent the infusion of unregulated credit into the securities 
markets by borrowers falsely certifying the purpose of a loan. The Board 
is of the view that the existence of Regulation X (12 CFR part 224), 
which makes the borrower liable for willful violations of the margin 
regulations, will allow a lender subject to this part to meet the good 
faith acceptance requirement of Sec. 221.3(c) without a face-to-face 
interview if the lender adopts a program, such as the one described in 
paragraph (c) of this section, which requires additional detailed 
information from the borrower and proper procedures are instituted to 
verify the truth of the information received. Lenders intending to 
embark on a similar program should discuss proposed plans with their 
district Federal Reserve Bank. Lenders may have existing or future loans 
with the prospective customers which could complicate the efforts to 
determine the true purpose of the loan.



Sec. 221.116  Bank loans to replenish working capital used to purchase mutual fund shares.

    (a) In a situation considered by the Board of Governors, a business 
concern (X) proposed to purchase mutual fund shares, from time to time, 
with proceeds from its accounts receivable, then pledge the shares with 
a bank in order to secure working capital. The bank was prepared to lend 
amounts equal to 70 percent of the current value of the shares as they 
were purchased by X. If the loans were subject to this part, only 50 
percent of the current market value of the shares could be lent.
    (b) The immediate purpose of the loans would be to replenish X's 
working capital. However, as time went on, X would be acquiring mutual 
fund shares at a cost that would exceed the net earnings it would 
normally have accumulated, and would become indebted to the lending bank 
in an amount approximately 70 percent of the prices of said shares.
    (c) The Board held that the loans were for the purpose of purchasing 
the shares, and therefore subject to the limitations prescribed by this 
part. As pointed out in Sec. 221.114 with respect to a similar program 
for putting a high proportion of cash income into stock, the borrowing 
against the margin stock to meet needs for which the cash would 
otherwise have been required, a contrary conclusion could largely defeat 
the basic purpose of the margin regulations.
    (d) Also considered was an alternative proposal under which X would 
deposit proceeds from accounts receivable in a time account for 1 year, 
before using those funds to purchase mutual fund shares. The Board held 
that this procedure would not change the situation in any significant 
way. Once the arrangement was established, the proceeds would be flowing 
into the time account at the same time that similar amounts were 
released to purchase the shares, and over any extended period of time 
the result would

[[Page 50]]

be the same. Accordingly, the Board concluded that bank loans made under 
the alternative proposal would similarly be subject to this part.



Sec. 221.117  When bank in ``good faith'' has not relied on stock as collateral.

    (a) The Board has received questions regarding the circumstances in 
which an extension or maintenance of credit will not be deemed to be 
``indirectly secured'' by stock as indicated by the phrase, ``if the 
lender, in good faith, has not relied upon the margin stock as 
collateral,'' contained in paragraph (2)(iv) of the definition of 
indirectly secured in Sec. 221.2.
    (b) In response, the Board noted that in amending this portion of 
the regulation in 1968 it was indicated that one of the purposes of the 
change was to make clear that the definition of indirectly secured does 
not apply to certain routine negative covenants in loan agreements. 
Also, while the question of whether or not a bank has relied upon 
particular stock as collateral is necessarily a question of fact to be 
determined in each case in the light of all relevant circumstances, some 
indication that the bank had not relied upon stock as collateral would 
seem to be afforded by such circumstances as the fact that:
    (1) The bank had obtained a reasonably current financial statement 
of the borrower and this statement could reasonably support the loan; 
and
    (2) The loan was not payable on demand or because of fluctuations in 
market value of the stock, but instead was payable on one or more fixed 
maturities which were typical of maturities applied by the bank to loans 
otherwise similar except for not involving any possible question of 
stock collateral.



Sec. 221.118  Bank arranging for extension of credit by corporation.

    (a) The Board considered the questions whether:
    (1) The guaranty by a corporation of an ``unsecured'' bank loan to 
exercise an option to purchase stock of the corporation is an 
``extension of credit'' for the purpose of this part;
    (2) Such a guaranty is given ``in the ordinary course of business'' 
of the corporation, as defined in Sec. 221.2; and
    (3) The bank involved took part in arranging for such credit on 
better terms than it could extend under the provisions of this part.
    (b) The Board understood that any officer or employee included under 
the corporation's stock option plan who wished to exercise his option 
could obtain a loan for the purchase price of the stock by executing an 
unsecured note to the bank. The corporation would issue to the bank a 
guaranty of the loan and hold the purchased shares as collateral to 
secure it against loss on the guaranty. Stock of the corporation is 
registered on a national securities exchange and therefore qualifies as 
``margin stock'' under this part.
    (c) A nonbank lender is subject to the registration and other 
requirements of this part if, in the ordinary course of his business, he 
extends credit on collateral that includes any margin stock in the 
amount of $200,000 or more in any calendar quarter, or has such credit 
outstanding in any calendar quarter in the amount of $500,000 or more. 
The Board understood that the corporation in question had sufficient 
guaranties outstanding during the applicable calendar quarter to meet 
the dollar thresholds for registration.
    (d) In the Board's judgment a person who guarantees a loan, and 
thereby becomes liable for the amount of the loan in the event the 
borrower should default, is lending his credit to the borrower. In the 
circumstances described, such a lending of credit must be considered an 
``extension of credit'' under this part in order to prevent 
circumvention of the regulation's limitation on the amount of credit 
that can be extended on the security of margin stock.
    (e) Under Sec. 221.2, the term in the ordinary course of business 
means ``occurring or reasonably expected to occur in carrying out or 
furthering any business purpose. * * *'' In general, stock option plans 
are designed to provide a company's employees with a proprietary 
interest in the company in the form of ownership of the company's stock. 
Such plans increase the company's

[[Page 51]]

ability to attract and retain able personnel and, accordingly, promote 
the interest of the company and its stockholders, while at the same time 
providing the company's employees with additional incentive to work 
toward the company's future success. An arrangement whereby 
participating employees may finance the exercise of their options 
through an unsecured bank loan guaranteed by the company, thereby 
facilitating the employees' acquisition of company stock, is likewise 
designed to promote the company's interest and is, therefore, in 
furtherance of a business purpose.
    (f) For the reasons indicated, the Board concluded that under the 
circumstances described a guaranty by the corporation constitutes credit 
extended in the ordinary course of business under this part, that the 
corporation is required to register pursuant to Sec. 221.3(b), and that 
such guaranties may not be given in excess of the maximum loan value of 
the collateral pledged to secure the guaranty.
    (g) Section 221.3(a)(3) provides that ``no lender may arrange for 
the extension or maintenance of any purpose credit, except upon the same 
terms and conditions on which the lender itself may extend or maintain 
purpose credit under this part''. Since the Board concluded that the 
giving of a guaranty by the corporation to secure the loan described 
above constitutes an extension of credit, and since the use of a 
guaranty in the manner described could not be effectuated without the 
concurrence of the bank involved, the Board further concluded that the 
bank took part in ``arranging'' for the extension of credit in excess of 
the maximum loan value of the margin stock pledged to secure the 
guaranties.



Sec. 221.119  Applicability of plan-lender provisions to financing of stock options and stock purchase rights qualified or restricted under Internal Revenue 
          Code.

    (a) The Board has been asked whether the plan-lender provisions of 
Sec. 221.4(a) and (b) were intended to apply to the financing of stock 
options restricted or qualified under the Internal Revenue Code where 
such options or the option plan do not provide for such financing.
    (b) It is the Board's experience that in some nonqualified plans, 
particularly stock purchase plans, the credit arrangement is distinct 
from the plan. So long as the credit extended, and particularly, the 
character of the plan-lender, conforms with the requirements of the 
regulation, the fact that option and credit are provided for in separate 
documents is immaterial. It should be emphasized that the Board does not 
express any view on the preferability of qualified as opposed to 
nonqualified options; its role is merely to prevent excessive credit in 
this area.
    (c) Section 221.4(a) provides that a plan-lender may include a 
wholly-owned subsidiary of the issuer of the collateral (taking as a 
whole, corporate groups including subsidiaries and affiliates). This 
clarifies the Board's intent that, to qualify for special treatment 
under that section, the lender must stand in a special employer-employee 
relationship with the borrower, and a special relationship of issuer 
with regard to the collateral. The fact that the Board, for convenience 
and practical reasons, permitted the employing corporation to act 
through a subsidiary or other entity should not be interpreted to mean 
the Board intended the lender to be other than an entity whose 
overriding interests were coextensive with the issuer. An independent 
corporation, with independent interests was never intended, regardless 
of form, to be at the base of exempt stock-plan lending.



Sec. 221.120  Allocation of stock collateral to purpose and nonpurpose credits to same customer.

    (a) A bank proposes to extend two credits (Credits A and B) to its 
customer. Although the two credits are proposed to be extended at the 
same time, each would be evidenced by a separate agreement. Credit A 
would be extended for the purpose of providing the customer with working 
capital (nonpurpose credit), collateralized by margin stock. Credit B 
would be extended for the purpose of purchasing or carrying margin stock 
(purpose credit), without collateral or on collateral other than stock.

[[Page 52]]

    (b) This part allows a bank to extend purpose and nonpurpose credits 
simultaneously or successively to the same customer. This rule is 
expressed in Sec. 221.3(d)(4) which provides in substance that for any 
nonpurpose credit to the same customer, the lender shall in good faith 
require as much collateral not already identified to the customer's 
purpose credit as the lender would require if it held neither the 
purpose loan nor the identified collateral. This rule in 
Sec. 221.3(d)(4) also takes into account that the lender would not 
necessarily be required to hold collateral for the nonpurpose credit if, 
consistent with good faith banking practices, it would normally make 
this kind of nonpurpose loan without collateral.
    (c) The Board views Sec. 221.3(d)(4), when read in conjunction with 
Sec. 221.3(c) and (f), as requiring that whenever a lender extends two 
credits to the same customer, one a purpose credit and the other 
nonpurpose, any margin stock collateral must first be identified with 
and attributed to the purpose loan by taking into account the maximum 
loan value of such collateral as prescribed in Sec. 221.7 (the 
Supplement).
    (d) The Board is further of the opinion that under the foregoing 
circumstances Credit B would be indirectly secured by stock, despite the 
fact that there would be separate loan agreements for both credits. This 
conclusion flows from the circumstance that the lender would hold in its 
possession stock collateral to which it would have access with respect 
to Credit B, despite any ostensible allocation of such collateral to 
Credit A.



Sec. 221.121  Extension of credit in certain stock option and stock purchase plans.

    Questions have been raised as to whether certain stock option and 
stock purchase plans involve extensions of credit subject to this part 
when the participant is free to cancel his participation at any time 
prior to full payment, but in the event of cancellation the participant 
remains liable for damages. It thus appears that the participant has the 
opportunity to gain and bears the risk of loss from the time the 
transaction is executed and payment is deferred. In some cases brought 
to the Board's attention damages are related to the market price of the 
stock, but in others, there may be no such relationship. In either of 
these circumstances, it is the Board's view that such plans involve 
extensions of credit. Accordingly, where the security being purchased is 
a margin security and the credit is secured, directly or indirectly, by 
any margin security, the creditor must register and the credit must 
conform with either the regular margin requirements of Sec. 221.3(a) or 
the special ``plan-lender'' provisions set forth in Sec. 221.4, 
whichever is applicable. This assumes, of course, that the amount of 
credit extended is such that the creditor is subject to the registration 
requirements of Sec. 221.3(b).



Sec. 221.122  Applicability of margin requirements to credit in connection with Insurance Premium Funding Programs.

    (a) The Board has been asked numerous questions regarding purpose 
credit in connection with insurance premium funding programs. The 
inquiries are included in a set of guidelines in the format of questions 
and answers. (The guidelines are available pursuant to the Board's Rules 
Regarding Availability of Information, 12 CFR part 261.) A glossary of 
terms customarily used in connection with insurance premium funding 
credit activities is included in the guidelines. Under a typical 
insurance premium funding program, a borrower acquires mutual fund 
shares for cash, or takes fund shares which he already owns, and then 
uses the loan value (currently 50 percent as set by the Board) to buy 
insurance. Usually, a funding company (the issuer) will sell both the 
fund shares and the insurance through either independent broker/dealers 
or subsidiaries or affiliates of the issuer. A typical plan may run for 
10 or 15 years with annual insurance premiums due. To illustrate, 
assuming an annual insurance premium of $300, the participant is 
required to put up mutual fund shares equivalent to 250 percent of the 
premium or $600 ($600 x 50 percent loan value equals $300 the amount of 
the insurance premium which is also the amount of the credit extended).

[[Page 53]]

    (b) The guidelines referenced in paragraph (a) of this section also:
    (1) Clarify an earlier 1969 Board interpretation to show that the 
public offering price of mutual fund shares (which includes the front 
load, or sales commission) may be used as a measure of their current 
market value when the shares serve as collateral on a purpose credit 
throughout the day of the purchase of the fund shares; and
    (2) Relax a 1965 Board position in connection with accepting purpose 
statements by mail.
    (c) It is the Board's view that when it is clearly established that 
a purpose statement supports a purpose credit then such statement 
executed by the borrower may be accepted by mail, provided it is 
received and also executed by the lender before the credit is extended.



Sec. 221.123  Combined credit for exercising employee stock options and paying income taxes incurred as a result of such exercise.

    (a) Section 221.4(a) and (b), which provides special treatment for 
credit extended under employee stock option plans, was designed to 
encourage their use in recognition of their value in giving an employee 
a proprietary interest in the business. Taking a position that might 
discourage the exercise of options because of tax complications would 
conflict with the purpose of Sec. 221.4(a) and (b).
    (b) Accordingly, the Board has concluded that the combined loans for 
the exercise of the option and the payment of the taxes in connection 
therewith under plans complying with Sec. 221.4(a)(2) may be regarded as 
purpose credit within the meaning of Sec. 221.2.



Sec. 221.124  Purchase of debt securities to finance corporate takeovers.

    (a) Petitions have been filed with the Board raising questions as to 
whether the margin requirements in this part apply to two types of 
corporate acquisitions in which debt securities are issued to finance 
the acquisition of margin stock of a target company.
    (b) In the first situation, the acquiring company, Company A, 
controls a shell corporation that would make a tender offer for the 
stock of Company B, which is margin stock (as defined in Sec. 221.2). 
The shell corporation has virtually no operations, has no significant 
business function other than to acquire and hold the stock of Company B, 
and has substantially no assets other than the margin stock to be 
acquired. To finance the tender offer, the shell corporation would issue 
debt securities which, by their terms, would be unsecured. If the tender 
offer is successful, the shell corporation would seek to merge with 
Company B. However, the tender offer seeks to acquire fewer shares of 
Company B than is necessary under state law to effect a short form 
merger with Company B, which could be consummated without the approval 
of shareholders or the board of directors of Company B.
    (c) The purchase of the debt securities issued by the shell 
corporation to finance the acquisition clearly involves purpose credit 
(as defined in Sec. 221.2). In addition, such debt securities would be 
purchased only by sophisticated investors in very large minimum 
denominations, so that the purchasers may be lenders for purposes of 
this part. See Sec. 221.3(b). Since the debt securities contain no 
direct security agreement involving the margin stock, applicability of 
the lending restrictions of this part turns on whether the arrangement 
constitutes an extension of credit that is secured indirectly by margin 
stock.
    (d) As the Board has recognized, indirect security can encompass a 
wide variety of arrangements between lenders and borrowers with respect 
to margin stock collateral that serve to protect the lenders' interest 
in assuring that a credit is repaid where the lenders do not have a 
conventional direct security interest in the collateral. See 
Sec. 221.124. However, credit is not ``indirectly secured'' by margin 
stock if the lender in good faith has not relied on the margin stock as 
collateral extending or maintaining credit. See Sec. 221.2.
    (e) The Board is of the view that, in the situation described in 
paragraph (b) of this section, the debt securities would be presumed to 
be indirectly secured by the margin stock to be acquired by the shell 
acquisition vehicle. The staff has previously expressed the view that 
nominally unsecured credit extended to an investment company, a

[[Page 54]]

substantial portion of whose assets consist of margin stock, is 
indirectly secured by the margin stock. See Federal Reserve Regulatory 
Service 5-917.12. (See 12 CFR 261.10(f) for information on how to obtain 
Board publications.) This opinion notes that the investment company has 
substantially no assets other than margin stock to support indebtedness 
and thus credit could not be extended to such a company in good faith 
without reliance on the margin stock as collateral.
    (f) The Board believes that this rationale applies to the debt 
securities issued by the shell corporation described in paragraph (b) of 
this section. At the time the debt securities are issued, the shell 
corporation has substantially no assets to support the credit other than 
the margin stock that it has acquired or intends to acquire and has no 
significant business function other than to hold the stock of the target 
company in order to facilitate the acquisition. Moreover, it is possible 
that the shell may hold the margin stock for a significant and 
indefinite period of time, if defensive measures by the target prevent 
consummation of the acquisition. Because of the difficulty in predicting 
the outcome of a contested takeover at the time that credit is committed 
to the shell corporation, the Board believes that the purchasers of the 
debt securities could not, in good faith, lend without reliance on the 
margin stock as collateral. The presumption that the debt securities are 
indirectly secured by margin stock would not apply if there is specific 
evidence that lenders could in good faith rely on assets other than 
margin stock as collateral, such as a guaranty of the debt securities by 
the shell corporation's parent company or another company that has 
substantial non-margin stock assets or cash flow. This presumption would 
also not apply if there is a merger agreement between the acquiring and 
target companies entered into at the time the commitment is made to 
purchase the debt securities or in any event before loan funds are 
advanced. In addition, the presumption would not apply if the obligation 
of the purchasers of the debt securities to advance funds to the shell 
corporation is contingent on the shell's acquisition of the minimum 
number of shares necessary under applicable state law to effect a merger 
between the acquiring and target companies without the approval of 
either the shareholders or directors of the target company. In these two 
situations where the merger will take place promptly, the Board believes 
the lenders could reasonably be presumed to be relying on the assets of 
the target for repayment.
    (g) In addition, the Board is of the view that the debt securities 
described in paragraph (b) of this section are indirectly secured by 
margin stock because there is a practical restriction on the ability of 
the shell corporation to dispose of the margin stock of the target 
company. Indirectly secured is defined in Sec. 221.2 to include any 
arrangement under which the customer's right or ability to sell, pledge, 
or otherwise dispose of margin stock owned by the customer is in any way 
restricted while the credit remains outstanding. The purchasers of the 
debt securities issued by a shell corporation to finance a takeover 
attempt clearly understand that the shell corporation intends to acquire 
the margin stock of the target company in order to effect the 
acquisition of that company. This understanding represents a practical 
restriction on the ability of the shell corporation to dispose of the 
target's margin stock and to acquire other assets with the proceeds of 
the credit.
    (h) In the second situation, Company C, an operating company with 
substantial assets or cash flow, seeks to acquire Company D, which is 
significantly larger than Company C. Company C establishes a shell 
corporation that together with Company C makes a tender offer for the 
shares of Company D, which is margin stock. To finance the tender offer, 
the shell corporation would obtain a bank loan that complies with the 
margin lending restrictions of this part and Company C would issue debt 
securities that would not be directly secured by any margin stock. The 
Board is of the opinion that these debt securities should not be 
presumed to be indirectly secured by the margin stock of Company D, 
since, as an operating business, Company C has substantial assets or 
cash flow without regard to the margin stock of Company

[[Page 55]]

D. Any presumption would not be appropriate because the purchasers of 
the debt securities may be relying on assets other than margin stock of 
Company D for repayment of the credit.



Sec. 221.125  Credit to brokers and dealers.

    (a) The National Securities Markets Improvement Act of 1996 (Pub. L. 
104-290, 110 Stat. 3416) restricts the Board's margin authority by 
repealing section 8(a) of the Securities Exchange Act of 1934 (the 
Exchange Act) and amending section 7 of the Exchange Act (15 U.S.C. 78g) 
to exclude the borrowing by a member of a national securities exchange 
or a registered broker or dealer ``a substantial portion of whose 
business consists of transactions with persons other than brokers or 
dealers'' and borrowing by a member of a national securities exchange or 
a registered broker or dealer to finance its activities as a market 
maker or an underwriter. Notwithstanding this exclusion, the Board may 
impose such rules and regulations if it determines they are ``necessary 
or appropriate in the public interest or for the protection of 
investors.''
    (b) The Board has not found that it is necessary or appropriate in 
the public interest or for the protection of investors to impose rules 
and regulations regarding loans to brokers and dealers covered by the 
National Securities Markets Improvement Act of 1996.



PART 224--BORROWERS OF SECURITIES CREDIT (REGULATION X)--Table of Contents




Sec.
224.1  Authority, purpose, and scope.
224.2  Definitions.
224.3  Margin regulations to be applied by nonexempted borrowers.

    Authority: 15 U.S.C. 78g.

    Source: Reg. X, 48 FR 56572, Dec. 22, 1983, unless otherwise noted.

    Editorial Note: See the List of CFR Sections Affected in the Finding 
Aids section of this volume for FR citations to Part 224 OTC Margin 
Stocks changes.



Sec. 224.1  Authority, purpose, and scope.

    (a) Authority and purpose. Regulation X (this part) is issued by the 
Board of Governors of the Federal Reserve System (the Board) under the 
Securities Exchange Act of 1934, as amended (the Act) (15 U.S.C. 78a et 
seq.). This part implements section 7(f) of the Act (15 U.S.C. 78g(f)), 
the purpose of which is to require that credit obtained within or 
outside the United States complies with the limitations of the Board's 
Margin Regulations T and U (12 CFR parts 220 and 221, respectively).
    (b) Scope and exemptions. The Act and this part apply the Board's 
margin regulations to United States persons and foreign persons 
controlled by or acting on behalf of or in conjunction with United 
States persons (hereinafter borrowers), who obtain credit outside the 
United States to purchase or carry United States securities, or within 
the United States to purchase or carry any securities (both types of 
credit are hereinafter referred to as purpose credit). The following 
borrowers are exempt from the Act and this part:
    (1) Any borrower who obtains purpose credit within the United 
States, unless the borrower willfully causes the credit to be extended 
in contravention of Regulations T or U.
    (2) Any borrower whose permanent residence is outside the United 
States and who does not obtain or have outstanding, during any calendar 
year, a total of more than $100,000 in purpose credit obtained outside 
the United States; and
    (3) Any borrower who is exempt by Order upon terms and conditions 
set by the Board.

[Reg. X, 48 FR 56572, Dec. 22, 1983, as amended by Reg. X, 63 FR 2839, 
Jan. 16, 1998]



Sec. 224.2  Definitions.

    The terms used in this part have the meanings given to them in 
sections 3(a) and 7(f) of the Act, and in Regulations T and U. Section 
7(f) of the Act contains the following definitions:
    (a) United States person includes a person which is organized or 
exists under the laws of any State or, in the case of a natural person, 
a citizen or resident of the United States; a domestic estate; or a 
trust in which one or more of the foregoing persons has a cumulative 
direct or indirect beneficial interest in excess of 50 per centum of the 
valve of the trust.

[[Page 56]]

    (b) United States security means a security (other than an exempted 
security) issued by a person incorporated under the laws of any State, 
or whose principal place of business is within a State.
    (c) Foreign person controlled by a United States person includes any 
noncorporate entity in which United States persons directly or 
indirectly have more than a 50 per centum beneficial interest, and any 
corporation in which one or more United States persons, directly or 
indirectly, own stock possessing more than 50 per centum of the total 
combined voting power of all classes of stock entitled to vote, or more 
than 50 per centum of the total value of shares of all classes of stock.

[Reg. X, 48 FR 56572, Dec. 22, 1983, as amended by Reg. X, 63 FR 2839, 
Jan. 16, 1998]



Sec. 224.3  Margin regulations to be applied by nonexempted borrowers.

    (a) Credit transactions outside the United States. No borrower shall 
obtain purpose credit from outside the United States unless it conforms 
to the following margin regulations:
    (1) Regulation T (12 CFR part 220) if the credit is obtained from a 
foreign branch of a broker-dealer;
    (2) Regulation U (12 CFR part 221), as it applies to banks, if the 
credit is obtained from a foreign branch of a bank, except for the 
requirement of a purpose statement (12 CFR 221.3(c)(1)(i) and 
(c)(2)(i)); and
    (3) Regulation U (12 CFR part 221), as it applies to nonbank 
lenders, if the credit is obtained from any other lender outside the 
United States, except for the requirement of a purpose statement (12 CFR 
221.3(c)(1)(ii) and (c)(2)(ii)).
    (b) Credit transactions within the United States. Any borrower who 
willfully causes credit to be extended in contravention of Regulations T 
and U (12 CFR parts 220 and 221), and who, therefore, is not exempted by 
Sec. 224.1(b)(1), must conform the credit to the margin regulation that 
applies to the lender.

[Reg. X, 63 FR 2839, Jan. 16, 1998]



PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL (REGULATION Y)--Table of Contents




                               Regulations

                      Subpart A--General Provisions

Sec.
225.1  Authority, purpose, and scope.
225.2  Definitions.
225.3  Administration.
225.4  Corporate practices.
225.5  Registration, reports, and inspections.
225.6  Penalties for violations.
225.7  Exceptions to tying restrictions.

           Subpart B--Acquisition of Bank Securities or Assets

225.11  Transactions requiring Board approval.
225.12  Transactions not requiring Board approval.
225.13  Factors considered in acting on bank acquisition proposals.
225.14  Expedited action for certain bank acquisitions by well-run bank 
          holding companies.
225.15  Procedures for other bank acquisition proposals.
225.16  Public notice, comments, hearings, and other provisions 
          governing applications and notices.
225.17  Notice procedure for one-bank holding company formations.

   Subpart C--Nonbanking Activities and Acquisitions by Bank Holding 
                                Companies

225.21  Prohibited nonbanking activities and acquisitions; exempt bank 
          holding companies.
225.22  Exempt nonbanking activities and acquisitions.
225.23  Expedited action for certain nonbanking proposals by well-run 
          bank holding companies.
225.24  Procedures for other nonbanking proposals.
225.25  Hearings, alteration of activities, and other matters.
225.26  Factors considered in acting on nonbanking proposals.
225.27  Procedures for determining scope of nonbanking activities.
225.28  List of permissible nonbanking activities.

             Subpart D--Control and Divestiture Proceedings

225.31  Control proceedings.

                    Subpart E--Change in Bank Control

225.41  Transactions requiring prior notice.

[[Page 57]]

225.42  Transactions not requiring prior notice.
225.43  Procedures for filing, processing, publishing, and acting on 
          notices.
225.44  Reporting of stock loans.

                 Subpart F--Limitations on Nonbank Banks

225.52  Limitation on overdrafts.

    Subpart G--Appraisal Standards for Federally Related Transactions

225.61  Authority, purpose, and scope.
225.62  Definitions.
225.63  Appraisals required; transactions requiring a State certified or 
          licensed appraiser.
225.64  Minimum appraisal standards.
225.65  Appraiser independence.
225.66  Professional association membership; competency.
225.67  Enforcement.

    Subpart H--Notice of Addition or Change of Directors and Senior 
                           Executive Officers

225.71  Definitions.
225.72  Director and officer appointments; prior notice requirement.
225.73  Procedures for filing, processing, and acting on notices; 
          standards for disapproval; waiver of notice.

                             Interpretations

225.101  Bank holding company's subsidiary banks owning shares of 
          nonbanking companies.
225.102  Bank holding company indirectly owning nonbanking company 
          through subsidiaries.
225.103  Bank holding company acquiring stock by dividends, stock splits 
          or exercise of rights.
225.104  ``Services'' under section 4(c)(1) of Bank Holding Company Act.
225.107  Acquisition of stock in small business investment company.
225.109  ``Services'' under section 4(c)(1) of Bank Holding Company Act.
225.111  Limit on investment by bank holding company system in stock of 
          small business investment companies.
225.112  Indirect control of small business concern through convertible 
          debentures held by small business investment company.
225.113  Services under section 4(a) of Bank Holding Company Act.
225.115  Applicability of Bank Service Corporation Act in certain bank 
          holding company situations.
225.118  Computer services for customers of subsidiary banks.
225.121  Acquisition of Edge corporation affiliate by State member banks 
          of registered bank holding company.
225.122  Bank holding company ownership of mortgage companies.
225.123  Activities closely related to banking.
225.124  Foreign bank holding companies.
225.125  Investment adviser activities.
225.126  Activities not closely related to banking.
225.127  Investment in corporations or projects designed primarily to 
          promote community welfare.
225.129  Activities closely related to banking.
225.130  Issuance and sale of short-term debt obligations by bank 
          holding companies.
225.131  Activities closely related to banking.
225.132  Acquisition of assets.
225.133  Computation of amount invested in foreign corporations under 
          general consent procedures.
225.134  Escrow arrangements involving bank stock resulting in a 
          violation of the Bank Holding Company Act.
225.136  Utilization of foreign subsidiaries to sell long-term debt 
          obligations in foreign markets and to transfer the proceeds to 
          their United States parent(s) for domestic purposes.
225.137  Acquisitions of shares pursuant to section 4(c)(6) of the Bank 
          Holding Company Act.
225.138  Statement of policy concerning divestitures by bank holding 
          companies.
225.139  Presumption of continued control under section (2)(g)(3) of the 
          Bank Holding Company Act.
225.140  Disposition of property acquired in satisfaction of debts 
          previously contracted.
225.141  Operations subsidiaries of a bank holding company.
225.142  Statement of policy concerning bank holding companies engaging 
          in futures, forward and options contracts on U.S. Government 
          and agency securities and money market instruments.
225.143  Policy statement on nonvoting equity investments by bank 
          holding companies.
225.145  Limitations established by the Competitive Equality Banking Act 
          of 1987 on the activities and growth of nonbank banks.

                          Conditions to Orders

225.200  Conditions to Board's section 20 orders.

Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding 
          Companies: Risk-Based Measure
Appendix B to Part 225--Capital Adequacy Guidelines for Bank Holding 
          Companies and State Member Banks: Leverage Measure
Appendix C to Part 225--Small Bank Holding Company Policy Statement

[[Page 58]]

Appendix D to Part 225--Capital Adequacy Guidelines for Bank Holding 
          Companies: Tier 1 Leverage Measure
Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding 
          Companies: Market Risk Measure

    Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1, 
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and 
3909.

    Source: Reg. Y, 49 FR 818, Jan. 5, 1984, unless otherwise noted.

                               Regulations



                      Subpart A--General Provisions

    Source: Reg. Y, 62 FR 9319, Feb. 28, 1997, unless otherwise noted.



Sec. 225.1  Authority, purpose, and scope.

    (a) Authority. This part 1 (Regulation Y) is issued by 
the Board of Governors of the Federal Reserve System (Board) under 
section 5(b) of the Bank Holding Company Act of 1956, as amended (12 
U.S.C. 1844(b)) (BHC Act); sections 8 and 13(a) of the International 
Banking Act of 1978 (12 U.S.C. 3106 and 3108); section 7(j)(13) of the 
Federal Deposit Insurance Act, as amended by the Change in Bank Control 
Act of 1978 (12 U.S.C. 1817(j)(13)) (Bank Control Act); section 8(b) of 
the Federal Deposit Insurance Act (12 U.S.C. 1818(b)); section 914 of 
the Financial Institutions Reform, Recovery and Enforcement Act of 1989 
(12 U.S.C. 1831i); section 106 of the Bank Holding Company Act 
Amendments of 1970 (12 U.S.C. 1972); and the International Lending 
Supervision Act of 1983 (Pub. L. 98-181, title IX). The BHC Act is 
codified at 12 U.S.C. 1841, et seq.
---------------------------------------------------------------------------

    \1\ Code of Federal Regulations, title 12, chapter II, part 225.
---------------------------------------------------------------------------

    (b) Purpose. The principal purposes of this part are to:
    (1) Regulate the acquisition of control of banks by companies and 
individuals;
    (2) Define and regulate the nonbanking activities in which bank 
holding companies and foreign banking organizations with United States 
operations may engage; and
    (3) Set forth the procedures for securing approval for these 
transactions and activities.
    (c) Scope--(1) Subpart A contains general provisions and definitions 
of terms used in this regulation.
    (2) Subpart B governs acquisitions of bank or bank holding company 
securities and assets by bank holding companies or by any company that 
will become a bank holding company as a result of the acquisition.
    (3) Subpart C defines and regulates the nonbanking activities in 
which bank holding companies and foreign banking organizations may 
engage directly or through a subsidiary. The Board's Regulation K 
governs certain nonbanking activities conducted by foreign banking 
organizations and certain foreign activities conducted by bank holding 
companies (12 CFR part 211, International Banking Operations).
    (4) Subpart D specifies situations in which a company is presumed to 
control voting securities or to have the power to exercise a controlling 
influence over the management or policies of a bank or other company; 
sets forth the procedures for making a control determination; and 
provides rules governing the effectiveness of divestitures by bank 
holding companies.
    (5) Subpart E governs changes in bank control resulting from the 
acquisition by individuals or companies (other than bank holding 
companies) of voting securities of a bank holding company or state 
member bank of the Federal Reserve System.
    (6) Subpart F specifies the limitations that govern companies that 
control so-called nonbank banks and the activities of nonbank banks.
    (7) Subpart G prescribes minimum standards that apply to the 
performance of real estate appraisals and identifies transactions that 
require state certified appraisers.
    (8) Subpart H identifies the circumstances when written notice must 
be provided to the Board prior to the appointment of a director or 
senior officer of a bank holding company and establishes procedures for 
obtaining the required Board approval.
    (9) Appendix A to the regulation contains the Board's Risk-Based 
Capital Adequacy Guidelines for bank holding companies.

[[Page 59]]

    (10) Appendix B contains the Board's Capital Adequacy Guidelines for 
measuring leverage for bank holding companies and state member banks.
    (11) Appendix C contains the Board's policy statement governing 
small bank holding companies.
    (12) Appendix D contains the Board's Capital Adequacy Guidelines for 
measuring tier 1 leverage for bank holding companies.
    (13) Appendix E contains the Board's Capital Adequacy Guidelines for 
measuring market risk of bank holding companies.



Sec. 225.2  Definitions.

    Except as modified in this regulation or unless the context 
otherwise requires, the terms used in this regulation have the same 
meaning as set forth in the relevant statutes.
    (a) Affiliate means any company that controls, is controlled by, or 
is under common control with, another company.
    (b)(1) Bank means:
    (i) An insured bank as defined in section 3(h) of the Federal 
Deposit Insurance Act (12 U.S.C. 1813(h)); or
    (ii) An institution organized under the laws of the United States 
which both:
    (A) Accepts demand deposits or deposits that the depositor may 
withdraw by check or similar means for payment to third parties or 
others; and
    (B) Is engaged in the business of making commercial loans.
    (2) Bank does not include those institutions qualifying under the 
exceptions listed in section 2(c)(2) of the BHC Act (12 U.S.C. 
1841(c)(2)).
    (c)(1) Bank holding company means any company (including a bank) 
that has direct or indirect control of a bank, other than control that 
results from the ownership or control of:
    (i) Voting securities held in good faith in a fiduciary capacity 
(other than as provided in paragraphs (e)(2)(ii) and (iii) of this 
section) without sole discretionary voting authority, or as otherwise 
exempted under section 2(a)(5)(A) of the BHC Act;
    (ii) Voting securities acquired and held only for a reasonable 
period of time in connection with the underwriting of securities, as 
provided in section 2(a)(5)(B) of the BHC Act;
    (iii) Voting rights to voting securities acquired for the sole 
purpose and in the course of participating in a proxy solicitation, as 
provided in section 2(a)(5)(C) of the BHC Act;
    (iv) Voting securities acquired in satisfaction of debts previously 
contracted in good faith, as provided in section 2(a)(5)(D) of the BHC 
Act, if the securities are divested within two years of acquisition (or 
such later period as the Board may permit by order); or
    (v) Voting securities of certain institutions owned by a thrift 
institution or a trust company, as provided in sections 2(a)(5)(E) and 
(F) of the BHC Act.
    (2) Except for the purposes of Sec. 225.4(b) of this subpart and 
subpart E of this part, or as otherwise provided in this regulation, 
bank holding company includes a foreign banking organization. For the 
purposes of subpart B of this part, bank holding company includes a 
foreign banking organization only if it owns or controls a bank in the 
United States.
    (d)(1) Company includes any bank, corporation, general or limited 
partnership, association or similar organization, business trust, or any 
other trust unless by its terms it must terminate either within 25 
years, or within 21 years and 10 months after the death of individuals 
living on the effective date of the trust.
    (2) Company does not include any organization, the majority of the 
voting securities of which are owned by the United States or any state.
    (3) Testamentary trusts exempt. Unless the Board finds that the 
trust is being operated as a business trust or company, a trust is 
presumed not to be a company if the trust:
    (i) Terminates within 21 years and 10 months after the death of 
grantors or beneficiaries of the trust living on the effective date of 
the trust or within 25 years;
    (ii) Is a testamentary or inter vivos trust established by an 
individual or individuals for the benefit of natural persons (or trusts 
for the benefit of natural persons) who are related by blood, marriage 
or adoption;

[[Page 60]]

    (iii) Contains only assets previously owned by the individual or 
individuals who established the trust;
    (iv) Is not a Massachusetts business trust; and
    (v) Does not issue shares, certificates, or any other evidence of 
ownership.
    (4) Qualified limited partnerships exempt. Company does not include 
a qualified limited partnership, as defined in section 2(o)(10) of the 
BHC Act.
    (e)(1) Control of a bank or other company means (except for the 
purposes of subpart E of this part):
    (i) Ownership, control, or power to vote 25 percent or more of the 
outstanding shares of any class of voting securities of the bank or 
other company, directly or indirectly or acting through one or more 
other persons;
    (ii) Control in any manner over the election of a majority of the 
directors, trustees, or general partners (or individuals exercising 
similar functions) of the bank or other company;
    (iii) The power to exercise, directly or indirectly, a controlling 
influence over the management or policies of the bank or other company, 
as determined by the Board after notice and opportunity for hearing in 
accordance with Sec. 225.31 of subpart D of this part; or
    (iv) Conditioning in any manner the transfer of 25 percent or more 
of the outstanding shares of any class of voting securities of a bank or 
other company upon the transfer of 25 percent or more of the outstanding 
shares of any class of voting securities of another bank or other 
company.
    (2) A bank or other company is deemed to control voting securities 
or assets owned, controlled, or held, directly or indirectly:
    (i) By any subsidiary of the bank or other company;
    (ii) In a fiduciary capacity (including by pension and profit-
sharing trusts) for the benefit of the shareholders, members, or 
employees (or individuals serving in similar capacities) of the bank or 
other company or any of its subsidiaries; or
    (iii) In a fiduciary capacity for the benefit of the bank or other 
company or any of its subsidiaries.
    (f) Foreign banking organization and qualifying foreign banking 
organization have the same meanings as provided in Sec. 211.21(n) and 
Sec. 211.23 of the Board's Regulation K (12 CFR 211.21(n) and 211.23).
    (g) Insured depository institution includes an insured bank as 
defined in section 3(h) of the Federal Deposit Insurance Act (12 U.S.C. 
1813(h)) and a savings association.
    (h) Lead insured depository institution means the largest insured 
depository institution controlled by the bank holding company as of the 
quarter ending immediately prior to the proposed filing, based on a 
comparison of the average total risk-weighted assets controlled during 
the previous 12-month period by each insured depository institution 
subsidiary of the holding company.
    (i) Management official means any officer, director (including 
honorary or advisory directors), partner, or trustee of a bank or other 
company, or any employee of the bank or other company with policy-making 
functions.
    (j) Nonbank bank means any institution that:
    (1) Became a bank as a result of enactment of the Competitive 
Equality Amendments of 1987 (Pub. L. 100-86), on the date of enactment 
(August 10, 1987); and
    (2) Was not controlled by a bank holding company on the day before 
the enactment of the Competitive Equality Amendments of 1987 (August 9, 
1987).
    (k) Outstanding shares means any voting securities, but does not 
include securities owned by the United States or by a company wholly 
owned by the United States.
    (l) Person includes an individual, bank, corporation, partnership, 
trust, association, joint venture, pool, syndicate, sole proprietorship, 
unincorporated organization, or any other form of entity.
    (m) Savings association means:
    (1) Any federal savings association or federal savings bank;
    (2) Any building and loan association, savings and loan association, 
homestead association, or cooperative bank if such association or 
cooperative bank is a member of the Savings Association Insurance Fund; 
and
    (3) Any savings bank or cooperative that is deemed by the director 
of the

[[Page 61]]

Office of Thrift Supervision to be a savings association under section 
10(l) of the Home Owners Loan Act.
    (n) Shareholder--(1) Controlling shareholder means a person that 
owns or controls, directly or indirectly, 25 percent or more of any 
class of voting securities of a bank or other company.
    (2) Principal shareholder means a person that owns or controls, 
directly or indirectly, 10 percent or more of any class of voting 
securities of a bank or other company, or any person that the Board 
determines has the power, directly or indirectly, to exercise a 
controlling influence over the management or policies of a bank or other 
company.
    (o) Subsidiary means a bank or other company that is controlled by 
another company, and refers to a direct or indirect subsidiary of a bank 
holding company. An indirect subsidiary is a bank or other company that 
is controlled by a subsidiary of the bank holding company.
    (p) United States means the United States and includes any state of 
the United States, the District of Columbia, any territory of the United 
States, Puerto Rico, Guam, American Samoa, and the Virgin Islands.
    (q)(1) Voting securities means shares of common or preferred stock, 
general or limited partnership shares or interests, or similar interests 
if the shares or interest, by statute, charter, or in any manner, 
entitle the holder:
    (i) To vote for or to select directors, trustees, or partners (or 
persons exercising similar functions of the issuing company); or
    (ii) To vote on or to direct the conduct of the operations or other 
significant policies of the issuing company.
    (2) Nonvoting shares. Preferred shares, limited partnership shares 
or interests, or similar interests are not voting securities if:
    (i) Any voting rights associated with the shares or interest are 
limited solely to the type customarily provided by statute with regard 
to matters that would significantly and adversely affect the rights or 
preference of the security or other interest, such as the issuance of 
additional amounts or classes of senior securities, the modification of 
the terms of the security or interest, the dissolution of the issuing 
company, or the payment of dividends by the issuing company when 
preferred dividends are in arrears;
    (ii) The shares or interest represent an essentially passive 
investment or financing device and do not otherwise provide the holder 
with control over the issuing company; and
    (iii) The shares or interest do not entitle the holder, by statute, 
charter, or in any manner, to select or to vote for the selection of 
directors, trustees, or partners (or persons exercising similar 
functions) of the issuing company.
    (3) Class of voting shares. Shares of stock issued by a single 
issuer are deemed to be the same class of voting shares, regardless of 
differences in dividend rights or liquidation preference, if the shares 
are voted together as a single class on all matters for which the shares 
have voting rights other than matters described in paragraph (o)(2)(i) 
of this section that affect solely the rights or preferences of the 
shares.
    (r) Well-capitalized-(1) Bank holding company. In the case of a bank 
holding company,2 well-capitalized means that:
---------------------------------------------------------------------------

    \2\ For purposes of this subpart and subparts B and C of this part, 
a bank holding company with consolidated assets under $150 million that 
is subject to the Small Bank Holding Company Policy Statement in 
Appendix C of this part will be deemed to be ``well-capitalized'' if the 
bank holding company meets the requirements for expedited/waived 
processing in Appendix C.
---------------------------------------------------------------------------

    (i) On a consolidated basis, the bank holding company maintains a 
total risk-based capital ratio of 10.0 percent or greater, as defined in 
Appendix A of this part;
    (ii) On a consolidated basis, the bank holding company maintains a 
Tier 1 risk-based capital ratio of 6.0 percent or greater, as defined in 
Appendix A of this part; and
    (iii) The bank holding company is not subject to any written 
agreement, order, capital directive, or prompt corrective action 
directive issued by the Board to meet and maintain a specific capital 
level for any capital measure.
    (2) Insured depository institution. In the case of an insured 
depository institution, well-capitalized means that the

[[Page 62]]

institution maintains at least the capital levels required to be ``well-
capitalized'' under the capital adequacy regulations or guidelines 
applicable to the institution that have been adopted by the appropriate 
federal banking agency for the institution under section 38 of the 
Federal Deposit Insurance Act (12 U.S.C. 1831o).
    (3) Foreign banks--(i) Standards applied. For purposes of 
determining whether a foreign banking organization qualifies under 
paragraph (r)(1) of this section:
    (A) A foreign banking organization whose home country supervisor, as 
defined in Sec. 211.21 of the Board's Regulation K (12 CFR 211.21), has 
adopted capital standards consistent in all respects with the Capital 
Accord of the Basle Committee on Banking Supervision (Basle Accord) may 
calculate its capital ratios under the home country standard; and
    (B) A foreign banking organization whose home country supervisor has 
not adopted capital standards consistent in all respects with the Basle 
Accord shall obtain a determination from the Board that its capital is 
equivalent to the capital that would be required of a U.S. banking 
organization under paragraph (r)(1) of this section.
    (ii) Branches and agencies. For purposes of determining, under 
paragraph (r)(1) of this section, whether a branch or agency of a 
foreign banking organization is well-capitalized, the branch or agency 
shall be deemed to have the same capital ratios as the foreign banking 
organization.
    (s) Well-managed--(1) In general. A company, insured depository 
institution, or branch or agency of a foreign banking organization is 
well-managed if:
    (i) At its most recent inspection or examination or subsequent 
review by the appropriate federal banking agency for the company or 
institution, the company or institution received:
    (A) At least a satisfactory composite rating; and
    (B) At least a satisfactory rating for management and for 
compliance, if such a rating is given; or
    (ii) In the case of a company or insured depository institution that 
has not received an examination rating, the Board has determined, after 
a review of the managerial and other resources of the company or 
depository institution, that the company or institution qualifies for 
the streamlined procedures in this subpart, and subparts B and C of this 
part.
    (2) Foreign banking organizations. A foreign banking organization 
shall qualify under this paragraph if the combined operations of the 
foreign banking organization in the United States have received at least 
a satisfactory composite rating at the most recent annual assessment.



Sec. 225.3  Administration.

    (a) Delegation of authority. Designated Board members and officers 
and the Federal Reserve Banks are authorized by the Board to exercise 
various functions prescribed in this regulation and in the Board's Rules 
Regarding Delegation of Authority (12 CFR part 265) and the Board's 
Rules of Procedure (12 CFR part 262).
    (b) Appropriate Federal Reserve Bank. In administering this 
regulation, unless a different Federal Reserve Bank is designated by the 
Board, the appropriate Federal Reserve Bank is as follows:
    (1) For a bank holding company (or a company applying to become a 
bank holding company): the Reserve Bank of the Federal Reserve district 
in which the company's banking operations are principally conducted, as 
measured by total domestic deposits in its subsidiary banks on the date 
it became (or will become) a bank holding company;
    (2) For a foreign banking organization that has no subsidiary bank 
and is not subject to paragraph (b)(1) of this section: the Reserve Bank 
of the Federal Reserve district in which the total assets of the 
organization's United States branches, agencies, and commercial lending 
companies are the largest as of the later of January 1, 1980, or the 
date it becomes a foreign banking organization;
    (3) For an individual or company submitting a notice under subpart E 
of this part: The Reserve Bank of the Federal Reserve district in which 
the banking operations of the bank holding company or state member bank 
to be acquired are principally conducted, as

[[Page 63]]

measured by total domestic deposits on the date the notice is filed.



Sec. 225.4  Corporate practices.

    (a) Bank holding company policy and operations. (1) A bank holding 
company shall serve as a source of financial and managerial strength to 
its subsidiary banks and shall not conduct its operations in an unsafe 
or unsound manner.
    (2) Whenever the Board believes an activity of a bank holding 
company or control of a nonbank subsidiary (other than a nonbank 
subsidiary of a bank) constitutes a serious risk to the financial 
safety, soundness, or stability of a subsidiary bank of the bank holding 
company and is inconsistent with sound banking principles or the 
purposes of the BHC Act or the Financial Institutions Supervisory Act of 
1966, as amended (12 U.S.C. 1818(b) et seq.), the Board may require the 
bank holding company to terminate the activity or to terminate control 
of the subsidiary, as provided in section 5(e) of the BHC Act.
    (b) Purchase or redemption by bank holding company of its own 
securities--(1) Filing notice. Except as provided in paragraph (b)(6) of 
this section, a bank holding company shall give the Board prior written 
notice before purchasing or redeeming its equity securities if the gross 
consideration for the purchase or redemption, when aggregated with the 
net consideration paid by the company for all such purchases or 
redemptions during the preceding 12 months, is equal to 10 percent or 
more of the company's consolidated net worth. For the purposes of this 
section, ``net consideration'' is the gross consideration paid by the 
company for all of its equity securities purchased or redeemed during 
the period minus the gross consideration received for all of its equity 
securities sold during the period.
    (2) Contents of notice. Any notice under this section shall be filed 
with the appropriate Reserve Bank and shall contain the following 
information:
    (i) The purpose of the transaction, a description of the securities 
to be purchased or redeemed, the total number of each class outstanding, 
the gross consideration to be paid, and the terms and sources of funding 
for the transaction;
    (ii) A description of all equity securities redeemed within the 
preceding 12 months, the net consideration paid, and the terms of any 
debt incurred in connection with those transactions; and
    (iii) (A) If the bank holding company has consolidated assets of 
$150 million or more, consolidated pro forma risk-based capital and 
leverage ratio calculations for the bank holding company as of the most 
recent quarter, and, if the redemption is to be debt funded, a parent-
only pro forma balance sheet as of the most recent quarter; or
    (B) If the bank holding company has consolidated assets of less than 
$150 million, a pro forma parent-only balance sheet as of the most 
recent quarter, and, if the redemption is to be debt funded, one-year 
income statement and cash flow projections.
    (3) Acting on notice. Within 15 calendar days of receipt of a notice 
under this section, the appropriate Reserve Bank shall either approve 
the transaction proposed in the notice or refer the notice to the Board 
for decision. If the notice is referred to the Board for decision, the 
Board shall act on the notice within 30 calendar days after the Reserve 
Bank receives the notice.
    (4) Factors considered in acting on notice. (i) The Board may 
disapprove a proposed purchase or redemption if it finds that the 
proposal would constitute an unsafe or unsound practice, or would 
violate any law, regulation, Board order, directive, or any condition 
imposed by, or written agreement with, the Board.
    (ii) In determining whether a proposal constitutes an unsafe or 
unsound practice, the Board shall consider whether the bank holding 
company's financial condition, after giving effect to the proposed 
purchase or redemption, meets the financial standards applied by the 
Board under section 3 of the BHC Act, including the Board's Capital 
Adequacy Guidelines (Appendix A of this part) and the Board's Policy 
Statement for Small Bank Holding Companies (Appendix C of this part).
    (5) Disapproval and hearing. (i) The Board shall notify the bank 
holding company in writing of the reasons for a

[[Page 64]]

decision to disapprove any proposed purchase or redemption. Within 10 
calendar days of receipt of a notice of disapproval by the Board, the 
bank holding company may submit a written request for a hearing.
    (ii) The Board shall order a hearing within 10 calendar days of 
receipt of the request if it finds that material facts are in dispute, 
or if it otherwise appears appropriate. Any hearing conducted under this 
paragraph shall be held in accordance with the Board's Rules of Practice 
for Formal Hearings (12 CFR part 263).
    (iii) At the conclusion of the hearing, the Board shall by order 
approve or disapprove the proposed purchase or redemption on the basis 
of the record of the hearing.
    (6) Exception for well-capitalized bank holding companies. A bank 
holding company is not required to obtain prior Board approval for the 
redemption or purchase of its equity securities under this section 
provided:
    (i) Both before and immediately after the redemption, the bank 
holding company is well-capitalized;
    (ii) The bank holding company is well-managed; and
    (iii) The bank holding company is not the subject of any unresolved 
supervisory issues.
    (c) Deposit insurance. Every bank that is a bank holding company or 
a subsidiary of a bank holding company shall obtain Federal Deposit 
Insurance and shall remain an insured bank as defined in section 3(h) of 
the Federal Deposit Insurance Act (12 U.S.C. 1813(h)).
    (d) Acting as transfer agent or clearing agent. A bank holding 
company or any nonbanking subsidiary that is a ``bank,'' as defined in 
section 3(a)(6) of the Securities Exchange Act of 1934 (15 U.S.C. 
78c(a)(6)), and that is a transfer agent of securities, a clearing 
agency, or a participant in a clearing agency (as those terms are 
defined in section 3(a) of the Securities Exchange Act (15 U.S.C. 
78c(a)), shall be subject to Secs. 208.31-208.33 of the Board's 
Regulation H (12 CFR 208.31-208.33) as if it were a state member bank.
    (e) Reporting requirement for credit secured by certain bank holding 
company stock. Each executive officer or director of a bank holding 
company the shares of which are not publicly traded shall report 
annually to the board of directors of the bank holding company the 
outstanding amount of any credit that was extended to the executive 
officer or director and that is secured by shares of the bank holding 
company. For purposes of this paragraph, the terms ``executive officer'' 
and ``director'' shall have the meaning given in Sec. 215.2 of 
Regulation O (12 CFR 215.2).
    (f) Suspicious activity report. A bank holding company or any 
nonbank subsidiary thereof, or a foreign bank that is subject to the BHC 
Act or any nonbank subsidiary of such foreign bank operating in the 
United States, shall file a suspicious activity report in accordance 
with the provisions of Sec. 208.62 of the Board's Regulation H (12 CFR 
208.62).

[Reg. Y, 62 FR 9319, Feb. 28, 1997, as amended by Reg. Y, 63 FR 58621, 
Nov. 2, 1998]



Sec. 225.5  Registration, reports, and inspections.

    (a) Registration of bank holding companies. Each company shall 
register within 180 days after becoming a bank holding company by 
furnishing information in the manner and form prescribed by the Board. A 
company that receives the Board's prior approval under subpart B of this 
part to become a bank holding company may complete this registration 
requirement through submission of its first annual report to the Board 
as required by paragraph (b) of this section.
    (b) Reports of bank holding companies. Each bank holding company 
shall furnish, in the manner and form prescribed by the Board, an annual 
report of the company's operations for the fiscal year in which it 
becomes a bank holding company, and for each fiscal year during which it 
remains a bank holding company. Additional information and reports shall 
be furnished as the Board may require.
    (c) Examinations and inspections. The Board may examine or inspect 
any bank holding company and each of its subsidiaries and prepare a 
report of their operations and activities. With respect to a foreign 
banking organization, the Board may also examine any branch or agency of 
a foreign bank in any state of the United States and may

[[Page 65]]

examine or inspect each of the organization's subsidiaries in the United 
States and prepare reports of their operations and activities. The Board 
shall rely, as far as possible, on the reports of examination made by 
the primary federal or state supervisor of the subsidiary bank of the 
bank holding company or of the branch or agency of the foreign bank.



Sec. 225.6  Penalties for violations.

    (a) Criminal and civil penalties. (1) Section 8 of the BHC Act 
provides criminal penalties for willful violation, and civil penalties 
for violation, by any company or individual, of the BHC Act or any 
regulation or order issued under it, or for making a false entry in any 
book, report, or statement of a bank holding company.
    (2) Civil money penalty assessments for violations of the BHC Act 
shall be made in accordance with subpart C of the Board's Rules of 
Practice for Hearings (12 CFR part 263, subpart C). For any willful 
violation of the Bank Control Act or any regulation or order issued 
under it, the Board may assess a civil penalty as provided in 12 U.S.C. 
1817(j)(15).
    (b) Cease-and-desist proceedings. For any violation of the BHC Act, 
the Bank Control Act, this regulation, or any order or notice issued 
thereunder, the Board may institute a cease-and-desist proceeding in 
accordance with the Financial Institutions Supervisory Act of 1966, as 
amended (12 U.S.C. 1818(b) et seq.).



Sec. 225.7  Exceptions to tying restrictions.

    (a) Purpose. This section establishes exceptions to the anti-tying 
restrictions of section 106 of the Bank Holding Company Act Amendments 
of 1970 (12 U.S.C. 1971, 1972(1)). These exceptions are in addition to 
those in section 106. The section also restricts tying of electronic 
benefit transfer services by bank holding companies and their nonbank 
subsidiaries.
    (b) Exceptions to statute. Subject to the limitations of paragraph 
(c) of this section, a bank may:
    (1) Extension to affiliates of statutory exceptions preserving 
traditional banking relationships. Extend credit, lease or sell property 
of any kind, or furnish any service, or fix or vary the consideration 
for any of the foregoing, on the condition or requirement that a 
customer:
    (i) Obtain a loan, discount, deposit, or trust service from an 
affiliate of the bank; or
    (ii) Provide to an affiliate of the bank some additional credit, 
property, or service that the bank could require to be provided to 
itself pursuant to section 106(b)(1)(C) of the Bank Holding Company Act 
Amendments of 1970 (12 U.S.C. 1972(1)(C)).
    (2) Safe harbor for combined-balance discounts. Vary the 
consideration for any product or package of products based on a 
customer's maintaining a combined minimum balance in certain products 
specified by the bank (eligible products), if:
    (i) The bank offers deposits, and all such deposits are eligible 
products; and
    (ii) Balances in deposits count at least as much as nondeposit 
products toward the minimum balance.
    (3) Safe harbor for foreign transactions. Engage in any transaction 
with a customer if that customer is:
    (i) A corporation, business, or other person (other than an 
individual) that:
    (A) Is incorporated, chartered, or otherwise organized outside the 
United States; and
    (B) Has its principal place of business outside the United States; 
or
    (ii) An individual who is a citizen of a foreign country and is not 
resident in the United States.
    (c) Limitations on exceptions. Any exception granted pursuant to 
this section shall terminate upon a finding by the Board that the 
arrangement is resulting in anti-competitive practices. The eligibility 
of a bank to operate under any exception granted pursuant to this 
section shall terminate upon a finding by the Board that its exercise of 
this authority is resulting in anti-competitive practices.
    (d) Extension of statute to electronic benefit transfer services. A 
bank holding company or nonbank subsidiary of a bank holding company 
that provides electronic benefit transfer services shall be subject to 
the anti-tying restrictions applicable to such services

[[Page 66]]

set forth in section 7(i)(11) of the Food Stamp Act of 1977 (7 U.S.C. 
2016(i)(11)).
    (e) For purposes of this section, bank has the meaning given that 
term in section 106(a) of the Bank Holding Company Act Amendments of 
1970 (12 U.S.C. 1971), but shall also include a United States branch, 
agency, or commercial lending company subsidiary of a foreign bank that 
is subject to section 106 pursuant to section 8(d) of the International 
Banking Act of 1978 (12 U.S.C. 3106(d)), and any company made subject to 
section 106 by section 4(f)(9) or 4(h) of the BHC Act.



           Subpart B--Acquisition of Bank Securities or Assets

    Source: Reg. Y, 62 FR 9324, Feb. 28, 1997, unless otherwise noted.



Sec. 225.11  Transactions requiring Board approval.

    The following transactions require the Board's prior approval under 
section 3 of the Bank Holding Company Act except as exempted under 
Sec. 225.12 or as otherwise covered by Sec. 225.17 of this subpart:
    (a) Formation of bank holding company. Any action that causes a bank 
or other company to become a bank holding company.
    (b) Acquisition of subsidiary bank. Any action that causes a bank to 
become a subsidiary of a bank holding company.
    (c) Acquisition of control of bank or bank holding company 
securities.
    (1) The acquisition by a bank holding company of direct or indirect 
ownership or control of any voting securities of a bank or bank holding 
company, if the acquisition results in the company's control of more 
than 5 percent of the outstanding shares of any class of voting 
securities of the bank or bank holding company.
    (2) An acquisition includes the purchase of additional securities 
through the exercise of preemptive rights, but does not include 
securities received in a stock dividend or stock split that does not 
alter the bank holding company's proportional share of any class of 
voting securities.
    (d) Acquisition of bank assets. The acquisition by a bank holding 
company or by a subsidiary thereof (other than a bank) of all or 
substantially all of the assets of a bank.
    (e) Merger of bank holding companies. The merger or consolidation of 
bank holding companies, including a merger through the purchase of 
assets and assumption of liabilities.
    (f) Transactions by foreign banking organization. Any transaction 
described in paragraphs (a) through (e) of this section by a foreign 
banking organization that involves the acquisition of an interest in a 
U.S. bank or in a bank holding company for which application would be 
required if the foreign banking organization were a bank holding 
company.



Sec. 225.12  Transactions not requiring Board approval.

    The following transactions do not require the Board's approval under 
Sec. 225.11 of this subpart:
    (a) Acquisition of securities in fiduciary capacity. The acquisition 
by a bank or other company (other than a trust that is a company) of 
control of voting securities of a bank or bank holding company in good 
faith in a fiduciary capacity, unless:
    (1) The acquiring bank or other company has sole discretionary 
authority to vote the securities and retains this authority for more 
than two years; or
    (2) The acquisition is for the benefit of the acquiring bank or 
other company, or its shareholders, employees, or subsidiaries.
    (b) Acquisition of securities in satisfaction of debts previously 
contracted. The acquisition by a bank or other company of control of 
voting securities of a bank or bank holding company in the regular 
course of securing or collecting a debt previously contracted in good 
faith, if the acquiring bank or other company divests the securities 
within two years of acquisition. The Board or Reserve Bank may grant 
requests for up to three one-year extensions.
    (c) Acquisition of securities by bank holding company with majority 
control. The acquisition by a bank holding company of additional voting 
securities of a bank or bank holding company if more than 50 percent of 
the outstanding voting securities of the bank or bank holding company is 
lawfully

[[Page 67]]

controlled by the acquiring bank holding company prior to the 
acquisition.
    (d) Acquisitions involving bank mergers and internal corporate 
reorganizations--(1) Transactions subject to Bank Merger Act. The merger 
or consolidation of a subsidiary bank of a bank holding company with 
another bank, or the purchase of assets by the subsidiary bank, or a 
similar transaction involving subsidiary banks of a bank holding 
company, if the transaction requires the prior approval of a federal 
supervisory agency under the Bank Merger Act (12 U.S.C. 1828(c)) and 
does not involve the acquisition of shares of a bank. This exception 
does not include:
    (i) The merger of a nonsubsidiary bank and a nonoperating subsidiary 
bank formed by a company for the purpose of acquiring the nonsubsidiary 
bank; or
    (ii) Any transaction requiring the Board's prior approval under 
Sec. 225.11(e) of this subpart.
    The Board may require an application under this subpart if it 
determines that the merger or consolidation would have a significant 
adverse impact on the financial condition of the bank holding company, 
or otherwise requires approval under section 3 of the BHC Act.
    (2) Certain acquisitions subject to Bank Merger Act. The acquisition 
by a bank holding company of shares of a bank or company controlling a 
bank or the merger of a company controlling a bank with the bank holding 
company, if the transaction is part of the merger or consolidation of 
the bank with a subsidiary bank (other than a nonoperating subsidiary 
bank) of the acquiring bank holding company, or is part of the purchase 
of substantially all of the assets of the bank by a subsidiary bank 
(other than a nonoperating subsidiary bank) of the acquiring bank 
holding company, and if:
    (i) The bank merger, consolidation, or asset purchase occurs 
simultaneously with the acquisition of the shares of the bank or bank 
holding company or the merger of holding companies, and the bank is not 
operated by the acquiring bank holding company as a separate entity 
other than as the survivor of the merger, consolidation, or asset 
purchase;
    (ii) The transaction requires the prior approval of a federal 
supervisory agency under the Bank Merger Act (12 U.S.C. 1828(c));
    (iii) The transaction does not involve the acquisition of any 
nonbank company that would require prior approval under section 4 of the 
BHC Act (12 U.S.C. 1843);
    (iv) Both before and after the transaction, the acquiring bank 
holding company meets the Board's Capital Adequacy Guidelines 
(Appendixes A, B, C, D, and E of this part);
    (v) At least 10 days prior to the transaction, the acquiring bank 
holding company has provided to the Reserve Bank written notice of the 
transaction that contains:
    (A) A copy of the filing made to the appropriate federal banking 
agency under the Bank Merger Act; and
    (B) A description of the holding company's involvement in the 
transaction, the purchase price, and the source of funding for the 
purchase price; and
    (vi) Prior to expiration of the period provided in paragraph 
(d)(2)(v) of this section, the Reserve Bank has not informed the bank 
holding company that an application under Sec. 225.11 is required.
    (3) Internal corporate reorganizations. (i) Subject to paragraph 
(d)(3)(ii) of this section, any of the following transactions performed 
in the United States by a bank holding company:
    (A) The merger of holding companies that are subsidiaries of the 
bank holding company;
    (B) The formation of a subsidiary holding company; 1
---------------------------------------------------------------------------

    \1\ In the case of a transaction that results in the formation or 
designation of a new bank holding company, the new bank holding company 
must complete the registration requirements described in Sec. 225.5.
---------------------------------------------------------------------------

    (C) The transfer of control or ownership of a subsidiary bank or a 
subsidiary holding company between one subsidiary holding company and 
another subsidiary holding company or the bank holding company.
    (ii) A transaction described in paragraph (d)(3)(i) of this section 
qualifies for this exception if:
    (A) The transaction represents solely a corporate reorganization 
involving

[[Page 68]]

companies and insured depository institutions that, both preceding and 
following the transaction, are lawfully controlled and operated by the 
bank holding company;
    (B) The transaction does not involve the acquisition of additional 
voting shares of an insured depository institution that, prior to the 
transaction, was less than majority owned by the bank holding company;
    (C) The bank holding company is not organized in mutual form; and
    (D) Both before and after the transaction, the bank holding company 
meets the Board's Capital Adequacy Guidelines (Appendixes A, B, C, D, 
and E of this part).
    (e) Holding securities in escrow. The holding of any voting 
securities of a bank or bank holding company in an escrow arrangement 
for the benefit of an applicant pending the Board's action on an 
application for approval of the proposed acquisition, if title to the 
securities and the voting rights remain with the seller and payment for 
the securities has not been made to the seller.
    (f) Acquisition of foreign banking organization. The acquisition of 
a foreign banking organization where the foreign banking organization 
does not directly or indirectly own or control a bank in the United 
States, unless the acquisition is also by a foreign banking organization 
and otherwise subject to Sec. 225.11(f) of this subpart.



Sec. 225.13  Factors considered in acting on bank acquisition proposals.

    (a) Factors requiring denial. As specified in section 3(c) of the 
BHC Act, the Board may not approve any application under this subpart 
if:
    (1) The transaction would result in a monopoly or would further any 
combination or conspiracy to monopolize, or to attempt to monopolize, 
the business of banking in any part of the United States;
    (2) The effect of the transaction may be substantially to lessen 
competition in any section of the country, tend to create a monopoly, or 
in any other manner be in restraint of trade, unless the Board finds 
that the transaction's anti-competitive effects are clearly outweighed 
by its probable effect in meeting the convenience and needs of the 
community;
    (3) The applicant has failed to provide the Board with adequate 
assurances that it will make available such information on its 
operations or activities, and the operations or activities of any 
affiliate of the applicant, that the Board deems appropriate to 
determine and enforce compliance with the BHC Act and other applicable 
federal banking statutes, and any regulations thereunder; or
    (4) In the case of an application involving a foreign banking 
organization, the foreign banking organization is not subject to 
comprehensive supervision or regulation on a consolidated basis by the 
appropriate authorities in its home country, as provided in 
Sec. 211.24(c)(1)(ii) of the Board's Regulation K (12 CFR 
211.24(c)(1)(ii)).
    (b) Other factors. In deciding applications under this subpart, the 
Board also considers the following factors with respect to the 
applicant, its subsidiaries, any banks related to the applicant through 
common ownership or management, and the bank or banks to be acquired:
    (1) Financial condition. Their financial condition and future 
prospects, including whether current and projected capital positions and 
levels of indebtedness conform to standards and policies established by 
the Board.
    (2) Managerial resources. The competence, experience, and integrity 
of the officers, directors, and principal shareholders of the applicant, 
its subsidiaries, and the banks and bank holding companies concerned; 
their record of compliance with laws and regulations; and the record of 
the applicant and its affiliates of fulfilling any commitments to, and 
any conditions imposed by, the Board in connection with prior 
applications.
    (3) Convenience and needs of community. The convenience and needs of 
the communities to be served, including the record of performance under 
the Community Reinvestment Act of 1977 (12 U.S.C. 2901 et seq.) and 
regulations issued thereunder, including the Board's Regulation BB (12 
CFR part 228).
    (c) Interstate transactions. The Board may approve any application 
or notice

[[Page 69]]

under this subpart by a bank holding company to acquire control of all 
or substantially all of the assets of a bank located in a state other 
than the home state of the bank holding company, without regard to 
whether the transaction is prohibited under the law of any state, if the 
transaction complies with the requirements of section 3(d) of the BHC 
Act (12 U.S.C. 1842(d)).
    (d) Conditional approvals. The Board may impose conditions on any 
approval, including conditions to address competitive, financial, 
managerial, safety and soundness, convenience and needs, compliance or 
other concerns, to ensure that approval is consistent with the relevant 
statutory factors and other provisions of the BHC Act.



Sec. 225.14  Expedited action for certain bank acquisitions by well-run bank holding companies.

    (a) Filing of notice--(1) Information required and public notice. As 
an alternative to the procedure provided in Sec. 225.15, a bank holding 
company that meets the requirements of paragraph (c) of this section may 
satisfy the prior approval requirements of Sec. 225.11 in connection 
with the acquisition of shares, assets or control of a bank, or a merger 
or consolidation between bank holding companies, by providing the 
appropriate Reserve Bank with a written notice containing the following:
    (i) A certification that all of the criteria in paragraph (c) of 
this section are met;
    (ii) A description of the transaction that includes identification 
of the companies and insured depository institutions involved in the 
transaction 2 and identification of each banking market 
affected by the transaction;
---------------------------------------------------------------------------

    \2\ If, in connection with a transaction under this subpart, any 
person or group of persons proposes to acquire control of the acquiring 
bank holding company for purposes of the Bank Control Act or 
Sec. 225.41, the person or group of persons may fulfill the notice 
requirements of the Bank Control Act and Sec. 225.43 by providing, as 
part of the submission by the acquiring bank holding company under this 
subpart, identifying and biographical information required in paragraph 
(6)(A) of the Bank Control Act (12 U.S.C. 1817(j)(6)(A)), as well as any 
financial or other information requested by the Reserve Bank under 
Sec. 225.43.
---------------------------------------------------------------------------

    (iii) A description of the effect of the transaction on the 
convenience and needs of the communities to be served and of the actions 
being taken by the bank holding company to improve the CRA performance 
of any insured depository institution subsidiary that does not have at 
least a satisfactory CRA performance rating at the time of the 
transaction;
    (iv) Evidence that notice of the proposal has been published in 
accordance with Sec. 225.16(b)(1);
    (v)(A) If the bank holding company has consolidated assets of $150 
million or more, an abbreviated consolidated pro forma balance sheet as 
of the most recent quarter showing credit and debit adjustments that 
reflect the proposed transaction, consolidated pro forma risk-based 
capital ratios for the acquiring bank holding company as of the most 
recent quarter, and a description of the purchase price and the terms 
and sources of funding for the transaction;
    (B) If the bank holding company has consolidated assets of less than 
$150 million, a pro forma parent-only balance sheet as of the most 
recent quarter showing credit and debit adjustments that reflect the 
proposed transaction, and a description of the purchase price, the terms 
and sources of funding for the transaction, and the sources and schedule 
for retiring any debt incurred in the transaction;
    (vi) If the bank holding company has consolidated assets of less 
than $300 million, a list of and biographical information regarding any 
directors or senior executive officers of the resulting bank holding 
company that are not directors or senior executive officers of the 
acquiring bank holding company or of a company or institution to be 
acquired;
    (vii) For each insured depository institution whose Tier 1 capital, 
total capital, total assets or risk-weighted assets change as a result 
of the transaction, the total risk-weighted assets, total assets, Tier 1 
capital and total capital of the institution on a pro forma basis; and
    (viii) The market indexes for each relevant banking market 
reflecting the pro forma effect of the transaction.

[[Page 70]]

    (2) Waiver of unnecessary information. The Reserve Bank may reduce 
the information requirements in paragraph (a)(1)(v) through (viii) of 
this section as appropriate.
    (b)(1) Action on proposals under this section. The Board or the 
appropriate Reserve Bank shall act on a proposal submitted under this 
section or notify the bank holding company that the transaction is 
subject to the procedure in Sec. 225.15 within 5 business days after the 
close of the public comment period. The Board and the Reserve Bank shall 
not approve any proposal under this section prior to the third business 
day following the close of the public comment period, unless an 
emergency exists that requires expedited or immediate action. The Board 
may extend the period for action under this section for up to 5 business 
days.
    (2) Acceptance of notice in event expedited procedure not available. 
In the event that the Board or the Reserve Bank determines after the 
filing of a notice under this section that a bank holding company may 
not use the procedure in this section and must file an application under 
Sec. 225.15, the application shall be deemed accepted for purposes of 
Sec. 225.15 as of the date that the notice was filed under this section.
    (c) Criteria for use of expedited procedure. The procedure in this 
section is available only if:
    (1) Well-capitalized organization--(i) Bank holding company. Both at 
the time of and immediately after the proposed transaction, the 
acquiring bank holding company is well-capitalized;
    (ii) Insured depository institutions. Both at the time of and 
immediately after the proposed transaction:
    (A) The lead insured depository institution of the acquiring bank 
holding company is well-capitalized;
    (B) Well-capitalized insured depository institutions control at 
least 80 percent of the total risk-weighted assets of insured depository 
institutions controlled by the acquiring bank holding company; and
    (C) No insured depository institution controlled by the acquiring 
bank holding company is undercapitalized;
    (2) Well-managed organization. (i) Satisfactory examination ratings. 
At the time of the transaction, the acquiring bank holding company, its 
lead insured depository institution, and insured depository institutions 
that control at least 80 percent of the total risk-weighted assets of 
insured depository institutions controlled by the holding company are 
well-managed;
    (ii) No poorly managed institutions. No insured depository 
institution controlled by the acquiring bank holding company has 
received 1 of the 2 lowest composite ratings at the later of the 
institution's most recent examination or subsequent review by the 
appropriate federal banking agency for the institution;
    (iii) Recently acquired institutions excluded. Any insured 
depository institution that has been acquired by the bank holding 
company during the 12-month period preceding the date on which written 
notice is filed under paragraph (a) of this section may be excluded for 
purposes of paragraph (c)(2)(ii) of this section if :
    (A) The bank holding company has developed a plan acceptable to the 
appropriate federal banking agency for the institution to restore the 
capital and management of the institution; and
    (B) All insured depository institutions excluded under this 
paragraph represent, in the aggregate, less than 10 percent of the 
aggregate total risk-weighted assets of all insured depository 
institutions controlled by the bank holding company;
    (3) Convenience and needs criteria--(i) Effect on the community. The 
record indicates that the proposed transaction would meet the 
convenience and needs of the community standard in the BHC Act; and
    (ii) Established CRA performance record. At the time of the 
transaction, the lead insured depository institution of the acquiring 
bank holding company and insured depository institutions that control at 
least 80 percent of the total risk-weighted assets of insured 
institutions controlled by the holding company have received a 
satisfactory or better composite rating at the most recent examination 
under the Community Reinvestment Act;
    (4) Public comment. No comment that is timely and substantive as 
provided in Sec. 225.16 is received by the Board or

[[Page 71]]

the appropriate Reserve Bank other than a comment that supports approval 
of the proposal;
    (5) Competitive criteria--(i) Competitive screen. Without regard to 
any divestitures proposed by the acquiring bank holding company, the 
acquisition does not cause:
    (A) Insured depository institutions controlled by the acquiring bank 
holding company to control in excess of 35 percent of market deposits in 
any relevant banking market; or
    (B) The Herfindahl-Hirschman index to increase by more than 200 
points in any relevant banking market with a post-acquisition index of 
at least 1800; and
    (ii) Department of Justice. The Department of Justice has not 
indicated to the Board that consummation of the transaction is likely to 
have a significantly adverse effect on competition in any relevant 
banking market;
    (6) Size of acquisition--(i) In general--(A) Limited Growth. Except 
as provided in paragraph (c)(6)(ii) of this section, the sum of the 
aggregate risk-weighted assets to be acquired in the proposal and the 
aggregate risk- weighted assets acquired by the acquiring bank holding 
company in all other qualifying transactions does not exceed 35 percent 
of the consolidated risk-weighted assets of the acquiring bank holding 
company. For purposes of this paragraph other qualifying transactions 
means any transaction approved under this section or Sec. 225.23 during 
the 12 months prior to filing the notice under this section; and
    (B) Individual size limitation. The total risk-weighted assets to be 
acquired do not exceed $7.5 billion;
    (ii) Small bank holding companies. Paragraph (c)(6)(i)(A) of this 
section shall not apply if, immediately following consummation of the 
proposed transaction, the consolidated risk-weighted assets of the 
acquiring bank holding company are less than $300 million;
    (7) Supervisory actions. During the 12-month period ending on the 
date on which the bank holding company proposes to consummate the 
proposed transaction, no formal administrative order, including a 
written agreement, cease and desist order, capital directive, prompt 
corrective action directive, asset maintenance agreement, or other 
formal enforcement action, is or was outstanding against the bank 
holding company or any insured depository institution subsidiary of the 
holding company, and no formal administrative enforcement proceeding 
involving any such enforcement action, order, or directive is or was 
pending;
    (8) Interstate acquisitions. Board-approval of the transaction is 
not prohibited under section 3(d) of the BHC Act;
    (9) Other supervisory considerations. Board approval of the 
transaction is not prohibited under the informational sufficiency or 
comprehensive home country supervision standards set forth in section 
3(c)(3) of the BHC Act; and
    (10) Notification. The acquiring bank holding company has not been 
notified by the Board, in its discretion, prior to the expiration of the 
period in paragraph (b)(1) of this section that an application under 
Sec. 225.15 is required in order to permit closer review of any 
financial, managerial, competitive, convenience and needs or other 
matter related to the factors that must be considered under this part.
    (d) Comment by primary banking supervisor--(1) Notice. Upon receipt 
of a notice under this section, the appropriate Reserve Bank shall 
promptly furnish notice of the proposal and a copy of the information 
filed pursuant to paragraph (a) of this section to the primary banking 
supervisor of the insured depository institutions to be acquired.
    (2) Comment period. The primary banking supervisor shall have 30 
calendar days (or such shorter time as agreed to by the primary banking 
supervisor) from the date of the letter giving notice in which to submit 
its views and recommendations to the Board.
    (3) Action subject to supervisor's comment. Action by the Board or 
the Reserve Bank on a proposal under this section is subject to the 
condition that the primary banking supervisor not recommend in writing 
to the Board disapproval of the proposal prior to the expiration of the 
comment period described in paragraph (d)(2) of this section. In such 
event, any approval given under this section shall be revoked and, if 
required by section 3(b) of the

[[Page 72]]

BHC Act, the Board shall order a hearing on the proposal.
    (4) Emergencies. Notwithstanding paragraphs (d)(2) and (d)(3) of 
this section, the Board may provide the primary banking supervisor with 
10 calendar days' notice of a proposal under this section if the Board 
finds that an emergency exists requiring expeditious action, and may act 
during the notice period or without providing notice to the primary 
banking supervisor if the Board finds that it must act immediately to 
prevent probable failure.
    (5) Primary banking supervisor. For purposes of this section and 
Sec. 225.15(b), the primary banking supervisor for an institution is:
    (i) The Office of the Comptroller of the Currency, in the case of a 
national banking association or District bank;
    (ii) The appropriate supervisory authority for the State in which 
the bank is chartered, in the case of a State bank;
    (iii) The Director of the Office of Thrift Supervision, in the case 
of a savings association.
    (e) Branches and agencies of foreign banking organizations. For 
purposes of this section, a U.S. branch or agency of a foreign banking 
organization shall be considered to be an insured depository 
institution. A U.S. branch or agency of a foreign banking organization 
shall be subject to paragraph (c)(3)(ii) of this section only to the 
extent it is insured by the Federal Deposit Insurance Corporation in 
accordance with section 6 of the International Banking Act of 1978 (12 
U.S.C. 3104).



Sec. 225.15  Procedures for other bank acquisition proposals.

    (a) Filing application. Except as provided in Sec. 225.14, an 
application for the Board's prior approval under this subpart shall be 
governed by the provisions of this section and shall be filed with the 
appropriate Reserve Bank on the designated form.
    (b) Notice to primary banking supervisor. Upon receipt of an 
application under this subpart, the Reserve Bank shall promptly furnish 
notice and a copy of the application to the primary banking supervisor 
of each bank to be acquired. The primary supervisor shall have 30 
calendar days from the date of the letter giving notice in which to 
submit its views and recommendations to the Board.
    (c) Accepting application for processing. Within 7 calendar days 
after the Reserve Bank receives an application under this section, the 
Reserve Bank shall accept it for processing as of the date the 
application was filed or return the application if it is substantially 
incomplete. Upon accepting an application, the Reserve Bank shall 
immediately send copies to the Board. The Reserve Bank or the Board may 
request additional information necessary to complete the record of an 
application at any time after accepting the application for processing.
    (d) Action on applications--(1) Action under delegated authority. 
The Reserve Bank shall approve an application under this section within 
30 calendar days after the acceptance date for the application, unless 
the Reserve Bank, upon notice to the applicant, refers the application 
to the Board for decision because action under delegated authority is 
not appropriate.
    (2) Board action. The Board shall act on an application under this 
subpart that is referred to it for decision within 60 calendar days 
after the acceptance date for the application, unless the Board notifies 
the applicant that the 60-day period is being extended for a specified 
period and states the reasons for the extension. In no event may the 
extension exceed the 91-day period provided in Sec. 225.16(f). The Board 
may, at any time, request additional information that it believes is 
necessary for its decision.



Sec. 225.16  Public notice, comments, hearings, and other provisions governing applications and notices.

    (a) In general. The provisions of this section apply to all notices 
and applications filed under Sec. 225.14 and Sec. 225.15.
    (b) Public notice--(1) Newspaper publication--(i) Location of 
publication. In the case of each notice or application submitted under 
Sec. 225.14 or Sec. 225.15, the applicant shall publish a notice in a 
newspaper of general circulation, in the form and at the locations 
specified in Sec. 262.3 of the Rules of Procedure (12 CFR 262.3);

[[Page 73]]

    (ii) Contents of notice. A newspaper notice under this paragraph 
shall provide an opportunity for interested persons to comment on the 
proposal for a period of at least 30 calendar days;
    (iii) Timing of publication. Each newspaper notice published in 
connection with a proposal under this paragraph shall be published no 
more than 15 calendar days before and no later than 7 calendar days 
following the date that a notice or application is filed with the 
appropriate Reserve Bank.
    (2) Federal Register notice. (i) Publication by Board. Upon receipt 
of a notice or application under Sec. 225.14 or Sec. 225.15, the Board 
shall promptly publish notice of the proposal in the Federal Register 
and shall provide an opportunity for interested persons to comment on 
the proposal for a period of no more than 30 days;
    (ii) Request for advance publication. A bank holding company may 
request that, during the 15-day period prior to filing a notice or 
application under Sec. 225.14 or Sec. 225.15, the Board publish notice 
of a proposal in the Federal Register. A request for advance Federal 
Register publication shall be made in writing to the appropriate Reserve 
Bank and shall contain the identifying information prescribed by the 
Board for Federal Register publication;
    (3) Waiver or shortening of notice. The Board may waive or shorten 
the required notice periods under this section if the Board determines 
that an emergency exists requiring expeditious action on the proposal, 
or if the Board finds that immediate action is necessary to prevent the 
probable failure of an insured depository institution.
    (c) Public comment--(1) Timely comments. Interested persons may 
submit information and comments regarding a proposal filed under this 
subpart. A comment shall be considered timely for purposes of this 
subpart if the comment, together with all supplemental information, is 
submitted in writing in accordance with the Board's Rules of Procedure 
and received by the Board or the appropriate Reserve Bank prior to the 
expiration of the latest public comment period provided in paragraph (b) 
of this section.
    (2) Extension of comment period--(i) In general. The Board may, in 
its discretion, extend the public comment period regarding any proposal 
submitted under this subpart.
    (ii) Requests in connection with obtaining application or notice. In 
the event that an interested person has requested a copy of a notice or 
application submitted under this subpart, the Board may, in its 
discretion and based on the facts and circumstances, grant such person 
an extension of the comment period for up to 15 calendar days.
    (iii) Joint requests by interested person and acquiring company. The 
Board will grant a joint request by an interested person and the 
acquiring bank holding company for an extension of the comment period 
for a reasonable period for a purpose related to the statutory factors 
the Board must consider under this subpart.
    (3) Substantive comment. A comment will be considered substantive 
for purposes of this subpart unless it involves individual complaints, 
or raises frivolous, previously-considered or wholly unsubstantiated 
claims or irrelevant issues.
    (d) Notice to Attorney General. The Board or Reserve Bank shall 
immediately notify the United States Attorney General of approval of any 
notice or application under Sec. 225.14 or Sec. 225.15.
    (e) Hearings. As provided in section 3(b) of the BHC Act, the Board 
shall order a hearing on any application or notice under Sec. 225.15 if 
the Board receives from the primary supervisor of the bank to be 
acquired, within the 30-day period specified in Sec. 225.15(b), a 
written recommendation of disapproval of an application. The Board may 
order a formal or informal hearing or other proceeding on the 
application or notice, as provided in Sec. 262.3(i)(2) of the Board's 
Rules of Procedure. Any request for a hearing (other than from the 
primary supervisor) shall comply with Sec. 262.3(e) of the Rules of 
Procedure (12 CFR 262.3(e)).
    (f) Approval through failure to act--(1) Ninety-one day rule. An 
application or notice under Sec. 225.14 or Sec. 225.15 shall be deemed 
approved if the Board fails to act on the application or notice within 
91 calendar days after the date of submission to the Board of the 
complete record on the application. For this purpose, the Board acts 
when it issues an

[[Page 74]]

order stating that the Board has approved or denied the application or 
notice, reflecting the votes of the members of the Board, and indicating 
that a statement of the reasons for the decision will follow promptly.
    (2) Complete record. For the purpose of computing the commencement 
of the 91-day period, the record is complete on the latest of:
    (i) The date of receipt by the Board of an application or notice 
that has been accepted by the Reserve Bank;
    (ii) The last day provided in any notice for receipt of comments and 
hearing requests on the application or notice;
    (iii) The date of receipt by the Board of the last relevant material 
regarding the application or notice that is needed for the Board's 
decision, if the material is received from a source outside of the 
Federal Reserve System; or
    (iv) The date of completion of any hearing or other proceeding.
    (g) Exceptions to notice and hearing requirements.
    (1) Probable bank failure. If the Board finds it must act 
immediately on an application or notice in order to prevent the probable 
failure of a bank or bank holding company, the Board may modify or 
dispense with the notice and hearing requirements of this section.
    (2) Emergency. If the Board finds that, although immediate action on 
an application or notice is not necessary, an emergency exists requiring 
expeditious action, the Board shall provide the primary supervisor 10 
days to submit its recommendation. The Board may act on such an 
application or notice without a hearing and may modify or dispense with 
the other notice and hearing requirements of this section.
    (h) Waiting period. A transaction approved under Sec. 225.14 or 
Sec. 225.15 shall not be consummated until 30 days after the date of 
approval of the application, except that a transaction may be 
consummated:
    (1) Immediately upon approval, if the Board has determined under 
paragraph (g) of this section that the application or notice involves a 
probable bank failure;
    (2) On or after the 5th calendar day following the date of approval, 
if the Board has determined under paragraph (g) of this section that an 
emergency exists requiring expeditious action; or
    (3) On or after the 15th calendar day following the date of 
approval, if the Board has not received any adverse comments from the 
United States Attorney General relating to the competitive factors and 
the Attorney General has consented to the shorter waiting period.



Sec. 225.17  Notice procedure for one-bank holding company formations.

    (a) Transactions that qualify under this section. An acquisition by 
a company of control of a bank may be consummated 30 days after 
providing notice to the appropriate Reserve Bank in accordance with 
paragraph (b) of this section, provided that all of the following 
conditions are met:
    (1) The shareholder or shareholders who control at least 67 percent 
of the shares of the bank will control, immediately after the 
reorganization, at least 67 percent of the shares of the holding company 
in substantially the same proportion, except for changes in 
shareholders' interests resulting from the exercise of dissenting 
shareholders' rights under state or federal law; 3
---------------------------------------------------------------------------

    \3\ A shareholder of a bank in reorganization will be considered to 
have the same proportional interest in the holding company if the 
shareholder interest increases, on a pro rata basis, as a result of 
either the redemption of shares from dissenting shareholders by the bank 
or bank holding company, or the acquisition of shares of dissenting 
shareholders by the remaining shareholders.
---------------------------------------------------------------------------

    (2) No shareholder, or group of shareholders acting in concert, 
will, following the reorganization, own or control 10 percent or more of 
any class of voting shares of the bank holding company, unless that 
shareholder or group of shareholders was authorized, after review under 
the Change in Bank Control Act of 1978 (12 U.S.C. 1817(j)) by the 
appropriate federal banking agency for the bank, to own or control 10 
percent or more of any class of voting shares of the bank; 4
---------------------------------------------------------------------------

    \4\ This procedure is not available in cases in which the exercise 
of dissenting shareholders' rights would cause a company that is not a 
bank holding company (other than the company in formation) to be 
required to register as a bank holding company. This procedure also is 
not available for the formation of a bank holding company organized in 
mutual form.

---------------------------------------------------------------------------

[[Page 75]]

    (3) The bank is adequately capitalized (as defined in section 38 of 
the Federal Deposit Insurance Act (12 U.S.C. 1831o));
    (4) The bank received at least a composite ``satisfactory'' rating 
at its most recent examination, in the event that the bank was examined;
    (5) At the time of the reorganization, neither the bank nor any of 
its officers, directors, or principal shareholders is involved in any 
unresolved supervisory or enforcement matters with any appropriate 
federal banking agency;
    (6) The company demonstrates that any debt that it incurs at the 
time of the reorganization, and the proposed means of retiring this 
debt, will not place undue burden on the holding company or its 
subsidiary on a pro forma basis; 5
---------------------------------------------------------------------------

    \5\ For a banking organization with consolidated assets, on a pro 
forma basis, of less than $150 million (other than a banking 
organization that will control a de novo bank), this requirement is 
satisfied if the proposal complies with the Board's policy statement on 
small bank holding companies (Appendix C of this part).
---------------------------------------------------------------------------

    (7) The holding company will not, as a result of the reorganization, 
acquire control of any additional bank or engage in any activities other 
than those of managing and controlling banks; and
    (8) During this period, neither the appropriate Reserve Bank nor the 
Board objected to the proposal or required the filing of an application 
under Sec. 225.15 of this subpart.
    (b) Contents of notice. A notice filed under this paragraph shall 
include:
    (1) Certification by the notificant's board of directors that the 
requirements of 12 U.S.C. 1842(a)(C) and this section are met by the 
proposal;
    (2) A list identifying all principal shareholders of the bank prior 
to the reorganization and of the holding company following the 
reorganization, and specifying the percentage of shares held by each 
principal shareholder in the bank and proposed to be held in the new 
holding company;
    (3) A description of the resulting management of the proposed bank 
holding company and its subsidiary bank, including:
    (i) Biographical information regarding any senior officers and 
directors of the resulting bank holding company who were not senior 
officers or directors of the bank prior to the reorganization; and
    (ii) A detailed history of the involvement of any officer, director, 
or principal shareholder of the resulting bank holding company in any 
administrative or criminal proceeding; and
    (4) Pro forma financial statements for the holding company, and a 
description of the amount, source, and terms of debt, if any, that the 
bank holding company proposes to incur, and information regarding the 
sources and timing for debt service and retirement.
    (c) Acknowledgment of notice. Within 7 calendar days following 
receipt of a notice under this section, the Reserve Bank shall provide 
the notificant with a written acknowledgment of receipt of the notice. 
This written acknowledgment shall indicate that the transaction 
described in the notice may be consummated on the 30th calendar day 
after the date of receipt of the notice if the Reserve Bank or the Board 
has not objected to the proposal during that time.
    (d) Application required upon objection. The Reserve Bank or the 
Board may object to a proposal during the notice period by providing the 
bank holding company with a written explanation of the reasons for the 
objection. In such case, the bank holding company may file an 
application for prior approval of the proposal pursuant to Sec. 225.15 
of this subpart.



   Subpart C--Nonbanking Activities and Acquisitions by Bank Holding 
                                Companies

    Source: Reg. Y, 62 FR 9329, Feb. 28, 1997, unless otherwise noted.



Sec. 225.21  Prohibited nonbanking activities and acquisitions; exempt bank holding companies.

    (a) Prohibited nonbanking activities and acquisitions. Except as 
provided in Sec. 225.22 of this subpart, a bank holding company or a 
subsidiary may not engage in, or acquire or control, directly

[[Page 76]]

or indirectly, voting securities or assets of a company engaged in, any 
activity other than:
    (1) Banking or managing or controlling banks and other subsidiaries 
authorized under the BHC Act; and
    (2) An activity that the Board determines to be so closely related 
to banking, or managing or controlling banks as to be a proper incident 
thereto, including any incidental activities that are necessary to carry 
on such an activity, if the bank holding company has obtained the prior 
approval of the Board for that activity in accordance with the 
requirements of this regulation.
    (b) Exempt bank holding companies. The following bank holding 
companies are exempt from the provisions of this subpart:
    (1) Family-owned companies. Any company that is a ``company covered 
in 1970'' (as defined in section 2(b) of the BHC Act), more than 85 
percent of the voting securities of which was collectively owned on June 
30, 1968, and continuously thereafter, by members of the same family (or 
their spouses) who are lineal descendants of common ancestors.
    (2) Labor, agricultural, and horticultural organizations. Any 
company that was on January 4, 1977, both a bank holding company and a 
labor, agricultural, or horticultural organization exempt from taxation 
under section 501 of the Internal Revenue Code (26 U.S.C. 501(c)).
    (3) Companies granted hardship exemption. Any bank holding company 
that has controlled only one bank since before July 1, 1968, and that 
has been granted an exemption by the Board under section 4(d) of the BHC 
Act, subject to any conditions imposed by the Board.
    (4) Companies granted exemption on other grounds. Any company that 
acquired control of a bank before December 10, 1982, without the Board's 
prior approval under section 3 of the BHC Act, on the basis of a narrow 
interpretation of the term demand deposit or commercial loan, if the 
Board has determined that:
    (i) Coverage of the company as a bank holding company under this 
subpart would be unfair or represent an unreasonable hardship; and
    (ii) Exclusion of the company from coverage under this part is 
consistent with the purposes of the BHC Act and section 106 of the Bank 
Holding Company Act Amendments of 1970 (12 U.S.C. 1971, 1972(1)). The 
provisions of Sec. 225.4 of subpart A of this part do not apply to a 
company exempt under this paragraph.



Sec. 225.22  Exempt nonbanking activities and acquisitions.

    (a) Certain de novo activities. A bank holding company may, either 
directly or indirectly, engage de novo in any nonbanking activity listed 
in Sec. 225.28(b) (other than operation of an insured depository 
institution) without obtaining the Board's prior approval if the bank 
holding company:
    (1) Meets the requirements of paragraphs (c) (1), (2), and (6) of 
Sec. 225.23;
    (2) Conducts the activity in compliance with all Board orders and 
regulations governing the activity; and
    (3) Within 10 business days after commencing the activity, provides 
written notice to the appropriate Reserve Bank describing the activity, 
identifying the company or companies engaged in the activity, and 
certifying that the activity will be conducted in accordance with the 
Board's orders and regulations and that the bank holding company meets 
the requirements of paragraphs (c) (1), (2), and (6) of Sec. 225.23.
    (b) Servicing activities. A bank holding company may, without the 
Board's prior approval under this subpart, furnish services to or 
perform services for, or establish or acquire a company that engages 
solely in servicing activities for:
    (1) The bank holding company or its subsidiaries in connection with 
their activities as authorized by law, including services that are 
necessary to fulfill commitments entered into by the subsidiaries with 
third parties, if the bank holding company or servicing company complies 
with the Board's published interpretations and does not act as principal 
in dealing with third parties; and

[[Page 77]]

    (2) The internal operations of the bank holding company or its 
subsidiaries. Services for the internal operations of the bank holding 
company or its subsidiaries include, but are not limited to:
    (i) Accounting, auditing, and appraising;
    (ii) Advertising and public relations;
    (iii) Data processing and data transmission services, data bases, or 
facilities;
    (iv) Personnel services;
    (v) Courier services;
    (vi) Holding or operating property used wholly or substantially by a 
subsidiary in its operations or for its future use;
    (vii) Liquidating property acquired from a subsidiary;
    (viii) Liquidating property acquired from any sources either prior 
to May 9, 1956, or the date on which the company became a bank holding 
company, whichever is later; and
    (ix) Selling, purchasing, or underwriting insurance, such as blanket 
bond insurance, group insurance for employees, and property and casualty 
insurance.
    (c) Safe deposit business. A bank holding company or nonbank 
subsidiary may, without the Board's prior approval, conduct a safe 
deposit business, or acquire voting securities of a company that 
conducts such a business.
    (d) Nonbanking acquisitions not requiring prior Board approval. The 
Board's prior approval is not required under this subpart for the 
following acquisitions:
    (1) DPC acquisitions. (i) Voting securities or assets, acquired by 
foreclosure or otherwise, in the ordinary course of collecting a debt 
previously contracted (DPC property) in good faith, if the DPC property 
is divested within two years of acquisition.
    (ii) The Board may, upon request, extend this two-year period for up 
to three additional years. The Board may permit additional extensions 
for up to 5 years (for a total of 10 years), for shares, real estate or 
other assets where the holding company demonstrates that each extension 
would not be detrimental to the public interest and either the bank 
holding company has made good faith attempts to dispose of such shares, 
real estate or other assets or disposal of the shares, real estate or 
other assets during the initial period would have been detrimental to 
the company.
    (iii) Transfers of DPC property within the bank holding company 
system do not extend any period for divestiture of the property.
    (2) Securities or assets required to be divested by subsidiary. 
Voting securities or assets required to be divested by a subsidiary at 
the request of an examining federal or state authority (except by the 
Board under the BHC Act or this regulation), if the bank holding company 
divests the securities or assets within two years from the date acquired 
from the subsidiary.
    (3) Fiduciary investments. Voting securities or assets acquired by a 
bank or other company (other than a trust that is a company) in good 
faith in a fiduciary capacity, if the voting securities or assets are:
    (i) Held in the ordinary course of business; and
    (ii) Not acquired for the benefit of the company or its 
shareholders, employees, or subsidiaries.
    (4) Securities eligible for investment by national bank. Voting 
securities of the kinds and amounts explicitly eligible by federal 
statute (other than section 4 of the Bank Service Corporation Act, 12 
U.S.C. 1864) for investment by a national bank, and voting securities 
acquired prior to June 30, 1971, in reliance on section 4(c)(5) of the 
BHC Act and interpretations of the Comptroller of the Currency under 
section 5136 of the Revised Statutes (12 U.S.C. 24(7)).
    (5) Securities or property representing 5 percent or less of a 
company. Voting securities of a company or property that, in the 
aggregate, represent 5 percent or less of the outstanding shares of any 
class of voting securities of a company, or that represent a 5 percent 
interest or less in the property, subject to the provisions of 12 CFR 
225.137.
    (6) Securities of investment company. Voting securities of an 
investment company that is solely engaged in investing in securities and 
that does not own or control more than 5 percent of the outstanding 
shares of any class of voting securities of any company.

[[Page 78]]

    (7) Assets acquired in ordinary course of business. Assets of a 
company acquired in the ordinary course of business, subject to the 
provisions of 12 CFR 225.132, if the assets relate to activities in 
which the acquiring company has previously received Board approval under 
this regulation to engage.
    (8) Asset acquisitions by lending company or industrial bank. Assets 
of an office(s) of a company, all or substantially all of which relate 
to making, acquiring, or servicing loans if:
    (i) The acquiring company has previously received Board approval 
under this regulation or is not required to obtain prior Board approval 
under this regulation to engage in lending activities or industrial 
banking activities;
    (ii) The assets acquired during any 12-month period do not represent 
more than 50 percent of the risk-weighted assets (on a consolidated 
basis) of the acquiring lending company or industrial bank, or more than 
$100 million, whichever amount is less;
    (iii) The assets acquired do not represent more than 50 percent of 
the selling company's consolidated assets that are devoted to lending 
activities or industrial banking business;
    (iv) The acquiring company notifies the Reserve Bank of the 
acquisition within 30 days after the acquisition; and
    (v) The acquiring company, after giving effect to the transaction, 
meets the Board's Capital Adequacy Guidelines (Appendix A of this part), 
and the Board has not previously notified the acquiring company that it 
may not acquire assets under the exemption in this paragraph.
    (e) Acquisition of securities by subsidiary banks--(1) National 
bank. A national bank or its subsidiary may, without the Board's 
approval under this subpart, acquire or retain securities on the basis 
of section 4(c)(5) of the BHC Act in accordance with the regulations of 
the Comptroller of the Currency.
    (2) State bank. A state-chartered bank or its subsidiary may, 
insofar as federal law is concerned, and without the Board's prior 
approval under this subpart:
    (i) Acquire or retain securities, on the basis of section 4(c)(5) of 
the BHC Act, of the kinds and amounts explicitly eligible by federal 
statute for investment by a national bank; or
    (ii) Acquire or retain all (but, except for directors' qualifying 
shares, not less than all) of the securities of a company that engages 
solely in activities in which the parent bank may engage, at locations 
at which the bank may engage in the activity, and subject to the same 
limitations as if the bank were engaging in the activity directly.
    (f) Activities and securities of new bank holding companies. A 
company that becomes a bank holding company may, for a period of two 
years, engage in nonbanking activities and control voting securities or 
assets of a nonbank subsidiary, if the bank holding company engaged in 
such activities or controlled such voting securities or assets on the 
date it became a bank holding company. The Board may grant requests for 
up to three one-year extensions of the two-year period.
    (g) Grandfathered activities and securities. Unless the Board orders 
divestiture or termination under section 4(a)(2) of the BHC Act, a 
``company covered in 1970,'' as defined in section 2(b) of the BHC Act, 
may:
    (1) Retain voting securities or assets and engage in activities that 
it has lawfully held or engaged in continuously since June 30, 1968; and
    (2) Acquire voting securities of any newly formed company to engage 
in such activities.
    (h) Securities or activities exempt under Regulation K. A bank 
holding company may acquire voting securities or assets and engage in 
activities as authorized in Regulation K (12 CFR part 211).



Sec. 225.23  Expedited action for certain nonbanking proposals by well-run bank holding companies.

    (a) Filing of notice--(1) Information required. A bank holding 
company that meets the requirements of paragraph (c) of this section may 
satisfy the notice requirement of this subpart in connection with the 
acquisition of voting securities or assets of a company engaged in 
nonbanking activities that the Board has permitted by order or

[[Page 79]]

regulation (other than an insured depository institution) 1, 
or a proposal to engage de novo, either directly or indirectly, in a 
nonbanking activity that the Board has permitted by order or by 
regulation, by providing the appropriate Reserve Bank with a written 
notice containing the following:
---------------------------------------------------------------------------

    \1\ A bank holding company may acquire voting securities or assets 
of a savings association or other insured depository institution that is 
not a bank by using the procedures in Sec. 225.14 of subpart B if the 
bank holding company and the proposal qualify under that section as if 
the savings association or other institution were a bank for purposes of 
that section.
---------------------------------------------------------------------------

    (i) A certification that all of the criteria in paragraph (c) of 
this section are met;
    (ii) A description of the transaction that includes identification 
of the companies involved in the transaction, the activities to be 
conducted, and a commitment to conduct the proposed activities in 
conformity with the Board's regulations and orders governing the conduct 
of the proposed activity;
    (iii) If the proposal involves an acquisition of a going concern:
    (A) If the bank holding company has consolidated assets of $150 
million or more, an abbreviated consolidated pro forma balance sheet for 
the acquiring bank holding company as of the most recent quarter showing 
credit and debit adjustments that reflect the proposed transaction, 
consolidated pro forma risk-based capital ratios for the acquiring bank 
holding company as of the most recent quarter, a description of the 
purchase price and the terms and sources of funding for the transaction, 
and the total revenue and net income of the company to be acquired;
    (B) If the bank holding company has consolidated assets of less than 
$150 million, a pro forma parent-only balance sheet as of the most 
recent quarter showing credit and debit adjustments that reflect the 
proposed transaction, a description of the purchase price and the terms 
and sources of funding for the transaction and the sources and schedule 
for retiring any debt incurred in the transaction, and the total assets, 
off-balance sheet items, revenue and net income of the company to be 
acquired;
    (C) For each insured depository institution whose Tier 1 capital, 
total capital, total assets or risk-weighted assets change as a result 
of the transaction, the total risk-weighted assets, total assets, Tier 1 
capital and total capital of the institution on a pro forma basis;
    (iv) Identification of the geographic markets in which competition 
would be affected by the proposal, a description of the effect of the 
proposal on competition in the relevant markets, a list of the major 
competitors in that market in the proposed activity if the affected 
market is local in nature, and, if requested, the market indexes for the 
relevant market; and
    (v) A description of the public benefits that can reasonably be 
expected to result from the transaction.
    (2) Waiver of unnecessary information. The Reserve Bank may reduce 
the information requirements in paragraphs (a)(1) (iii) and (iv) of this 
section as appropriate.
    (b)(1) Action on proposals under this section. The Board or the 
appropriate Reserve Bank shall act on a proposal submitted under this 
section, or notify the bank holding company that the transaction is 
subject to the procedure in Sec. 225.24, within 12 business days 
following the filing of all of the information required in paragraph (a) 
of this section.
    (2) Acceptance of notice if expedited procedure not available. If 
the Board or the Reserve Bank determines, after the filing of a notice 
under this section, that a bank holding company may not use the 
procedure in this section and must file a notice under Sec. 225.24, the 
notice shall be deemed accepted for purposes of Sec. 225.24 as of the 
date that the notice was filed under this section.
    (c) Criteria for use of expedited procedure. The procedure in this 
section is available only if:
    (1) Well-capitalized organization--(i) Bank holding company. Both at 
the time of and immediately after the proposed transaction, the 
acquiring bank holding company is well-capitalized;
    (ii) Insured depository institutions. Both at the time of and 
immediately after the transaction:

[[Page 80]]

    (A) The lead insured depository institution of the acquiring bank 
holding company is well-capitalized;
    (B) Well-capitalized insured depository institutions control at 
least 80 percent of the total risk-weighted assets of insured depository 
institutions controlled by the acquiring bank holding company; and
    (C) No insured depository institution controlled by the acquiring 
bank holding company is undercapitalized;
    (2) Well-managed organization--(i) Satisfactory examination ratings. 
At the time of the transaction, the acquiring bank holding company, its 
lead insured depository institution, and insured depository institutions 
that control at least 80 percent of the total risk-weighted assets of 
insured depository institutions controlled by such holding company are 
well-managed;
    (ii) No poorly managed institutions. No insured depository 
institution controlled by the acquiring bank holding company has 
received 1 of the 2 lowest composite ratings at the later of the 
institution's most recent examination or subsequent review by the 
appropriate federal banking agency for the institution.
    (iii) Recently acquired institutions excluded. Any insured 
depository institution that has been acquired by the bank holding 
company during the 12-month period preceding the date on which written 
notice is filed under paragraph (a) of this section may be excluded for 
purposes of paragraph (c)(2)(ii) of this section if:
    (A) The bank holding company has developed a plan acceptable to the 
appropriate federal banking agency for the institution to restore the 
capital and management of the institution; and
    (B) All insured depository institutions excluded under this 
paragraph represent, in the aggregate, less than 10 percent of the 
aggregate total risk-weighted assets of all insured depository 
institutions controlled by the bank holding company;
    (3) Permissible activity. (i) The Board has determined by regulation 
or order that each activity proposed to be conducted is so closely 
related to banking, or managing or controlling banks, as to be a proper 
incident thereto; and
    (ii) The Board has not indicated that proposals to engage in the 
activity are subject to the notice procedure provided in Sec. 225.24;
    (4) Competitive criteria--(i) Competitive screen. In the case of the 
acquisition of a going concern, the acquisition, without regard to any 
divestitures proposed by the acquiring bank holding company, does not 
cause:
    (A) The acquiring bank holding company to control in excess of 35 
percent of the market share in any relevant market; or
    (B) The Herfindahl-Hirschman index to increase by more than 200 
points in any relevant market with a post-acquisition index of at least 
1800; and
    (ii) Other competitive factors. The Board has not indicated that the 
transaction is subject to close scrutiny on competitive grounds;
    (5) Size of acquisition--(i) In general--(A) Limited growth. Except 
as provided in paragraph (c)(5)(ii) of this section, the sum of 
aggregate risk-weighted assets to be acquired in the proposal and the 
aggregate risk-weighted assets acquired by the acquiring bank holding 
company in all other qualifying transactions does not exceed 35 percent 
of the consolidated risk-weighted assets of the acquiring bank holding 
company. For purposes of this paragraph, ``other qualifying 
transactions'' means any transaction approved under this section or 
Sec. 225.14 during the 12 months prior to filing the notice under this 
section;
    (B) Consideration paid. The gross consideration to be paid by the 
acquiring bank holding company in the proposal does not exceed 15 
percent of the consolidated Tier 1 capital of the acquiring bank holding 
company; and
    (C) Individual size limitation. The total risk-weighted assets to be 
acquired do not exceed $7.5 billion;
    (ii) Small bank holding companies. Paragraph (c)(5)(i)(A) of this 
section shall not apply if, immediately following consummation of the 
proposed transaction, the consolidated risk-weighted assets of the 
acquiring bank holding company are less than $300 million;
    (6) Supervisory actions. During the 12-month period ending on the 
date on

[[Page 81]]

which the bank holding company proposes to consummate the proposed 
transaction, no formal administrative order, including a written 
agreement, cease and desist order, capital directive, prompt corrective 
action directive, asset maintenance agreement, or other formal 
enforcement order is or was outstanding against the bank holding company 
or any insured depository institution subsidiary of the holding company, 
and no formal administrative enforcement proceeding involving any such 
enforcement action, order, or directive is or was pending; and
    (7) Notification. The bank holding company has not been notified by 
the Board, in its discretion, prior to the expiration of the period in 
paragraph (b) of this section that a notice under Sec. 225.24 is 
required in order to permit closer review of any potential adverse 
effect or other matter related to the factors that must be considered 
under this part.
    (d) Branches and agencies of foreign banking organizations. For 
purposes of this section, a U.S. branch or agency of a foreign banking 
organization shall be considered to be an insured depository 
institution.



Sec. 225.24  Procedures for other nonbanking proposals.

    (a) Notice required for nonbanking activities. Except as provided in 
Sec. 225.22 and Sec. 225.23, a notice for the Board's prior approval 
under Sec. 225.21(a) to engage in or acquire a company engaged in a 
nonbanking activity shall be filed by a bank holding company (including 
a company seeking to become a bank holding company) with the appropriate 
Reserve Bank in accordance with this section and the Board's Rules of 
Procedure (12 CFR 262.3).
    (1) Engaging de novo in listed activities. A bank holding company 
seeking to commence or to engage de novo, either directly or through a 
subsidiary, in a nonbanking activity listed in Sec. 225.28 shall file a 
notice containing a description of the activities to be conducted and 
the identity of the company that will conduct the activity.
    (2) Acquiring company engaged in listed activities. A bank holding 
company seeking to acquire or control voting securities or assets of a 
company engaged in a nonbanking activity listed in Sec. 225.28 shall 
file a notice containing the following:
    (i) A description of the proposal, including a description of each 
proposed activity, and the effect of the proposal on competition among 
entities engaging in each proposed activity in each relevant market with 
relevant market indexes;
    (ii) The identity of any entity involved in the proposal, and, if 
the notificant proposes to conduct the activity through an existing 
subsidiary, a description of the existing activities of the subsidiary;
    (iii) A statement of the public benefits that can reasonably be 
expected to result from the proposal;
    (iv) If the bank holding company has consolidated assets of $150 
million or more:
    (A) Parent company and consolidated pro forma balance sheets for the 
acquiring bank holding company as of the most recent quarter showing 
credit and debit adjustments that reflect the proposed transaction;
    (B) Consolidated pro forma risk-based capital and leverage ratio 
calculations for the acquiring bank holding company as of the most 
recent quarter; and
    (C) A description of the purchase price and the terms and sources of 
funding for the transaction;
    (v) If the bank holding company has consolidated assets of less than 
$150 million:
    (A) A pro forma parent-only balance sheet as of the most recent 
quarter showing credit and debit adjustments that reflect the proposed 
transaction; and
    (B) A description of the purchase price and the terms and sources of 
funding for the transaction and, if the transaction is debt funded, one-
year income statement and cash flow projections for the parent company, 
and the sources and schedule for retiring any debt incurred in the 
transaction;
    (vi) For each insured depository institution whose Tier 1 capital, 
total capital, total assets or risk-weighted assets change as a result 
of the transaction, the total risk-weighted assets, total assets, Tier 1 
capital and total capital of the institution on a pro forma basis; and

[[Page 82]]

    (vii) A description of the management expertise, internal controls 
and risk management systems that will be utilized in the conduct of the 
proposed activities; and
    (viii) A copy of the purchase agreements, and balance sheet and 
income statements for the most recent quarter and year-end for any 
company to be acquired.
    (3) Engaging in or acquiring company to engage in unlisted 
activities. A bank holding company seeking to engage de novo in, or to 
acquire or control voting securities or assets of a company engaged in, 
any activity not listed in Sec. 225.28 shall file a notice containing 
the following:
    (i) Evidence that the proposed activity is so closely related to 
banking or managing or controlling banks as to be a proper incident 
thereto, or, if the Board previously determined by order that the 
activity is permissible for a bank holding company to conduct, a 
commitment to comply with all the conditions and limitations established 
by the Board governing the activity; and
    (ii) The information required in paragraphs (a)(1) or (a)(2) of this 
section, as appropriate.
    (b) Notice provided to Board. The Reserve Bank shall immediately 
send to the Board a copy of any notice received under paragraphs (a)(2) 
or (a)(3) of this section.
    (c) Notice to public--(1) Listed activities and activities approved 
by order--(i) In a case involving an activity listed in Sec. 225.28 or 
previously approved by the Board by order, the Reserve Bank shall notify 
the Board for publication in the Federal Register immediately upon 
receipt by the Reserve Bank of:
    (A) A notice under this section; or
    (B) A written request that notice of a proposal under this section 
or Sec. 225.23 be published in the Federal Register. Such a request may 
request that Federal Register publication occur up to 15 calendar days 
prior to submission of a notice under this subpart.
    (ii) The Federal Register notice published under this paragraph 
shall invite public comment on the proposal, generally for a period of 
15 days.
    (2) New activities--(i) In general. In the case of a notice under 
this subpart involving an activity that is not listed in Sec. 225.28 and 
that has not been previously approved by the Board by order, the Board 
shall send notice of the proposal to the Federal Register for 
publication, unless the Board determines that the notificant has not 
demonstrated that the activity is so closely related to banking or to 
managing or controlling banks as to be a proper incident thereto. The 
Federal Register notice shall invite public comment on the proposal for 
a reasonable period of time, generally for 30 days.
    (ii) Time for publication. The Board shall send the notice required 
under this paragraph to the Federal Register within 10 business days of 
acceptance by the Reserve Bank. The Board may extend the 10-day period 
for an additional 30 calendar days upon notice to the notificant. In the 
event notice of a proposal is not published for comment, the Board shall 
inform the notificant of the reasons for the decision.
    (d) Action on notices--(1) Reserve Bank action--(i) In general. 
Within 30 calendar days after receipt by the Reserve Bank of a notice 
filed pursuant to paragraphs (a)(1) or (a)(2) of this section, the 
Reserve Banks shall:
    (A) Approve the notice; or
    (B) Refer the notice to the Board for decision because action under 
delegated authority is not appropriate.
    (ii) Return of incomplete notice. Within 7 calendar days of receipt, 
the Reserve Bank may return any notice as informationally incomplete 
that does not contain all of the information required by this subpart. 
The return of such a notice shall be deemed action on the notice.
    (iii) Notice of action. The Reserve Bank shall promptly notify the 
bank holding company of any action or referral under this paragraph.
    (iv) Close of public comment period. The Reserve Bank shall not 
approve any notice under this paragraph (d)(1) of this section prior to 
the third business day after the close of the public comment period, 
unless an emergency exists that requires expedited or immediate action.
    (2) Board action; internal schedule. The Board seeks to act on every 
notice referred to it for decision within 60 days

[[Page 83]]

of the date that the notice is filed with the Reserve Bank. If the Board 
is unable to act within this period, the Board shall notify the 
notificant and explain the reasons and the date by which the Board 
expects to act.
    (3)(i) Required time limit for System action. The Board or the 
Reserve Bank shall act on any notice under this section within 60 days 
after the submission of a complete notice.
    (ii) Extension of required period for action (A) In general.--The 
Board may extend the 60-day period required for Board action under 
paragraph (d)(3)(i) of this section for an additional 30 days upon 
notice to the notificant.
    (B) Unlisted activities. If a notice involves a proposal to engage 
in an activity that is not listed in Sec. 225.28, the Board may extend 
the period required for Board action under paragraph (d)(3)(i) of this 
section for an additional 90 days. This 90-day extension is in addition 
to the 30-day extension period provided in paragraph (d)(3)(ii)(A) of 
this section. The Board shall notify the notificant that the notice 
period has been extended and explain the reasons for the extension.
    (4) Requests for additional information. The Board or the Reserve 
Bank may modify the information requirements under this section or at 
any time request any additional information that either believes is 
needed for a decision on any notice under this section.
    (5) Tolling of period. The Board or the Reserve Bank may at any time 
extend or toll the time period for action on a notice for any period 
with the consent of the notificant.

[Reg. Y, 62 FR 9332, Feb. 28, 1997, as amended by Reg. Y, 62 FR 60640, 
Nov. 12, 1997]



Sec. 225.25  Hearings, alteration of activities, and other matters.

    (a) Hearings--(1) Procedure to request hearing. Any request for a 
hearing on a notice under this subpart shall comply with the provisions 
of 12 CFR 262.3(e).
    (2) Determination to hold hearing. The Board may order a formal or 
informal hearing or other proceeding on a notice as provided in 12 CFR 
262.3(i)(2). The Board shall order a hearing only if there are disputed 
issues of material fact that cannot be resolved in some other manner.
    (3) Extension of period for hearing. The Board may extend the time 
for action on any notice for such time as is reasonably necessary to 
conduct a hearing and evaluate the hearing record. Such extension shall 
not exceed 91 calendar days after the date of submission to the Board of 
the complete record on the notice. The procedures for computation of the 
91-day rule as set forth in Sec. 225.16(f) apply to notices under this 
subpart that involve hearings.
    (b) Approval through failure to act. (1) Except as provided in 
paragraph (a) of this section or Sec. 225.24(d)(5), a notice under this 
subpart shall be deemed to be approved at the conclusion of the period 
that begins on the date the complete notice is received by the Reserve 
Bank or the Board and that ends 60 calendar days plus any applicable 
extension and tolling period thereafter.
    (2) Complete notice. For purposes of paragraph (b)(1) of this 
section, a notice shall be deemed complete at such time as it contains 
all information required by this subpart and all other information 
requested by the Board or the Reserve Bank.
    (c) Notice to expand or alter nonbanking activities--(1) De novo 
expansion. A notice under this subpart is required to open a new office 
or to form a subsidiary to engage in, or to relocate an existing office 
engaged in, a nonbanking activity that the Board has previously approved 
for the bank holding company under this regulation, only if:
    (i) The Board's prior approval was limited geographically;
    (ii) The activity is to be conducted in a country outside of the 
United States and the bank holding company has not previously received 
prior Board approval under this regulation to engage in the activity in 
that country; or
    (iii) The Board or appropriate Reserve Bank has notified the company 
that a notice under this subpart is required.
    (2) Activities outside United States. With respect to activities to 
be engaged in outside the United States that require approval under this 
subpart, the procedures of this section apply only to activities to be 
engaged in directly by a bank holding company that

[[Page 84]]

is not a qualifying foreign banking organization, or by a nonbank 
subsidiary of a bank holding company approved under this subpart. 
Regulation K (12 CFR part 211) governs other international operations of 
bank holding companies.
    (3) Alteration of nonbanking activity. Unless otherwise permitted by 
the Board, a notice under this subpart is required to alter a nonbanking 
activity in any material respect from that considered by the Board in 
acting on the application or notice to engage in the activity.
    (d) Emergency savings association acquisitions. In the case of a 
notice to acquire a savings association, the Board may modify or 
dispense with the public notice and hearing requirements of this subpart 
if the Board finds that an emergency exists that requires the Board to 
act immediately and the primary federal regulator of the institution 
concurs.

[Reg. Y, 62 FR 9333, Feb. 28, 1997, as amended by Reg. Y, 62 FR 60640, 
Nov. 12, 1997]



Sec. 225.26  Factors considered in acting on nonbanking proposals.

    (a) In general. In evaluating a notice under Sec. 225.23 or 
Sec. 225.24, the Board shall consider whether the notificant's 
performance of the activities can reasonably be expected to produce 
benefits to the public (such as greater convenience, increased 
competition, and gains in efficiency) that outweigh possible adverse 
effects (such as undue concentration of resources, decreased or unfair 
competition, conflicts of interest, and unsound banking practices).
    (b) Financial and managerial resources. Consideration of the factors 
in paragraph (a) of this section includes an evaluation of the financial 
and managerial resources of the notificant, including its subsidiaries 
and any company to be acquired, the effect of the proposed transaction 
on those resources, and the management expertise, internal control and 
risk-management systems, and capital of the entity conducting the 
activity.
    (c) Competitive effect of de novo proposals. Unless the record 
demonstrates otherwise, the commencement or expansion of a nonbanking 
activity de novo is presumed to result in benefits to the public through 
increased competition.
    (d) Denial for lack of information. The Board may deny any notice 
submitted under this subpart if the notificant neglects, fails, or 
refuses to furnish all information required by the Board.
    (e) Conditional approvals. The Board may impose conditions on any 
approval, including conditions to address permissibility, financial, 
managerial, safety and soundness, competitive, compliance, conflicts of 
interest, or other concerns to ensure that approval is consistent with 
the relevant statutory factors and other provisions of the BHC Act.



Sec. 225.27  Procedures for determining scope of nonbanking activities.

    (a) Advisory opinions regarding scope of previously approved 
nonbanking activities--(1) Request for advisory opinion. Any person may 
submit a request to the Board for an advisory opinion regarding the 
scope of any permissible nonbanking activity. The request shall be 
submitted in writing to the Board and shall identify the proposed 
parameters of the activity, or describe the service or product that will 
be provided, and contain an explanation supporting an interpretation 
regarding the scope of the permissible nonbanking activity.
    (2) Response to request. The Board shall provide an advisory opinion 
within 45 days of receiving a written request under this paragraph.
    (b) Procedure for consideration of new activities--(1) Initiation of 
proceeding. The Board may, at any time, on its own initiative or in 
response to a written request from any person, initiate a proceeding to 
determine whether any activity is so closely related to banking or 
managing or controlling banks as to be a proper incident thereto.
    (2) Requests for determination. Any request for a Board 
determination that an activity is so closely related to banking or 
managing or controlling banks as to be a proper incident thereto, shall 
be submitted to the Board in writing, and shall contain evidence that 
the proposed activity is so closely related to banking or managing or 
controlling banks as to be a proper incident thereto.

[[Page 85]]

    (3) Publication. The Board shall publish in the Federal Register 
notice that it is considering the permissibility of a new activity and 
invite public comment for a period of at least 30 calendar days. In the 
case of a request submitted under paragraph (b) of this section, the 
Board may determine not to publish notice of the request if the Board 
determines that the requester has provided no reasonable basis for a 
determination that the activity is so closely related to banking, or 
managing or controlling banks as to be a proper incident thereto, and 
notifies the requester of the determination.
    (4) Comments and hearing requests. Any comment and any request for a 
hearing regarding a proposal under this section shall comply with the 
provisions of Sec. 262.3(e) of the Board's Rules of Procedure (12 CFR 
262.3(e)).



Sec. 225.28  List of permissible nonbanking activities.

    (a) Closely related nonbanking activities. The activities listed in 
paragraph (b) of this section are so closely related to banking or 
managing or controlling banks as to be a proper incident thereto, and 
may be engaged in by a bank holding company or its subsidiary in 
accordance with the requirements of this regulation.
    (b) Activities determined by regulation to be permissible--(1) 
Extending credit and servicing loans. Making, acquiring, brokering, or 
servicing loans or other extensions of credit (including factoring, 
issuing letters of credit and accepting drafts) for the company's 
account or for the account of others.
    (2) Activities related to extending credit. Any activity usual in 
connection with making, acquiring, brokering or servicing loans or other 
extensions of credit, as determined by the Board. The Board has 
determined that the following activities are usual in connection with 
making, acquiring, brokering or servicing loans or other extensions of 
credit:
    (i) Real estate and personal property appraising. Performing 
appraisals of real estate and tangible and intangible personal property, 
including securities.
    (ii) Arranging commercial real estate equity financing. Acting as 
intermediary for the financing of commercial or industrial income-
producing real estate by arranging for the transfer of the title, 
control, and risk of such a real estate project to one or more 
investors, if the bank holding company and its affiliates do not have an 
interest in, or participate in managing or developing, a real estate 
project for which it arranges equity financing, and do not promote or 
sponsor the development of the property.
    (iii) Check-guaranty services. Authorizing a subscribing merchant to 
accept personal checks tendered by the merchant's customers in payment 
for goods and services, and purchasing from the merchant validly 
authorized checks that are subsequently dishonored.
    (iv) Collection agency services. Collecting overdue accounts 
receivable, either retail or commercial.
    (v) Credit bureau services. Maintaining information related to the 
credit history of consumers and providing the information to a credit 
grantor who is considering a borrower's application for credit or who 
has extended credit to the borrower.
    (vi) Asset management, servicing, and collection activities. 
Engaging under contract with a third party in asset management, 
servicing, and collection 2 of assets of a type that an 
insured depository institution may originate and own, if the company 
does not engage in real property management or real estate brokerage 
services as part of these services.
---------------------------------------------------------------------------

    \2\ Asset management services include acting as agent in the 
liquidation or sale of loans and collateral for loans, including real 
estate and other assets acquired through foreclosure or in satisfaction 
of debts previously contracted.
---------------------------------------------------------------------------

    (vii) Acquiring debt in default. Acquiring debt that is in default 
at the time of acquisition, if the company:
    (A) Divests shares or assets securing debt in default that are not 
permissible investments for bank holding companies, within the time 
period required for divestiture of property acquired in satisfaction of 
a debt previously contracted under Sec. 225.12(b); 3
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    \3\ For this purpose, the divestiture period for property begins on 
the date that the debt is acquired, regardless of when legal title to 
the property is acquired.

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[[Page 86]]

    (B) Stands only in the position of a creditor and does not purchase 
equity of obligors of debt in default (other than equity that may be 
collateral for such debt); and
    (C) Does not acquire debt in default secured by shares of a bank or 
bank holding company.
    (viii) Real estate settlement servicing. Providing real estate 
settlement services.4
---------------------------------------------------------------------------

    \4\ For purposes of this section, real estate settlement services do 
not include providing title insurance as principal, agent, or broker.
---------------------------------------------------------------------------

    (3) Leasing personal or real property. Leasing personal or real 
property or acting as agent, broker, or adviser in leasing such property 
if:
    (i) The lease is on a nonoperating basis; 5
---------------------------------------------------------------------------

    \5\ The requirement that the lease be on a nonoperating basis means 
that the bank holding company may not, directly or indirectly, engage in 
operating, servicing, maintaining, or repairing leased property during 
the lease term. For purposes of the leasing of automobiles, the 
requirement that the lease be on a nonoperating basis means that the 
bank holding company may not, directly or indirectly: (1) Provide 
servicing, repair, or maintenance of the leased vehicle during the lease 
term; (2) purchase parts and accessories in bulk or for an individual 
vehicle after the lessee has taken delivery of the vehicle; (3) provide 
the loan of an automobile during servicing of the leased vehicle; (4) 
purchase insurance for the lessee; or (5) provide for the renewal of the 
vehicle's license merely as a service to the lessee where the lessee 
could renew the license without authorization from the lessor. The bank 
holding company may arrange for a third party to provide these services 
or products.
---------------------------------------------------------------------------

    (ii) The initial term of the lease is at least 90 days;
    (iii) In the case of leases involving real property:
    (A) At the inception of the initial lease, the effect of the 
transaction will yield a return that will compensate the lessor for not 
less than the lessor's full investment in the property plus the 
estimated total cost of financing the property over the term of the 
lease from rental payments, estimated tax benefits, and the estimated 
residual value of the property at the expiration of the initial lease; 
and
    (B) The estimated residual value of property for purposes of 
paragraph (b)(3)(iii)(A) of this section shall not exceed 25 percent of 
the acquisition cost of the property to the lessor.
    (4) Operating nonbank depository institutions--(i) Industrial 
banking. Owning, controlling, or operating an industrial bank, Morris 
Plan bank, or industrial loan company, so long as the institution is not 
a bank.
    (ii) Operating savings association. Owning, controlling, or 
operating a savings association, if the savings association engages only 
in deposit-taking activities, lending, and other activities that are 
permissible for bank holding companies under this subpart C.
    (5) Trust company functions. Performing functions or activities that 
may be performed by a trust company (including activities of a 
fiduciary, agency, or custodial nature), in the manner authorized by 
federal or state law, so long as the company is not a bank for purposes 
of section 2(c) of the Bank Holding Company Act.
    (6) Financial and investment advisory activities. Acting as 
investment or financial advisor to any person, including (without, in 
any way, limiting the foregoing):
    (i) Serving as investment adviser (as defined in section 2(a)(20) of 
the Investment Company Act of 1940, 15 U.S.C. 80a-2(a)(20)), to an 
investment company registered under that act, including sponsoring, 
organizing, and managing a closed-end investment company;
    (ii) Furnishing general economic information and advice, general 
economic statistical forecasting services, and industry studies;
    (iii) Providing advice in connection with mergers, acquisitions, 
divestitures, investments, joint ventures, leveraged buyouts, 
recapitalizations, capital structurings, financing transactions and 
similar transactions, and conducting financial feasibility studies; 
6
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    \6\ Feasibility studies do not include assisting management with the 
planning or marketing for a given project or providing general 
operational or management advice.

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[[Page 87]]

    (iv) Providing information, statistical forecasting, and advice with 
respect to any transaction in foreign exchange, swaps, and similar 
transactions, commodities, and any forward contract, option, future, 
option on a future, and similar instruments;
    (v) Providing educational courses, and instructional materials to 
consumers on individual financial management matters; and
    (vi) Providing tax-planning and tax-preparation services to any 
person.
    (7) Agency transactional services for customer investments--(i) 
Securities brokerage. Providing securities brokerage services (including 
securities clearing and/or securities execution services on an 
exchange), whether alone or in combination with investment advisory 
services, and incidental activities (including related securities credit 
activities and custodial services), if the securities brokerage services 
are restricted to buying and selling securities solely as agent for the 
account of customers and do not include securities underwriting or 
dealing.
    (ii) Riskless principal transactions. Buying and selling in the 
secondary market all types of securities on the order of customers as a 
``riskless principal'' to the extent of engaging in a transaction in 
which the company, after receiving an order to buy (or sell) a security 
from a customer, purchases (or sells) the security for its own account 
to offset a contemporaneous sale to (or purchase from) the customer. 
This does not include:
    (A) Selling bank-ineligible securities 7 at the order of 
a customer that is the issuer of the securities, or selling bank-
ineligible securities in any transaction where the company has a 
contractual agreement to place the securities as agent of the issuer; or
---------------------------------------------------------------------------

    \7\ A bank-ineligible security is any security that a State member 
bank is not permitted to underwrite or deal in under 12 U.S.C. 24 and 
335.
---------------------------------------------------------------------------

    (B) Acting as a riskless principal in any transaction involving a 
bank-ineligible security for which the company or any of its affiliates 
acts as underwriter (during the period of the underwriting or for 30 
days thereafter) or dealer.8
---------------------------------------------------------------------------

    \8\ A company or its affiliates may not enter quotes for specific 
bank-ineligible securities in any dealer quotation system in connection 
with the company's riskless principal transactions; except that the 
company or its affiliates may enter ``bid'' or ``ask'' quotations, or 
publish ``offering wanted'' or ``bid wanted'' notices on trading systems 
other than NASDAQ or an exchange, if the company or its affiliate does 
not enter price quotations on different sides of the market for a 
particular security during any two-day period.
---------------------------------------------------------------------------

    (iii) Private placement services. Acting as agent for the private 
placement of securities in accordance with the requirements of the 
Securities Act of 1933 (1933 Act) and the rules of the Securities and 
Exchange Commission, if the company engaged in the activity does not 
purchase or repurchase for its own account the securities being placed, 
or hold in inventory unsold portions of issues of these securities.
    (iv) Futures commission merchant. Acting as a futures commission 
merchant (FCM) for unaffiliated persons in the execution, clearance, or 
execution and clearance of any futures contract and option on a futures 
contract traded on an exchange in the United States or abroad if:
    (A) The activity is conducted through a separately incorporated 
subsidiary of the bank holding company, which may engage in activities 
other than FCM activities (including, but not limited to, permissible 
advisory and trading activities); and
    (B) The parent bank holding company does not provide a guarantee or 
otherwise become liable to the exchange or clearing association other 
than for those trades conducted by the subsidiary for its own account or 
for the account of any affiliate.
    (v) Other transactional services. Providing to customers as agent 
transactional services with respect to swaps and similar transactions, 
any transaction described in paragraph (b)(8) of this section, any 
transaction that is permissible for a state member bank, and any other 
transaction involving a forward contract, option, futures, option on a 
futures or similar contract (whether traded on an exchange or not)

[[Page 88]]

relating to a commodity that is traded on an exchange.
    (8) Investment transactions as principal--(i) Underwriting and 
dealing in government obligations and money market instruments. 
Underwriting and dealing in obligations of the United States, general 
obligations of states and their political subdivisions, and other 
obligations that state member banks of the Federal Reserve System may be 
authorized to underwrite and deal in under 12 U.S.C. 24 and 335, 
including banker's acceptances and certificates of deposit, under the 
same limitations as would be applicable if the activity were performed 
by the bank holding company's subsidiary member banks or its subsidiary 
nonmember banks as if they were member banks.
    (ii) Investing and trading activities. Engaging as principal in:
    (A) Foreign exchange;
    (B) Forward contracts, options, futures, options on futures, swaps, 
and similar contracts, whether traded on exchanges or not, based on any 
rate, price, financial asset (including gold, silver, platinum, 
palladium, copper, or any other metal approved by the Board), 
nonfinancial asset, or group of assets, other than a bank-ineligible 
security,9 if:
---------------------------------------------------------------------------

    \9\ A bank-ineligible security is any security that a state member 
bank is not permitted to underwrite or deal in under 12 U.S.C. 24 and 
335.
---------------------------------------------------------------------------

    (1) A state member bank is authorized to invest in the asset 
underlying the contract;
    (2) The contract requires cash settlement; or
    (3) The contract allows for assignment, termination, or offset prior 
to delivery or expiration, and the company makes every reasonable effort 
to avoid taking or making delivery; and
    (C) Forward contracts, options,10 futures, options on 
futures, swaps, and similar contracts, whether traded on exchanges or 
not, based on an index of a rate, a price, or the value of any financial 
asset, nonfinancial asset, or group of assets, if the contract requires 
cash settlement.
---------------------------------------------------------------------------

    \10\ This reference does not include acting as a dealer in options 
based on indices of bank-ineligible securities when the options are 
traded on securities exchanges. These options are securities for 
purposes of the federal securities laws and bank-ineligible securities 
for purposes of section 20 of the Glass-Steagall Act, 12 U.S.C. 337. 
Similarly, this reference does not include acting as a dealer in any 
other instrument that is a bank-ineligible security for purposes of 
section 20. A bank holding company may deal in these instruments in 
accordance with the Board's orders on dealing in bank-ineligible 
securities.
---------------------------------------------------------------------------

    (iii) Buying and selling bullion, and related activities. Buying, 
selling and storing bars, rounds, bullion, and coins of gold, silver, 
platinum, palladium, copper, and any other metal approved by the Board, 
for the company's own account and the account of others, and providing 
incidental services such as arranging for storage, safe custody, 
assaying, and shipment.
    (9) Management consulting and counseling activities--(i) Management 
consulting. (A) Providing management consulting advice: 11
---------------------------------------------------------------------------

    \11\ In performing this activity, bank holding companies are not 
authorized to perform tasks or operations or provide services to client 
institutions either on a daily or continuing basis, except as necessary 
to instruct the client institution on how to perform such services for 
itself. See also the Board's interpretation of bank management 
consulting advice (12 CFR 225.131).
---------------------------------------------------------------------------

    (1) On any matter to unaffiliated depository institutions, including 
commercial banks, savings and loan associations, savings banks, credit 
unions, industrial banks, Morris Plan banks, cooperative banks, 
industrial loan companies, trust companies, and branches or agencies of 
foreign banks;
    (2) On any financial, economic, accounting, or audit matter to any 
other company.
    (B) A company conducting management consulting activities under this 
subparagraph and any affiliate of such company may not:
    (1) Own or control, directly or indirectly, more than 5 percent of 
the voting securities of the client institution; and
    (2) Allow a management official, as defined in 12 CFR 212.2(h), of 
the company or any of its affiliates to serve as a management official 
of the client institution, except where such interlocking relationship 
is permitted pursuant to an exemption granted under 12

[[Page 89]]

CFR 212.4(b) or otherwise permitted by the Board.
    (C) A company conducting management consulting activities may 
provide management consulting services to customers not described in 
paragraph (b)(9)(i)(A)(1) of this section or regarding matters not 
described in paragraph (b)(9)(i)(A)(2) of this section, if the total 
annual revenue derived from those management consulting services does 
not exceed 30 percent of the company's total annual revenue derived from 
management consulting activities.
    (ii) Employee benefits consulting services. Providing consulting 
services to employee benefit, compensation and insurance plans, 
including designing plans, assisting in the implementation of plans, 
providing administrative services to plans, and developing employee 
communication programs for plans.
    (iii) Career counseling services. Providing career counseling 
services to:
    (A) A financial organization 12 and individuals currently 
employed by, or recently displaced from, a financial organization;
---------------------------------------------------------------------------

    \12\ Financial organization refers to insured depository institution 
holding companies and their subsidiaries, other than nonbanking 
affiliates of diversified savings and loan holding companies that engage 
in activities not permissible under section 4(c)(8) of the Bank Holding 
Company Act (12 U.S.C. 1842(c)(8)).
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    (B) Individuals who are seeking employment at a financial 
organization; and
    (C) Individuals who are currently employed in or who seek positions 
in the finance, accounting, and audit departments of any company.
    (10) Support services--(i) Courier services. Providing courier 
services for:
    (A) Checks, commercial papers, documents, and written instruments 
(excluding currency or bearer-type negotiable instruments) that are 
exchanged among banks and financial institutions; and
    (B) Audit and accounting media of a banking or financial nature and 
other business records and documents used in processing such 
media.13
---------------------------------------------------------------------------

    \13\ See also the Board's interpretation on courier activities (12 
CFR 225.129), which sets forth conditions for bank holding company entry 
into the activity.
---------------------------------------------------------------------------

    (ii) Printing and selling MICR-encoded items. Printing and selling 
checks and related documents, including corporate image checks, cash 
tickets, voucher checks, deposit slips, savings withdrawal packages, and 
other forms that require Magnetic Ink Character Recognition (MICR) 
encoding.
    (11) Insurance agency and underwriting--(i) Credit insurance. Acting 
as principal, agent, or broker for insurance (including home mortgage 
redemption insurance) that is:
    (A) Directly related to an extension of credit by the bank holding 
company or any of its subsidiaries; and
    (B) Limited to ensuring the repayment of the outstanding balance due 
on the extension of credit 14 in the event of the death, 
disability, or involuntary unemployment of the debtor.
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    \14\ Extension of credit includes direct loans to borrowers, loans 
purchased from other lenders, and leases of real or personal property so 
long as the leases are nonoperating and full-payout leases that meet the 
requirements of paragraph (b)(3) of this section.
---------------------------------------------------------------------------

    (ii) Finance company subsidiary. Acting as agent or broker for 
insurance directly related to an extension of credit by a finance 
company 15 that is a subsidiary of a bank holding company, 
if:
---------------------------------------------------------------------------

    \15\ Finance company includes all non-deposit-taking financial 
institutions that engage in a significant degree of consumer lending 
(excluding lending secured by first mortgages) and all financial 
institutions specifically defined by individual states as finance 
companies and that engage in a significant degree of consumer lending.
---------------------------------------------------------------------------

    (A) The insurance is limited to ensuring repayment of the 
outstanding balance on such extension of credit in the event of loss or 
damage to any property used as collateral for the extension of credit; 
and
    (B) The extension of credit is not more than $10,000, or $25,000 if 
it is to finance the purchase of a residential manufactured home 
16 and the credit is secured by the home; and
---------------------------------------------------------------------------

    \16\ These limitations increase at the end of each calendar year, 
beginning with 1982, by the percentage increase in the Consumer Price 
Index for Urban Wage Earners and Clerical Workers published by the 
Bureau of Labor Statistics.
---------------------------------------------------------------------------

    (C) The applicant commits to notify borrowers in writing that:

[[Page 90]]

    (1) They are not required to purchase such insurance from the 
applicant;
    (2) Such insurance does not insure any interest of the borrower in 
the collateral; and
    (3) The applicant will accept more comprehensive property insurance 
in place of such single-interest insurance.
    (iii) Insurance in small towns. Engaging in any insurance agency 
activity in a place where the bank holding company or a subsidiary of 
the bank holding company has a lending office and that:
    (A) Has a population not exceeding 5,000 (as shown in the preceding 
decennial census); or
    (B) Has inadequate insurance agency facilities, as determined by the 
Board, after notice and opportunity for hearing.
    (iv) Insurance-agency activities conducted on May 1, 1982. Engaging 
in any specific insurance-agency activity 17 if the bank 
holding company, or subsidiary conducting the specific activity, 
conducted such activity on May 1, 1982, or received Board approval to 
conduct such activity on or before May 1, 1982.18 A bank 
holding company or subsidiary engaging in a specific insurance agency 
activity under this clause may:
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    \17\ Nothing contained in this provision shall preclude a bank 
holding company subsidiary that is authorized to engage in a specific 
insurance-agency activity under this clause from continuing to engage in 
the particular activity after merger with an affiliate, if the merger is 
for legitimate business purposes and prior notice has been provided to 
the Board.
    \18\ For the purposes of this paragraph, activities engaged in on 
May 1, 1982, include activities carried on subsequently as the result of 
an application to engage in such activities pending before the Board on 
May 1, 1982, and approved subsequently by the Board or as the result of 
the acquisition by such company pursuant to a binding written contract 
entered into on or before May 1, 1982, of another company engaged in 
such activities at the time of the acquisition.
---------------------------------------------------------------------------

    (A) Engage in such specific insurance agency activity only at 
locations:
    (1) In the state in which the bank holding company has its principal 
place of business (as defined in 12 U.S.C. 1842(d));
    (2) In any state or states immediately adjacent to such state; and
    (3) In any state in which the specific insurance-agency activity was 
conducted (or was approved to be conducted) by such bank holding company 
or subsidiary thereof or by any other subsidiary of such bank holding 
company on May 1, 1982; and
    (B) Provide other insurance coverages that may become available 
after May 1, 1982, so long as those coverages insure against the types 
of risks as (or are otherwise functionally equivalent to) coverages sold 
or approved to be sold on May 1, 1982, by the bank holding company or 
subsidiary.
    (v) Supervision of retail insurance agents. Supervising on behalf of 
insurance underwriters the activities of retail insurance agents who 
sell:
    (A) Fidelity insurance and property and casualty insurance on the 
real and personal property used in the operations of the bank holding 
company or its subsidiaries; and
    (B) Group insurance that protects the employees of the bank holding 
company or its subsidiaries.
    (vi) Small bank holding companies. Engaging in any insurance-agency 
activity if the bank holding company has total consolidated assets of 
$50 million or less. A bank holding company performing insurance-agency 
activities under this paragraph may not engage in the sale of life 
insurance or annuities except as provided in paragraphs (b)(11) (i) and 
(iii) of this section, and it may not continue to engage in insurance-
agency activities pursuant to this provision more than 90 days after the 
end of the quarterly reporting period in which total assets of the 
holding company and its subsidiaries exceed $50 million.
    (vii) Insurance-agency activities conducted before 1971. Engaging in 
any insurance-agency activity performed at any location in the United 
States directly or indirectly by a bank holding company that was engaged 
in insurance-agency activities prior to January 1, 1971, as a 
consequence of approval by the Board prior to January 1, 1971.
    (12) Community development activities--(i) Financing and investment 
activities. Making equity and debt investments in corporations or 
projects designed primarily to promote community welfare, such as the 
economic rehabilitation

[[Page 91]]

and development of low-income areas by providing housing, services, or 
jobs for residents.
    (ii) Advisory activities. Providing advisory and related services 
for programs designed primarily to promote community welfare.
    (13) Money orders, savings bonds, and traveler's checks. The 
issuance and sale at retail of money orders and similar consumer-type 
payment instruments; the sale of U.S. savings bonds; and the issuance 
and sale of traveler's checks.
    (14) Data processing. (i) Providing data processing and data 
transmission services, facilities (including data processing and data 
transmission hardware, software, documentation, or operating personnel), 
data bases, advice, and access to such services, facilities, or data 
bases by any technological means, if:
    (A) The data to be processed or furnished are financial, banking, or 
economic; and
    (B) The hardware provided in connection therewith is offered only in 
conjunction with software designed and marketed for the processing and 
transmission of financial, banking, or economic data, and where the 
general purpose hardware does not constitute more than 30 percent of the 
cost of any packaged offering.
    (ii) A company conducting data processing and data transmission 
activities may conduct data processing and data transmission activities 
not described in paragraph (b)(14)(i) of this section if the total 
annual revenue derived from those activities does not exceed 30 percent 
of the company's total annual revenues derived from data processing and 
data transmission activities.



             Subpart D--Control and Divestiture Proceedings



Sec. 225.31  Control proceedings.

    (a) Preliminary determination of control. (1) The Board may issue a 
preliminary determination of control under the procedures set forth in 
this section in any case in which:
    (i) Any of the presumptions of control set forth in paragraph (d) of 
this section is present; or
    (ii) It otherwise appears that a company has the power to exercise a 
controlling influence over the management or policies of a bank or other 
company.
    (2) If the Board makes a preliminary determination of control under 
this section, the Board shall send notice to the controlling company 
containing a statement of the facts upon which the preliminary 
determination is based.
    (b) Response to preliminary determination of control. Within 30 
calendar days of issuance by the Board of a preliminary determination of 
control or such longer period permitted by the Board, the company 
against whom the determination has been made shall:
    (1) Submit for the Board's approval a specific plan for the prompt 
termination of the control relationship;
    (2) File an application under subpart B or C of this regulation to 
retain the control relationship; or
    (3) Contest the preliminary determination by filing a response, 
setting forth the facts and circumstances in support of its position 
that no control exists, and, if desired, requesting a hearing or other 
proceeding.
    (c) Hearing and final determination. (1) The Board shall order a 
formal hearing or other appropriate proceeding upon the request of a 
company that contests a preliminary determination that the company has 
the power to exercise a controlling influence over the management or 
policies of a bank or other company, if the Board finds that material 
facts are in dispute. The Board may also in its discretion order a 
formal hearing or other proceeding with respect to a preliminary 
determination that the company controls voting securities of the bank or 
other company under the presumptions in paragraph (d)(1) of this 
section.
    (2) At a hearing or other proceeding, any applicable presumptions 
established by paragraph (d) of this section shall be considered in 
accordance with the Federal Rules of Evidence and the Board's Rules of 
Practice for Formal Hearings (12 CFR part 263).
    (3) After considering the submissions of the company and other 
evidence, including the record of any hearing or other proceeding, the 
Board shall issue a final order determining whether the company controls 
voting securities, or has the power to exercise a controlling

[[Page 92]]

influence over the management or policies, of the bank or other company. 
If a control relationship is found, the Board may direct the company to 
terminate the control relationship or to file an application for the 
Board's approval to retain the control relationship under subpart B or C 
of this regulation.
    (d) Rebuttable presumptions of control. The following rebuttable 
presumptions shall be used in any proceeding under this section:
    (1) Control of voting securities--(i) Securities convertible into 
voting securities. A company that owns, controls, or holds securities 
that are immediately convertible, at the option of the holder or owner, 
into voting securities of a bank or other company, controls the voting 
securities.
    (ii) Option or restriction on voting securities. A company that 
enters into an agreement or understanding under which the rights of a 
holder of voting securities of a bank or other company are restricted in 
any manner controls the securities. This presumption does not apply 
where the agreement or understanding:
    (A) Is a mutual agreement among shareholders granting to each other 
a right of first refusal with respect to their shares;
    (B) Is incident to a bona fide loan transaction; or
    (C) Relates to restrictions on transferability and continues only 
for the time necessary to obtain approval from the appropriate Federal 
supervisory authority with respect to acquisition by the company of the 
securities.
    (2) Control over company--(i) Management agreement. A company that 
enters into any agreement or understanding with a bank or other company 
(other than an investment advisory agreement), such as a management 
contract, under which the first company or any of its subsidiaries 
directs or exercises significant influence over the general management 
or overall operations of the bank or other company controls the bank or 
other company.
    (ii) Shares controlled by company and associated individuals. A 
company that, together with its management officials or controlling 
shareholders (including members of the immediate families of either), 
owns, controls, or holds with power to vote 25 percent or more of the 
outstanding shares of any class of voting securities of a bank or other 
company controls the bank or other company, if the first company owns, 
controls, or holds with power to vote more than 5 percent of the 
outstanding shares of any class of voting securities of the bank or 
other company.
    (iii) Common management officials. A company that has one or more 
management officials in common with a bank or other company controls the 
bank or other company, if the first company owns, controls or holds with 
power to vote more than 5 percent of the outstanding shares of any class 
of voting securities of the bank or other company, and no other person 
controls as much as 5 percent of the outstanding shares of any class of 
voting securities of the bank or other company.
    (iv) Shares held as fiduciary. The presumptions in paragraphs (d)(2) 
(ii) and (iii) of this section do not apply if the securities are held 
by the company in a fiduciary capacity without sole discretionary 
authority to exercise the voting rights.
    (e) Presumption of non-control--(1) In any proceeding under this 
section, there is a presumption that any company that directly or 
indirectly owns, controls, or has power to vote less than 5 percent of 
the outstanding shares of any class of voting securities of a bank or 
other company does not have control over that bank or other company.
    (2) In any proceeding under this section, or judicial proceeding 
under the BHC Act, other than a proceeding in which the Board has made a 
preliminary determination that a company has the power to exercise a 
controlling influence over the management or policies of the bank or 
other company, a company may not be held to have had control over the 
bank or other company at any given time, unless that company, at the 
time in question, directly or indirectly owned, controlled, or had power 
to vote 5 percent or more of the outstanding shares of any class of 
voting securities of the bank or other company, or had already been 
found to have control on the basis of

[[Page 93]]

the existence of a controlling influence relationship.

[Reg. Y, 49 FR 818, Jan. 5, 1984, as amended at 58 FR 474, Jan. 6, 1993; 
Reg. Y, 62 FR 9338, Feb. 28, 1997]



                    Subpart E--Change in Bank Control

    Source: Reg. Y, 62 FR 9338, Feb. 28, 1997, unless otherwise noted.



Sec. 225.41  Transactions requiring prior notice.

    (a) Prior notice requirement. Any person acting directly or 
indirectly, or through or in concert with one or more persons, shall 
give the Board 60 days' written notice, as specified in Sec. 225.43 of 
this subpart, before acquiring control of a state member bank or bank 
holding company, unless the acquisition is exempt under Sec. 225.42.
    (b) Definitions. For purposes of this subpart:
    (1) Acquisition includes a purchase, assignment, transfer, or pledge 
of voting securities, or an increase in percentage ownership of a state 
member bank or a bank holding company resulting from a redemption of 
voting securities.
    (2) Acting in concert includes knowing participation in a joint 
activity or parallel action towards a common goal of acquiring control 
of a state member bank or bank holding company whether or not pursuant 
to an express agreement.
    (3) Immediate family includes a person's father, mother, stepfather, 
stepmother, brother, sister, stepbrother, stepsister, son, daughter, 
stepson, stepdaughter, grandparent, grandson, granddaughter, father-in-
law, mother-in-law, brother-in-law, sister-in-law, son-in-law, daughter-
in-law, the spouse of any of the foregoing, and the person's spouse.
    (c) Acquisitions requiring prior notice--(1) Acquisition of control. 
The acquisition of voting securities of a state member bank or bank 
holding company constitutes the acquisition of control under the Bank 
Control Act, requiring prior notice to the Board, if, immediately after 
the transaction, the acquiring person (or persons acting in concert) 
will own, control, or hold with power to vote 25 percent or more of any 
class of voting securities of the institution.
    (2) Rebuttable presumption of control. The Board presumes that an 
acquisition of voting securities of a state member bank or bank holding 
company constitutes the acquisition of control under the Bank Control 
Act, requiring prior notice to the Board, if, immediately after the 
transaction, the acquiring person (or persons acting in concert) will 
own, control, or hold with power to vote 10 percent or more of any class 
of voting securities of the institution, and if:
    (i) The institution has registered securities under section 12 of 
the Securities Exchange Act of 1934 (15 U.S.C. 78l); or
    (ii) No other person will own, control, or hold the power to vote a 
greater percentage of that class of voting securities immediately after 
the transaction.1
---------------------------------------------------------------------------

    \1\ If two or more persons, not acting in concert, each propose to 
acquire simultaneously equal percentages of 10 percent or more of a 
class of voting securities of the state member bank or bank holding 
company, each person must file prior notice to the Board.
---------------------------------------------------------------------------

    (d) Rebuttable presumption of concerted action. The following 
persons shall be presumed to be acting in concert for purposes of this 
subpart:
    (1) A company and any controlling shareholder, partner, trustee, or 
management official of the company, if both the company and the person 
own voting securities of the state member bank or bank holding company;
    (2) An individual and the individual's immediate family;
    (3) Companies under common control;
    (4) Persons that are parties to any agreement, contract, 
understanding, relationship, or other arrangement, whether written or 
otherwise, regarding the acquisition, voting, or transfer of control of 
voting securities of a state member bank or bank holding company, other 
than through a revocable proxy as described in Sec. 225.42(a)(5) of this 
subpart;
    (5) Persons that have made, or propose to make, a joint filing under 
sections 13 or 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78m 
or

[[Page 94]]

78n), and the rules promulgated thereunder by the Securities and 
Exchange Commission; and
    (6) A person and any trust for which the person serves as trustee.
    (e) Acquisitions of loans in default. The Board presumes an 
acquisition of a loan in default that is secured by voting securities of 
a state member bank or bank holding company to be an acquisition of the 
underlying securities for purposes of this section.
    (f) Other transactions. Transactions other than those set forth in 
paragraph (c) of this section resulting in a person's control of less 
than 25 percent of a class of voting securities of a state member bank 
or bank holding company are not deemed by the Board to constitute 
control for purposes of the Bank Control Act.
    (g) Rebuttal of presumptions. Prior notice to the Board is not 
required for any acquisition of voting securities under the presumption 
of control set forth in this section, if the Board finds that the 
acquisition will not result in control. The Board shall afford any 
person seeking to rebut a presumption in this section an opportunity to 
present views in writing or, if appropriate, orally before its 
designated representatives at an informal conference.



Sec. 225.42  Transactions not requiring prior notice.

    (a) Exempt transactions. The following transactions do not require 
notice to the Board under this subpart:
    (1) Existing control relationships. The acquisition of additional 
voting securities of a state member bank or bank holding company by a 
person who:
    (i) Continuously since March 9, 1979 (or since the institution 
commenced business, if later), held power to vote 25 percent or more of 
any class of voting securities of the institution; or
    (ii) Is presumed, under Sec. 225.41(c)(2) of this subpart, to have 
controlled the institution continuously since March 9, 1979, if the 
aggregate amount of voting securities held does not exceed 25 percent or 
more of any class of voting securities of the institution or, in other 
cases, where the Board determines that the person has controlled the 
bank continuously since March 9, 1979;
    (2) Increase of previously authorized acquisitions. Unless the Board 
or the Reserve Bank otherwise provides in writing, the acquisition of 
additional shares of a class of voting securities of a state member bank 
or bank holding company by any person (or persons acting in concert) who 
has lawfully acquired and maintained control of the institution (for 
purposes of Sec. 225.41(c) of this subpart), after complying with the 
procedures and receiving approval to acquire voting securities of the 
institution under this subpart, or in connection with an application 
approved under section 3 of the BHC Act (12 U.S.C. 1842; Sec. 225.11 of 
subpart B of this part) or section 18(c) of the Federal Deposit 
Insurance Act (Bank Merger Act, 12 U.S.C. 1828(c));
    (3) Acquisitions subject to approval under BHC Act or Bank Merger 
Act. Any acquisition of voting securities subject to approval under 
section 3 of the BHC Act (12 U.S.C. 1842; Sec. 225.11 of subpart B of 
this part), or section 18(c) of the Federal Deposit Insurance Act (Bank 
Merger Act, 12 U.S.C. 1828(c));
    (4) Transactions exempt under BHC Act. Any transaction described in 
sections 2(a)(5), 3(a)(A), or 3(a)(B) of the BHC Act (12 U.S.C. 
1841(a)(5), 1842(a)(A), and 1842(a)(B)), by a person described in those 
provisions;
    (5) Proxy solicitation. The acquisition of the power to vote 
securities of a state member bank or bank holding company through 
receipt of a revocable proxy in connection with a proxy solicitation for 
the purposes of conducting business at a regular or special meeting of 
the institution, if the proxy terminates within a reasonable period 
after the meeting;
    (6) Stock dividends. The receipt of voting securities of a state 
member bank or bank holding company through a stock dividend or stock 
split if the proportional interest of the recipient in the institution 
remains substantially the same; and
    (7) Acquisition of foreign banking organization. The acquisition of 
voting securities of a qualifying foreign banking organization. (This 
exemption does not extend to the reports and information required under 
paragraphs 9, 10, and 12 of the Bank Control Act (12 U.S.C.

[[Page 95]]

1817(j) (9), (10), and (12)) and Sec. 225.44 of this subpart.)
    (b) Prior notice exemption. (1) The following acquisitions of voting 
securities of a state member bank or bank holding company, which would 
otherwise require prior notice under this subpart, are not subject to 
the prior notice requirements if the acquiring person notifies the 
appropriate Reserve Bank within 90 calendar days after the acquisition 
and provides any relevant information requested by the Reserve Bank:
    (i) Acquisition of voting securities through inheritance;
    (ii) Acquisition of voting securities as a bona fide gift; and
    (iii) Acquisition of voting securities in satisfaction of a debt 
previously contracted (DPC) in good faith.
    (2) The following acquisitions of voting securities of a state 
member bank or bank holding company, which would otherwise require prior 
notice under this subpart, are not subject to the prior notice 
requirements if the acquiring person does not reasonably have advance 
knowledge of the transaction, and provides the written notice required 
under section 225.43 to the appropriate Reserve Bank within 90 calendar 
days after the transaction occurs:
    (i) Acquisition of voting securities resulting from a redemption of 
voting securities by the issuing bank or bank holding company; and
    (ii) Acquisition of voting securities as a result of actions 
(including the sale of securities) by any third party that is not within 
the control of the acquiror.
    (3) Nothing in paragraphs (b)(1) or (b)(2) of this section limits 
the authority of the Board to disapprove a notice pursuant to 
Sec. 225.43(h) of this subpart.



Sec. 225.43  Procedures for filing, processing, publishing, and acting on notices.

    (a) Filing notice. (1) A notice required under this subpart shall be 
filed with the appropriate Reserve Bank and shall contain all the 
information required by paragraph 6 of the Bank Control Act (12 U.S.C. 
1817(j)(6)), or prescribed in the designated Board form.
    (2) The Board may waive any of the informational requirements of the 
notice if the Board determines that it is in the public interest.
    (3) A notificant shall notify the appropriate Reserve Bank or the 
Board immediately of any material changes in a notice submitted to the 
Reserve Bank, including changes in financial or other conditions.
    (4) When the acquiring person is an individual, or group of 
individuals acting in concert, the requirement to provide personal 
financial data may be satisfied by a current statement of assets and 
liabilities and an income summary, as required in the designated Board 
form, together with a statement of any material changes since the date 
of the statement or summary. The Reserve Bank or the Board, 
nevertheless, may request additional information, if appropriate.
    (b) Acceptance of notice. The 60-day notice period specified in 
Sec. 225.41 of this subpart begins on the date of receipt of a complete 
notice. The Reserve Bank shall notify the person or persons submitting a 
notice under this subpart in writing of the date the notice is or was 
complete and thereby accepted for processing. The Reserve Bank or the 
Board may request additional relevant information at any time after the 
date of acceptance.
    (c) Publication--(1) Newspaper Announcement. Any person(s) filing a 
notice under this subpart shall publish, in a form prescribed by the 
Board, an announcement soliciting public comment on the proposed 
acquisition. The announcement shall be published in a newspaper of 
general circulation in the community in which the head office of the 
state member bank to be acquired is located or, in the case of a 
proposed acquisition of a bank holding company, in the community in 
which its head office is located and in the community in which the head 
office of each of its subsidiary banks is located. The announcement 
shall be published no earlier than 15 calendar days before the filing of 
the notice with the appropriate Reserve Bank and no later than 10 
calendar days after the filing date; and the publisher's affidavit of a 
publication shall be provided to the appropriate Reserve Bank.

[[Page 96]]

    (2) Contents of newspaper announcement. The newspaper announcement 
shall state:
    (i) The name of each person identified in the notice as a proposed 
acquiror of the bank or bank holding company;
    (ii) The name of the bank or bank holding company to be acquired, 
including the name of each of the bank holding company's subsidiary 
banks; and
    (iii) A statement that interested persons may submit comments on the 
notice to the Board or the appropriate Reserve Bank for a period of 20 
days, or such shorter period as may be provided, pursuant to paragraph 
(c)(5) of this section.
    (3) Federal Register announcement. The Board shall, upon filing of a 
notice under this subpart, publish announcement in the Federal Register 
of receipt of the notice. The Federal Register announcement shall 
contain the information required under paragraphs (c)(2)(i) and 
(c)(2)(ii) of this section and a statement that interested persons may 
submit comments on the proposed acquisition for a period of 15 calendar 
days, or such shorter period as may be provided, pursuant to paragraph 
(c)(5) of this section. The Board may waive publication in the Federal 
Register, if the Board determines that such action is appropriate.
    (4) Delay of publication. The Board may permit delay in the 
publication required under paragraphs (c)(1) and (c)(3) of this section 
if the Board determines, for good cause shown, that it is in the public 
interest to grant such delay. Requests for delay of publication may be 
submitted to the appropriate Reserve Bank.
    (5) Shortening or waiving notice. The Board may shorten or waive the 
public comment or newspaper publication requirements of this paragraph, 
or act on a notice before the expiration of a public comment period, if 
it determines in writing that an emergency exists, or that disclosure of 
the notice, solicitation of public comment, or delay until expiration of 
the public comment period would seriously threaten the safety or 
soundness of the bank or bank holding company to be acquired.
    (6) Consideration of public comments. In acting upon a notice filed 
under this subpart, the Board shall consider all public comments 
received in writing within the period specified in the newspaper or 
Federal Register announcement, whichever is later. At the Board's 
option, comments received after this period may, but need not, be 
considered.
    (7) Standing. No person (other than the acquiring person) who 
submits comments or information on a notice filed under this subpart 
shall thereby become a party to the proceeding or acquire any standing 
or right to participate in the Board's consideration of the notice or to 
appeal or otherwise contest the notice or the Board's action regarding 
the notice.
    (d) Time period for Board action--(1) Consummation of acquisition --
(i) The notificant(s) may consummate the proposed acquisition 60 days 
after submission to the Reserve Bank of a complete notice under 
paragraph (a) of this section, unless within that period the Board 
disapproves the proposed acquisition or extends the 60-day period, as 
provided under paragraph (d)(2) of this section.
    (ii) The notificant(s) may consummate the proposed transaction 
before the expiration of the 60-day period if the Board notifies the 
notificant(s) in writing of the Board's intention not to disapprove the 
acquisition.
    (2) Extensions of time period. (i) The Board may extend the 60-day 
period in paragraph (d)(1) of this section for an additional 30 days by 
notifying the acquiring person(s).
    (ii) The Board may further extend the period during which it may 
disapprove a notice for two additional periods of not more than 45 days 
each, if the Board determines that:
    (A) Any acquiring person has not furnished all the information 
required under paragraph (a) of this section;
    (B) Any material information submitted is substantially inaccurate;
    (C) The Board is unable to complete the investigation of an 
acquiring person because of inadequate cooperation or delay by that 
person; or
    (D) Additional time is needed to investigate and determine that no 
acquiring person has a record of failing to

[[Page 97]]

comply with the requirements of the Bank Secrecy Act, subchapter II of 
Chapter 53 of Title 31, United States Code.
    (iii) If the Board extends the time period under this paragraph, it 
shall notify the acquiring person(s) of the reasons therefor and shall 
include a statement of the information, if any, deemed incomplete or 
inaccurate.
    (e) Advice to bank supervisory agencies. (1) Upon accepting a notice 
relating to acquisition of securities of a state member bank, the 
Reserve Bank shall send a copy of the notice to the appropriate state 
bank supervisor, which shall have 30 calendar days from the date the 
notice is sent in which to submit its views and recommendations to the 
Board. The Reserve Bank also shall send a copy of any notice to the 
Comptroller of the Currency, the Federal Deposit Insurance Corporation, 
and the Office of Thrift Supervision.
    (2) If the Board finds that it must act immediately in order to 
prevent the probable failure of the bank or bank holding company 
involved, the Board may dispense with or modify the requirements for 
notice to the state supervisor.
    (f) Investigation and report. (1) After receiving a notice under 
this subpart, the Board or the appropriate Reserve Bank shall conduct an 
investigation of the competence, experience, integrity, and financial 
ability of each person by and for whom an acquisition is to be made. The 
Board shall also make an independent determination of the accuracy and 
completeness of any information required to be contained in a notice 
under paragraph (a) of this section. In investigating any notice 
accepted under this subpart, the Board or Reserve Bank may solicit 
information or views from any person, including any bank or bank holding 
company involved in the notice, and any appropriate state, federal, or 
foreign governmental authority.
    (2) The Board or the appropriate Reserve Bank shall prepare a 
written report of its investigation, which shall contain, at a minimum, 
a summary of the results of the investigation.
    (g) Factors considered in acting on notices. In reviewing a notice 
filed under this subpart, the Board shall consider the information in 
the record, the views and recommendations of the appropriate bank 
supervisor, and any other relevant information obtained during any 
investigation of the notice.
    (h) Disapproval and hearing--(1) Disapproval of notice. The Board 
may disapprove an acquisition if it finds adverse effects with respect 
to any of the factors set forth in paragraph 7 of the Bank Control Act 
(12 U.S.C. 1817(j)(7)) (i.e., competitive, financial, managerial, 
banking, or incompleteness of information).
    (2) Disapproval notification. Within three days after its decision 
to issue a notice of intent to disapprove any proposed acquisition, the 
Board shall notify the acquiring person in writing of the reasons for 
the action.
    (3) Hearing. Within 10 calendar days of receipt of the notice of the 
Board's intent to disapprove, the acquiring person may submit a written 
request for a hearing. Any hearing conducted under this paragraph shall 
be in accordance with the Rules of Practice for Formal Hearings (12 CFR 
part 263). At the conclusion of the hearing, the Board shall, by order, 
approve or disapprove the proposed acquisition on the basis of the 
record of the hearing. If the acquiring person does not request a 
hearing, the notice of intent to disapprove becomes final and 
unappealable.



Sec. 225.44  Reporting of stock loans.

    (a) Requirements. (1) Any foreign bank or affiliate of a foreign 
bank that has credit outstanding to any person or group of persons, in 
the aggregate, which is secured, directly or indirectly, by 25 percent 
or more of any class of voting securities of a state member bank, shall 
file a consolidated report with the appropriate Reserve Bank for the 
state member bank.
    (2) The foreign bank or its affiliate also shall file a copy of the 
report with its appropriate Federal banking agency.
    (3) Any shares of the state member bank held by the foreign bank or 
any affiliate of the foreign bank as principal must be included in the 
calculation of the number of shares in which the foreign bank or its 
affiliate has a security interest for purposes of paragraph (a) of this 
section.

[[Page 98]]

    (b) Definitions. For purposes of paragraph (a) of this section:
    (1) Foreign bank shall have the same meaning as in section 1(b) of 
the International Banking Act of 1978 (12 U.S.C. 3101).
    (2) Credit outstanding includes any loan or extension of credit; the 
issuance of a guarantee, acceptance, or letter of credit, including an 
endorsement or standby letter of credit; and any other type of 
transaction that extends credit or financing to the person or group of 
persons.
    (3) Group of persons includes any number of persons that the foreign 
bank or any affiliate of a foreign bank has reason to believe:
    (i) Are acting together, in concert, or with one another to acquire 
or control shares of the same insured depository institution, including 
an acquisition of shares of the same depository institution at 
approximately the same time under substantially the same terms; or
    (ii) Have made, or propose to make, a joint filing under section 13 
or 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78n), and 
the rules promulgated thereunder by the Securities and Exchange 
Commission regarding ownership of the shares of the same insured 
depository institution.
    (c) Exceptions. Compliance with paragraph (a) of this section is not 
required if:
    (1) The person or group of persons referred to in that paragraph has 
disclosed the amount borrowed and the security interest therein to the 
Board or appropriate Reserve Bank in connection with a notice filed 
under Sec. 225.41 of this subpart, or another application filed with the 
Board or Reserve Bank as a substitute for a notice under Sec. 225.41 of 
this subpart, including an application filed under section 3 of the BHC 
Act (12 U.S.C. 1842) or section 18(c) of the Federal Deposit Insurance 
Act (Bank Merger Act, 12 U.S.C. 1828(c)), or an application for 
membership in the Federal Reserve System; or
    (2) The transaction involves a person or group of persons that has 
been the owner or owners of record of the stock for a period of one year 
or more; or, if the transaction involves stock issued by a newly 
chartered bank, before the bank is opened for business.
    (d) Report requirements. (1) The consolidated report shall indicate 
the number and percentage of shares securing each applicable extension 
of credit, the identity of the borrower, and the number of shares held 
as principal by the foreign bank and any affiliate thereof.
    (2) A foreign bank, or any affiliate of a foreign bank, shall file 
the consolidated report in writing within 30 days of the date on which 
the foreign bank or affiliate first believes that the security for any 
outstanding credit consists of 25 percent or more of any class of voting 
securities of a state member bank.
    (e) Other reporting requirements. A foreign bank, or any affiliate 
thereof, that is supervised by the System and is required to report 
credit outstanding that is secured by the shares of an insured 
depository institution to another Federal banking agency also shall file 
a copy of the report with the appropriate Reserve Bank.



                 Subpart F--Limitations on Nonbank Banks



Sec. 225.52  Limitation on overdrafts.

    (a) Definitions. For purposes of this section--
    (1) Account means a reserve account, clearing account, or deposit 
account as defined in the Board's Regulation D (12 CFR 204.2(a)(1)(i)), 
that is maintained at a Federal Reserve Bank or nonbank bank.
    (2) Cash item means (i) a check other than a check classified as a 
noncash item; or (ii) any other item payable on demand and collectible 
at par that the Federal Reserve Bank of the district in which the item 
is payable is willing to accept as a cash item.
    (3) Discount window loan means any credit extended by a Federal 
Reserve Bank to a nonbank bank or industrial bank pursuant to the 
provisions of the Board's Regulation A (12 CFR part 201).
    (4) Industrial bank means an institution as defined in section 
2(c)(2)(H) of the BHC Act (12 U.S.C. 1841(c)(2)(H)).
    (5) Noncash item means an item handled by a Reserve Bank as a 
noncash

[[Page 99]]

item under the Reserve Bank's ``Collection of Noncash Items Operating 
Circular'' (e.g., a maturing bankers' acceptance or a maturing security, 
or a demand item, such as a check, with special instructions or an item 
that has not been preprinted or post-encoded).
    (6) Other nonelectronic transactions include all other transactions 
not included as funds transfers, book-entry securities transfers, cash 
items, noncash items, automated clearing house transactions, net 
settlement entries, and discount window loans (e.g., original issue of 
securities or redemption of securities).
    (7) An overdraft in an account occurs whenever the Federal Reserve 
Bank, nonbank bank, or industrial bank holding an account posts a 
transaction to the account of the nonbank bank, industrial bank, or 
affiliate that exceeds the aggregate balance of the accounts of the 
nonbank bank, industrial bank, or affiliate, as determined by the 
posting rules set forth in paragraphs (d) and (e) of this section and 
continues until the aggregate balance of the account is zero or greater.
    (8) Transfer item means an item as defined in subpart B of 
Regulation J (12 CFR 210.25 et seq).
    (b) Restriction on overdrafts--(1) Affiliates. Neither a nonbank 
bank nor an industrial bank shall permit any affiliate to incur any 
overdraft in its account with the nonbank bank or industrial bank.
    (2) Nonbank banks or industrial banks. (i) No nonbank bank or 
industrial bank shall incur any overdraft in its account at a Federal 
Reserve Bank on behalf of an affiliate.
    (ii) An overdraft by a nonbank bank or industrial bank in its 
account at a Federal Reserve Bank shall be deemed to be on behalf of an 
affiliate whenever:
    (A) A nonbank bank or industrial bank holds an account for an 
affiliate from which third-party payments can be made; and
    (B) When the posting of an affiliate's transaction to the nonbank 
bank's or industrial bank's account at a Reserve Bank creates an 
overdraft in its account at a Federal Reserve Bank or increases the 
amount of an existing overdraft in its account at a Federal Reserve 
Bank.
    (c) Permissible overdrafts. The following are permissible overdrafts 
not subject to paragraph (b) of this section:
    (1) Inadvertent error. An overdraft in its account by a nonbank bank 
or its affiliate, or an industrial bank or its affiliate, that results 
from an inadvertent computer error or inadvertent accounting error, that 
was not reasonably forseeable or could not have been prevented through 
the maintenance of procedures reasonably adopted by the nonbank bank or 
affiliate to avoid such overdraft; and
    (2) Fully secured primary dealer affiliate overdrafts. (i) An 
overdraft incurred by an affiliate of a nonbank bank, which affiliate is 
recognized as a primary dealer by the Federal Reserve Bank of New York, 
in the affiliate's account at the nonbank bank, or an overdraft incurred 
by a nonbank bank on behalf of its primary dealer affiliate in the 
nonbank bank's account at a Federal Reserve Bank; provided: the 
overdraft is fully secured by bonds, notes, or other obligations which 
are direct obligations of the United States or on which the principal 
and interest are fully guaranteed by the United States or by securities 
and obligations eligible for settlement on the Federal Reserve book-
entry system.
    (ii) An overdraft by a nonbank bank in its account at a Federal 
Reserve Bank that is on behalf of a primary dealer affiliate is fully 
secured when that portion of its overdraft at the Federal Reserve Bank 
that corresponds to the transaction posted for an affiliate that caused 
or increased the nonbank bank's overdraft is fully secured in accordance 
with paragraph (c)(2)(iii) of this section.
    (iii) An overdraft is fully secured under paragraph (c)(2)(i) when 
the nonbank bank can demonstrate that the overdraft is secured, at all 
times, by a perfected security interest in specific, identified 
obligations described in paragraph (c)(2)(i) with a market value that, 
in the judgment of the Reserve Bank holding the nonbank bank's account, 
is sufficiently in excess of the amount of the overdraft to provide a

[[Page 100]]

margin of protection in a volatile market or in the event the securities 
need to be liquidated quickly.
    (d) Posting by Federal Reserve Banks. For purposes of determining 
the balance of an account under this section, payments and transfers by 
nonbank banks and industrial banks processed by the Federal Reserve 
Banks shall be considered posted to their accounts at Federal Reserve 
Banks as follows:
    (1) Funds transfers. Transfer items shall be posted:
    (i) To the transferor's account at the time the transfer is actually 
made by the transferor's Federal Reserve Bank; and
    (ii) To the transferee's account at the time the transferee's 
Reserve Bank sends the transfer item or sends or telephones the advice 
of credit for the item to the transferee, whichever occurs first.
    (2) Book-entry securities transfers against payment. A book-entry 
securities transfer against payment shall be posted: (i) to the 
transferor's account at the time the entry is made by the transferor's 
Reserve Bank; and (ii) to the transferee's account at the time the entry 
is made by the transferee's Reserve Bank.
    (3) Discount window loans. Credit for a discount window loan shall 
be posted to the account of a nonbank bank or industrial bank at the 
close of business on the day that it is made or such earlier time as may 
be specifically agreed to by the Federal Reserve Bank and the nonbank 
bank under the terms of the loan. Debit for repayment of a discount 
window loan shall be posted to the account of the nonbank bank or 
industrial bank as of the close of business on the day of maturity of 
the loan or such earlier time as may be agreed to by the Federal Reserve 
Bank and the nonbank bank or required by the Federal Reserve Bank under 
the terms of the loan.
    (4) Other transactions. Total aggregate credits for automated 
clearing house transfers, cash items, noncash items, net settlement 
entries, and other nonelectronic transactions shall be posted to the 
account of a nonbank bank or industrial bank as of the opening of 
business on settlement day. Total aggregate debits for these 
transactions and entries shall be posted to the account of a nonbank 
bank or industrial bank as of the close of business on settlement day.
    (e) Posting by nonbank banks and industrial banks. For purposes of 
determining the balance of an affiliate's account under this section, 
payments and transfers through an affiliate's account at a nonbank bank 
or industrial bank shall be posted as follows:
    (1) Funds transfers. (i) Fedwire transfer items shall be posted:
    (A) To the transferor affiliate's account no later than the time the 
transfer is actually made by the transferor's Federal Reserve Bank; and
    (B) To the transferee affiliate's account no earlier than the time 
the transferee's Reserve Bank sends the transfer item, or sends or 
telephones the advice of credit for the item to the transferee, 
whichever occurs first.
    (ii) For funds transfers not sent or received through Federal 
Reserve Banks, debits shall be posted to the transferor affiliate's 
account not later than the time the nonbank bank or industrial bank 
becomes obligated on the transfer. Credits shall not be posted to the 
transferee affiliate's account before the nonbank bank or industrial 
bank has received actually and finally collected funds for the transfer.
    (2) Book-entry securities transfers against payment. (i) A book-
entry securities transfer against payment shall be posted:
    (A) To the transferor affiliate's account not earlier than the time 
the entry is made by the transferor's Reserve Bank; and
    (B) To the transferee affiliate's account not later than the time 
the entry is made by the transferee's Reserve Bank.
    (ii) For book-entry securities transfers against payment that are 
not sent or received through Federal Reserve Banks, entries shall be 
posted:
    (A) To the buyer-affiliate's account not later than the time the 
nonbank bank or industrial bank becomes obligated on the transfer; and
    (B) To the seller-affiliate's account not before the nonbank bank or 
industrial bank has received actually and finally collected funds for 
the transfer.

[[Page 101]]

    (3) Other transactions--(i) Credits. Except as otherwise provided in 
this paragraph, credits for cash items, noncash items, ACH transfers, 
net settlement entries, and all other nonelectronic transactions shall 
be posted to an affiliate's account on the day of the transaction (i.e., 
settlement day for ACH transactions or the day of credit for check 
transactions), but no earlier than the Federal Reserve Bank's opening of 
business on that day. Credit for cash items that are required by federal 
or state statute or regulation to be made available to the depositor for 
withdrawal prior to the posting time set forth in the preceding 
paragraph shall be posted as of the required availability time.
    (ii) Debits. Debits for cash items, noncash items, ACH transfers, 
net settlement entries, and all other nonelectronic transactions shall 
be posted to an affiliate's account on the day of the transaction (e.g., 
settlement day for ACH transactions or the day of presentment for check 
transactions), but no later than the Federal Reserve Bank's close of 
business on that day. If a check drawn on an affiliate's account or an 
ACH debit transfer received by an affiliate is returned timely by the 
nonbank bank or industrial bank in accordance with applicable law and 
agreements, no entry need to be posted to the affiliate's account for 
such item.


[Reg. Y, 53 FR 37744, Sept. 28, 1988]



    Subpart G--Appraisal Standards for Federally Related Transactions

    Source: Reg. Y, 55 FR 27771, July 5, 1990, unless otherwise noted.



Sec. 225.61  Authority, purpose, and scope.

    (a) Authority. This subpart is issued by the Board of Governors of 
the Federal Reserve System (the Board) under title XI of the Financial 
Institutions Reform, Recovery, and Enforcement Act of 1989 (FlRREA) 
(Pub. L. No. 101-73, 103 Stat. 183 (1989)), 12 U.S.C. 3310, 3331-3351, 
and section 5(b) of the Bank Holding Company Act, 12 U.S.C. 1844(b).
    (b) Purpose and scope. (1) Title XI provides protection for federal 
financial and public policy interests in real estate related 
transactions by requiring real estate appraisals used in connection with 
federally related transactions to be performed in writing, in accordance 
with uniform standards, by appraisers whose competency has been 
demonstrated and whose professional conduct will be subject to effective 
supervision. This subpart implements the requirements of title XI, and 
applies to all federally related transactions entered into by the Board 
or by institutions regulated by the Board (regulated institutions).
    (2) This subpart:
    (i) Identifies which real estate-related financial transactions 
require the services of an appraiser;
    (ii) Prescribes which categories of federally related transactions 
shall be appraised by a State certified appraiser and which by a State 
licensed appraiser; and
    (iii) Prescribes minimum standards for the performance of real 
estate appraisals in connection with federally related transactions 
under the jurisdiction of the Board.



Sec. 225.62  Definitions.

    (a) Appraisal means a written statement independently and 
impartially prepared by a qualified appraiser setting forth an opinion 
as to the market value of an adequately described property as of a 
specific date(s), supported by the presentation and analysis of relevant 
market information.
    (b) Appraisal Foundation means the Appraisal Foundation established 
on November 30, 1987, as a not-for-profit corporation under the laws of 
Illinois.
    (c) Appraisal Subcommittee means the Appraisal Subcommittee of the 
Federal Financial Institutions Examination Council.
    (d) Business loan means a loan or extension of credit to any 
corporation, general or limited partnership, business trust, joint 
venture, pool, syndicate, sole proprietorship, or other business entity.
    (e) Complex 1-to-4 family residential property appraisal means one 
in which the property to be appraised, the form of ownership, or market 
conditions are atypical.

[[Page 102]]

    (f) Federally related transaction means any real estate-related 
financial transaction entered into on or after August 9, 1990, that:
    (1) The Board or any regulated institution engages in or contracts 
for; and
    (2) Requires the services of an appraiser.
    (g) Market value means the most probable price which a property 
should bring in a competitive and open market under all conditions 
requisite to a fair sale, the buyer and seller each acting prudently and 
knowledgeably, and assuming the price is not affected by undue stimulus. 
Implicit in this definition is the consummation of a sale as of a 
specified date and the passing of title from seller to buyer under 
conditions whereby:
    (1) Buyer and seller are typically motivated;
    (2) Both parties are well informed or well advised, and acting in 
what they consider their own best interests;
    (3) A reasonable time is allowed for exposure in the open market;
    (4) Payment is made in terms of cash in U.S. dollars or in terms of 
financial arrangements comparable thereto; and
    (5) The price represents the normal consideration for the property 
sold unaffected by special or creative financing or sales concessions 
granted by anyone associated with the sale.
    (h) Real estate or real property means an identified parcel or tract 
of land, with improvements, and includes easements, rights of way, 
undivided or future interests, or similar rights in a tract of land, but 
does not include mineral rights, timber rights, growing crops, water 
rights, or similar interests severable from the land when the 
transaction does not involve the associated parcel or tract of land.
    (i) Real estate-related financial transaction means any transaction 
involving:
    (1) The sale, lease, purchase, investment in or exchange of real 
property, including interests in property, or the financing thereof; or
    (2) The refinancing of real property or interests in real property; 
or
    (3) The use of real property or interests in property as security 
for a loan or investment, including mortgage-backed securities.
    (j) State certified appraiser means any individual who has satisfied 
the requirements for certification in a State or territory whose 
criteria for certification as a real estate appraiser currently meet or 
exceed the minimum criteria for certification issued by the Appraiser 
Qualifications Board of the Appraisal Foundation. No individual shall be 
a State certified appraiser unless such individual has achieved a 
passing grade upon a suitable examination administered by a State or 
territory that is consistent with and equivalent to the Uniform State 
Certification Examination issued or endorsed by the Appraiser 
Qualifications Board of the Appraisal Foundation. In addition, the 
Appraisal Subcommittee must not have issued a finding that the policies, 
practices, or procedures of the State or territory are inconsistent with 
title XI of FIRREA. The Board may, from time to time, impose additional 
qualification criteria for certified appraisers performing appraisals in 
connection with federally related transactions within its jurisdiction.
    (k) State licensed appraiser means any individual who has satisfied 
the requirements for licensing in a State or territory where the 
licensing procedures comply with title XI of FIRREA and where the 
Appraisal Subcommittee has not issued a finding that the policies, 
practices, or procedures of the State or territory are inconsistent with 
title XI. The Board may, from time to time, impose additional 
qualification criteria for licensed appraisers performing appraisals in 
connection with federally related transactions within the Board's 
jurisdiction.
    (l) Tract development means a project of five units or more that is 
constructed or is to be constructed as a single development.
    (m) Transaction value means:
    (1) For loans or other extensions of credit, the amount of the loan 
or extension of credit;
    (2) For sales, leases, purchases, and investments in or exchanges of 
real property, the market value of the real property interest involved; 
and
    (3) For the pooling of loans or interests in real property for 
resale or purchase, the amount of the loan or the

[[Page 103]]

market value of the real property calculated with respect to each such 
loan or interest in real property.

[Reg. Y, 55 FR 27771, July 5, 1990, as amended at 59 FR 29500, June 7, 
1994]



Sec. 225.63  Appraisals required; transactions requiring a State certified or licensed appraiser.

    (a) Appraisals required. An appraisal performed by a State certified 
or licensed appraiser is required for all real estate-related financial 
transactions except those in which:
    (1) The transaction value is $250,000 or less;
    (2) A lien on real estate has been taken as collateral in an 
abundance of caution;
    (3) The transaction is not secured by real estate;
    (4) A lien on real estate has been taken for purposes other than the 
real estate's value;
    (5) The transaction is a business loan that:
    (i) Has a transaction value of $1 million or less; and
    (ii) Is not dependent on the sale of, or rental income derived from, 
real estate as the primary source of repayment;
    (6) A lease of real estate is entered into, unless the lease is the 
economic equivalent of a purchase or sale of the leased real estate;
    (7) The transaction involves an existing extension of credit at the 
lending institution, provided that:
    (i) There has been no obvious and material change in market 
conditions or physical aspects of the property that threatens the 
adequacy of the institution's real estate collateral protection after 
the transaction, even with the advancement of new monies; or
    (ii) There is no advancement of new monies, other than funds 
necessary to cover reasonable closing costs;
    (8) The transaction involves the purchase, sale, investment in, 
exchange of, or extension of credit secured by, a loan or interest in a 
loan, pooled loans, or interests in real property, including mortgaged-
backed securities, and each loan or interest in a loan, pooled loan, or 
real property interest met Board regulatory requirements for appraisals 
at the time of origination;
    (9) The transaction is wholly or partially insured or guaranteed by 
a United States government agency or United States government sponsored 
agency;
    (10) The transaction either:
    (i) Qualifies for sale to a United States government agency or 
United States government sponsored agency; or
    (ii) Involves a residential real estate transaction in which the 
appraisal conforms to the Federal National Mortgage Association or 
Federal Home Loan Mortgage Corporation appraisal standards applicable to 
that category of real estate;
    (11) The regulated institution is acting in a fiduciary capacity and 
is not required to obtain an appraisal under other law;
    (12) The transaction involves underwriting or dealing in mortgage-
backed securities; or
    (13) The Board determines that the services of an appraiser are not 
necessary in order to protect Federal financial and public policy 
interests in real estate-related financial transactions or to protect 
the safety and soundness of the institution.
    (b) Evaluations required. For a transaction that does not require 
the services of a State certified or licensed appraiser under paragraph 
(a)(1), (a)(5) or (a)(7) of this section, the institution shall obtain 
an appropriate evaluation of real property collateral that is consistent 
with safe and sound banking practices.
    (c) Appraisals to address safety and soundness concerns. The Board 
reserves the right to require an appraisal under this subpart whenever 
the agency believes it is necessary to address safety and soundness 
concerns.
    (d) Transactions requiring a State certified appraiser--(1) All 
transactions of $1,000,000 or more. All federally related transactions 
having a transaction value of $1,000,000 or more shall require an 
appraisal prepared by a State certified appraiser.
    (2) Nonresidential transactions of $250,000 or more. All federally 
related transactions having a transaction value of $250,000 or more, 
other than those involving appraisals of 1-to-4

[[Page 104]]

family residential properties, shall require an appraisal prepared by a 
State certified appraiser.
    (3) Complex residential transactions of $250,000 or more. All 
complex 1-to-4 family residential property appraisals rendered in 
connection with federally related transactions shall require a State 
certified appraiser if the transaction value is $250,000 or more. A 
regulated institution may presume that appraisals of 1-to-4 family 
residential properties are not complex, unless the institution has 
readily available information that a given appraisal will be complex. 
The regulated institution shall be responsible for making the final 
determination of whether the appraisal is complex. If during the course 
of the appraisal a licensed appraiser identifies factors that would 
result in the property, form of ownership, or market conditions being 
considered atypical, then either:
    (i) The regulated institution may ask the licensed appraiser to 
complete the appraisal and have a certified appraiser approve and co-
sign the appraisal; or
    (ii) The institution may engage a certified appraiser to complete 
the appraisal.
    (e) Transactions requiring either a State certified or licensed 
appraiser. All appraisals for federally related transactions not 
requiring the services of a State certified appraiser shall be prepared 
by either a State certified appraiser or a State licensed appraiser.

[Reg. Y, 55 FR 27771, July 5, 1990, as amended at 58 FR 15077, Mar. 19, 
1993; 59 FR 29500, June 7, 1994; 63 FR 65532, Nov. 27, 1998]



Sec. 225.64  Minimum appraisal standards.

    For federally related transactions, all appraisals shall, at a 
minimum:
    (a) Conform to generally accepted appraisal standards as evidenced 
by the Uniform Standards of Professional Appraisal Practice promulgated 
by the Appraisal Standards Board of the Appraisal Foundation, 1029 
Vermont Ave., NW., Washington, DC 20005, unless principles of safe and 
sound banking require compliance with stricter standards;
    (b) Be written and contain sufficient information and analysis to 
support the institution's decision to engage in the transaction;
    (c) Analyze and report appropriate deductions and discounts for 
proposed construction or renovation, partially leased buildings, non-
market lease terms, and tract developments with unsold units;
    (d) Be based upon the definition of market value as set forth in 
this subpart; and
    (e) Be performed by State licensed or certified appraisers in 
accordance with requirements set forth in this subpart.

[Reg. Y, 59 FR 29501, June 7, 1994]



Sec. 225.65  Appraiser independence.

    (a) Staff appraisers. If an appraisal is prepared by a staff 
appraiser, that appraiser must be independent of the lending, 
investment, and collection functions and not involved, except as an 
appraiser, in the federally related transaction, and have no direct or 
indirect interest, financial or otherwise, in the property. If the only 
qualified persons available to perform an appraisal are involved in the 
lending, investment, or collection functions of the regulated 
institution, the regulated institution shall take appropriate steps to 
ensure that the appraisers exercise independent judgment and that the 
appraisal is adequate. Such steps include, but are not limited to, 
prohibiting an individual from performing appraisals in connection with 
federally related transactions in which the appraiser is otherwise 
involved and prohibiting directors and officers from participating in 
any vote or approval involving assets on which they performed an 
appraisal.
    (b) Fee appraisers. (1) If an appraisal is prepared by a fee 
appraiser, the appraiser shall be engaged directly by the regulated 
institution or its agent, and have no direct or indirect interest, 
financial or otherwise, in the property or the transaction.
    (2) A regulated institution also may accept an appraisal that was 
prepared by an appraiser engaged directly by another financial services 
institution, if:
    (i) The appraiser has no direct or indirect interest, financial or 
otherwise, in the property or the transaction; and
    (ii) The regulated institution determines that the appraisal 
conforms to

[[Page 105]]

the requirements of this subpart and is otherwise acceptable.

[Reg. Y, 55 FR 27771, July 5, 1990, as amended at 59 FR 29501, June 7, 
1994]



Sec. 225.66  Professional association membership; competency.

    (a) Membership in appraisal organizations. A State certified 
appraiser or a State licensed appraiser may not be excluded from 
consideration for an assignment for a federally related transaction 
solely by virtue of membership or lack of membership in any particular 
appraisal organization.
    (b) Competency. All staff and fee appraisers performing appraisals 
in connection with federally related transactions must be State 
certified or licensed, as appropriate. However, a State certified or 
licensed appraiser may not be considered competent solely by virtue of 
being certified or licensed. Any determination of competency shall be 
based upon the individual's experience and educational background as 
they relate to the particular appraisal assignment for which he or she 
is being considered.



Sec. 225.67  Enforcement.

    Institutions and institution-affiliated parties, including staff 
appraisers and fee appraisers, may be subject to removal and/or 
prohibition orders, cease and desist orders, and the imposition of civil 
money penalties pursuant to the Federal Deposit Insurance Act, 12 U.S.C 
1811 et seq., as amended, or other applicable law.



    Subpart H--Notice of Addition or Change of Directors and Senior 
                           Executive Officers

    Source: Reg. Y, 62 FR 9341, Feb. 28, 1997, unless otherwise noted.



Sec. 225.71  Definitions.

    (a) Director means a person who serves on the board of directors of 
a regulated institution, except that this term does not include an 
advisory director who:
    (1) Is not elected by the shareholders of the regulated institution;
    (2) Is not authorized to vote on any matters before the board of 
directors or any committee thereof;
    (3) Solely provides general policy advice to the board of directors 
and any committee thereof; and
    (4) Has not been identified by the Board or Reserve Bank as a person 
who performs the functions of a director for purposes of this subpart.
    (b) Regulated institution means a state member bank or a bank 
holding company.
    (c) Senior executive officer means a person who holds the title or, 
without regard to title, salary, or compensation, performs the function 
of one or more of the following positions: president, chief executive 
officer, chief operating officer, chief financial officer, chief lending 
officer, or chief investment officer. Senior executive officer also 
includes any other person identified by the Board or Reserve Bank, 
whether or not hired as an employee, with significant influence over, or 
who participates in, major policymaking decisions of the regulated 
institution.
    (d) Troubled condition for a regulated institution means an 
institution that:
    (1) Has a composite rating, as determined in its most recent report 
of examination or inspection, of 4 or 5 under the Uniform Financial 
Institutions Rating System or under the Federal Reserve Bank Holding 
Company Rating System;
    (2) Is subject to a cease-and-desist order or formal written 
agreement that requires action to improve the financial condition of the 
institution, unless otherwise informed in writing by the Board or 
Reserve Bank; or
    (3) Is informed in writing by the Board or Reserve Bank that it is 
in troubled condition for purposes of the requirements of this subpart 
on the basis of the institution's most recent report of condition or 
report of examination or inspection, or other information available to 
the Board or Reserve Bank.



Sec. 225.72  Director and officer appointments; prior notice requirement.

    (a) Prior notice by regulated institution. A regulated institution 
shall give the

[[Page 106]]

Board 30 days' written notice, as specified in Sec. 225.73, before 
adding or replacing any member of its board of directors, employing any 
person as a senior executive officer of the institution, or changing the 
responsibilities of any senior executive officer so that the person 
would assume a different senior executive officer position, if:
    (1) The regulated institution is not in compliance with all minimum 
capital requirements applicable to the institution as determined on the 
basis of the institution's most recent report of condition or report of 
examination or inspection;
    (2) The regulated institution is in troubled condition; or
    (3) The Board determines, in connection with its review of a capital 
restoration plan required under section 38 of the Federal Deposit 
Insurance Act or subpart B of the Board's Regulation H, or otherwise, 
that such notice is appropriate.
    (b) Prior notice by individual. The prior notice required by 
paragraph (a) of this section may be provided by an individual seeking 
election to the board of directors of a regulated institution.



Sec. 225.73  Procedures for filing, processing, and acting on notices; standards for disapproval; waiver of notice.

    (a) Filing notice--(1) Content. The notice required in Sec. 225.72 
shall be filed with the appropriate Reserve Bank and shall contain:
    (i) The information required by paragraph 6(A) of the Change in Bank 
Control Act (12 U.S.C. 1817(j)(6)(A)) as may be prescribed in the 
designated Board form;
    (ii) Additional information consistent with the Federal Financial 
Institutions Examination Council's Joint Statement of Guidelines on 
Conducting Background Checks and Change in Control Investigations, as 
set forth in the designated Board form; and
    (iii) Such other information as may be required by the Board or 
Reserve Bank.
    (2) Modification. The Reserve Bank may modify or accept other 
information in place of the requirements of Sec. 225.73(a)(1) for a 
notice filed under this subpart.
    (3) Acceptance and processing of notice. The 30-day notice period 
specified in Sec. 225.72 shall begin on the date all information 
required to be submitted by the notificant pursuant to Sec. 225.73(a)(1) 
is received by the appropriate Reserve Bank. The Reserve Bank shall 
notify the regulated institution or individual submitting the notice of 
the date on which all required information is received and the notice is 
accepted for processing, and of the date on which the 30-day notice 
period will expire. The Board or Reserve Bank may extend the 30-day 
notice period for an additional period of not more than 60 days by 
notifying the regulated institution or individual filing the notice that 
the period has been extended and stating the reason for not processing 
the notice within the 30-day notice period.
    (b) Commencement of service--(1) At expiration of period. A proposed 
director or senior executive officer may begin service after the end of 
the 30-day period and any extension as provided under paragraph (a)(3) 
of this section, unless the Board or Reserve Bank disapproves the notice 
before the end of the period.
    (2) Prior to expiration of period. A proposed director or senior 
executive officer may begin service before the end of the 30-day period 
and any extension as provided under paragraph (a)(3) of this section, if 
the Board or the Reserve Bank notifies in writing the regulated 
institution or individual submitting the notice of the Board's or 
Reserve Bank's intention not to disapprove the notice.
    (c) Notice of disapproval. The Board or Reserve Bank shall 
disapprove a notice under Sec. 225.72 if the Board or Reserve Bank finds 
that the competence, experience, character, or integrity of the 
individual with respect to whom the notice is submitted indicates that 
it would not be in the best interests of the depositors of the regulated 
institution or in the best interests of the public to permit the 
individual to be employed by, or associated with, the regulated 
institution. The notice of disapproval shall contain a statement of the 
basis for disapproval and shall be

[[Page 107]]

sent to the regulated institution and the disapproved individual.
    (d) Appeal of a notice of disapproval. (1) A disapproved individual 
or a regulated institution that has submitted a notice that is 
disapproved under this section may appeal the disapproval to the Board 
within 15 days of the effective date of the notice of disapproval. An 
appeal shall be in writing and explain the reasons for the appeal and 
include all facts, documents, and arguments that the appealing party 
wishes to be considered in the appeal, and state whether the appealing 
party is requesting an informal hearing.
    (2) Written notice of the final decision of the Board shall be sent 
to the appealing party within 60 days of the receipt of an appeal, 
unless the appealing party's request for an informal hearing is granted.
    (3) The disapproved individual may not serve as a director or senior 
executive officer of the state member bank or bank holding company while 
the appeal is pending.
    (e) Informal hearing. (1) An individual or regulated institution 
whose notice under this section has been disapproved may request an 
informal hearing on the notice. A request for an informal hearing shall 
be in writing and shall be submitted within 15 days of a notice of 
disapproval. The Board may, in its sole discretion, order an informal 
hearing if the Board finds that oral argument is appropriate or 
necessary to resolve disputes regarding material issues of fact.
    (2) An informal hearing shall be held within 30 days of a request, 
if granted, unless the requesting party agrees to a later date.
    (3) Written notice of the final decision of the Board shall be given 
to the individual and the regulated institution within 60 days of the 
conclusion of any informal hearing ordered by the Board, unless the 
requesting party agrees to a later date.
    (f) Waiver of notice--(1) Waiver requests. The Board or Reserve Bank 
may permit an individual to serve as a senior executive officer or 
director before the notice required under this subpart is provided, if 
the Board or Reserve Bank finds that:
    (i) Delay would threaten the safety or soundness of the regulated 
institution or a bank controlled by a bank holding company;
    (ii) Delay would not be in the public interest; or
    (iii) Other extraordinary circumstances exist that justify waiver of 
prior notice.
    (2) Automatic waiver. An individual may serve as a director upon 
election to the board of directors of a regulated institution before the 
notice required under this subpart is provided if the individual:
    (i) Is not proposed by the management of the regulated institution;
    (ii) Is elected as a new member of the board of directors at a 
meeting of the regulated institution; and
    (iii) Provides to the appropriate Reserve Bank all the information 
required in Sec. 225.73(a) within two (2) business days after the 
individual's election.
    (3) Effect on disapproval authority. A waiver shall not affect the 
authority of the Board or Reserve Bank to disapprove a notice within 30 
days after a waiver is granted under paragraph (f)(1) of this section or 
the election of an individual who has filed a notice and is serving 
pursuant to an automatic waiver under paragraph (f)(2) of this section.

                             Interpretations



Sec. 225.101  Bank holding company's subsidiary banks owning shares of nonbanking companies.

    (a) The Board's opinion has been requested on the following related 
matters under the Bank Holding Company Act of 1956.
    (b) The question is raised as to whether shares in a nonbanking 
company which were acquired by a banking subsidiary of the bank holding 
company many years ago when their acquisition was lawful and are now 
held as investments, and which do not include more than 5 percent of the 
outstanding voting securities of such nonbanking company and do not have 
a value greater than 5 percent of the value of the bank holding 
company's total assets, are exempted from the divestment requirements of 
the Act by the provisions of section 4(c)(5) of the Act.
    (c) In the Board's opinion, this exemption is as applicable to such 
shares

[[Page 108]]

when held by a banking subsidiary of a bank holding company as when held 
directly by the bank holding company itself. While the exemption 
specifically refers only to shares held or acquired by the bank holding 
company, the prohibition of the Act against retention of nonbanking 
interests applies to indirect as well as direct ownership of shares of a 
nonbanking company, and, in the absence of a clear mandate to the 
contrary, any exception to this prohibition should be given equal 
breadth with the prohibition. Any other interpretation would lead to 
unwarranted results.
    (d) Although certain of the other exemptions in section 4(c) of the 
Act specifically refer to shares held or acquired by banking 
subsidiaries, an analysis of those exemptions suggests that such 
specific reference to banking subsidiaries was for the purpose of 
excluding nonbanking subsidiaries from such exemptions, rather than for 
the purpose of providing an inclusionary emphasis on banking 
subsidiaries.
    (e) It should be noted that the Board's view as to this question 
should not be interpreted as meaning that each banking subsidiary could 
own up to 5 percent of the stock of the same nonbanking organization. In 
the Board's opinion the limitations set forth in section 4(c)(5) apply 
to the aggregate amount of stock held in a particular organization by 
the bank holding company itself and by all of its subsidiaries.
    (f) Secondly, question is raised as to whether shares in a 
nonbanking company acquired in satisfaction of debts previously 
contracted (d.p.c.) by a banking subsidiary of the bank holding company 
may be retained if such shares meet the conditions contained in section 
4(c)(5) as to value and amount, notwithstanding the requirement of 
section 4(c)(2) that shares acquired d.p.c. be disposed of within two 
years after the date of their acquisition or the date of the Act, 
whichever is later. In the Board's opinion, the 5 percent exemption 
provided by section 4(c)(5) covers any shares, including shares acquired 
d.p.c., that meet the conditions set forth in that exemption, and, 
consequently, d.p.c. shares held by a banking subsidiary of a bank 
holding company which meet such conditions are not subject to the two-
year disposition requirement prescribed by section 4(c)(2), although any 
such shares would, of course, continue to be subject to such requirement 
for disposition as may be prescribed by provisions of any applicable 
banking laws or by the appropriate bank supervisory authorities.
    (g) Finally, question is raised as to whether shares held by banking 
subsidiaries of the bank holding company in companies holding bank 
premises of such subsidiaries are exempted from the divestment 
requirements by section 4(c)(1) of the Act. It is the Board's view that 
section 4(c)(1), exempting shares owned or acquired by a bank holding 
company in any company engaged solely in holding or operating properties 
used wholly or substantially by any subsidiary bank, is to be read and 
interpreted, like section 4(c)(5), as applying to shares owned 
indirectly by a bank holding company through a banking subsidiary as 
well as to shares held directly by the bank holding company. A contrary 
interpretation would impair the right that member banks controlled by 
bank holding companies would otherwise have to invest, subject to the 
limitations of section 24A of the Federal Reserve Act, in stock of 
companies holding their bank premises; and such a result was not, in the 
Board's opinion, intended by the Bank Holding Company Act.

[21 FR 10472, Dec. 29, 1956. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.102  Bank holding company indirectly owning nonbanking company through subsidiaries.

    (a) The Board of Governors has been requested for an opinion 
regarding the exemptions contained in section 4(c)(5) of the Bank 
Holding Company Act of 1956. It is stated that Y Company is an 
investment company which is not a bank holding company and which is not 
engaged in any business other than investing in securities, which 
securities do not include more than 5 per centum of the outstanding 
voting securities of any company and do not include any asset having a 
value greater than 5 per centum of the value of the total assets of X 
Corporation, a bank holding

[[Page 109]]

company. It is stated that direct ownership by X Corporation of voting 
shares of Y Company would be exempt by reason of section 4(c)(5) from 
the prohibition of section 4 of the Act against ownership by bank 
holding companies of nonbanking assets.
    (b) It was asked whether it makes any difference that the shares of 
Y Company are not owned directly by X Corporation but instead are owned 
through Subsidiaries A and B. X Corporation owns all the voting shares 
of Subsidiary A, which owns one-half of the voting shares of Subsidiary 
B. Subsidiaries A and B each own one-third of the voting shares of Y 
Company.
    (c) Section 4(c)(5) is divided into two parts. The first part 
exempts the ownership of securities of nonbanking companies when the 
securities do not include more than 5 percent of the voting securities 
of the nonbanking company and do not have a value greater than 5 percent 
of the value of the total assets of the bank holding company. The second 
part exempts the ownership of securities of an investment company which 
is not a bank holding company and is not engaged in any business other 
than investing in securities, provided the securities held by the 
investment company meet the 5 percent tests mentioned above.
    (d) In Sec. 225.101, the Board expressed the opinion that the first 
exemption in section 4(c)(5):

    * * * is as applicable to such shares when held by a banking 
subsidiary of a bank holding company as when held directly by the bank 
holding company itself. While the exemption specifically refers only to 
shares held or acquired by the bank holding company, the prohibition of 
the Act against retention of nonbanking interests applies to indirect as 
well as direct ownership of shares of a nonbanking company, and, in the 
absence of a clear mandate to the contrary, any exception to this 
prohibition should be given equal breadth with the prohibition. Any 
other interpretation would lead to unwarranted results.

    (e) The Board is of the view that the principles stated in that 
opinion are also applicable to the second exemption in section 4(c)(5), 
and that they apply whether or not the subsidiary owning the shares is a 
banking subsidiary. Accordingly, on the basis of the facts presented, 
the Board is of the opinion that the second exemption in section 4(c)(5) 
applies to the indirect ownership by X Corporation of shares of Y 
Company through Subsidiaries A and B.

[22 FR 2533, Apr. 13, 1957. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.103  Bank holding company acquiring stock by dividends, stock splits or exercise of rights.

    (a) The Board of Governors has been asked whether a bank holding 
company may receive bank stock dividends or participate in bank stock 
splits without the Board's prior approval, and whether such a company 
may exercise, without the Board's prior approval, rights to subscribe to 
new stock issued by banks in which the holding company already owns 
stock.
    (b) Neither a stock dividend nor a stock split results in any change 
in a stockholder's proportional interest in the issuing company or any 
increase in the assets of that company. Such a transaction would have no 
effect upon the extent of a holding company's control of the bank 
involved; and none of the five factors required by the Bank Holding 
Company Act to be considered by the Board in approving a stock 
acquisition would seem to have any application. In view of the 
objectives and purposes of the act, the word ``acquire'' would not seem 
reasonably to include transactions of this kind.
    (c) On the other hand, the exercise by a bank holding company of the 
right to subscribe to an issue of additional stock of a bank could 
result in an increase in the holding company's proportional interest in 
the bank. The holding company would voluntarily pay additional funds for 
the extra shares and would ``acquire'' the additional stock even under a 
narrow meaning of that term. Moreover, the exercise of such rights would 
cause the assets of the issuing company to be increased and in a sense, 
therefore, the ``size or extent'' of the bank holding company system 
would be expanded.
    (d) In the circumstances, it is the Board's opinion that receipt of 
bank stock by means of a stock dividend or stock split, assuming no 
change in the class of stock, does not require the Board's prior 
approval under the act,

[[Page 110]]

but that purchase of bank stock by a bank holding company through the 
exercise of rights does require the Board's prior approval, unless one 
of the exceptions set forth in section 3(a) is applicable.

[22 FR 7461, Sept. 19, 1957. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.104  ``Services'' under section 4(c)(1) of Bank Holding Company Act.

    (a) Section 4(c)(1) of the Bank Holding Company Act, among other 
things, exempts from the nonbanking divestment requirements of section 
4(a) of the Act shares of a company engaged ``solely in the business of 
furnishing services to or performing services for'' its bank holding 
company or subsidiary banks thereof.
    (b) The Board of Governors has had occasion to express opinions as 
to whether this section of law applies to the following two sets of 
facts:
    (1) In the first case, Corporation X, a nonbanking subsidiary of a 
bank holding company (Holding Company A), was engaged in the business of 
purchasing installment paper suitable for investment by banking 
subsidiaries of Holding Company A. All installment paper purchased by 
Corporation X was sold by it to a bank which is a subsidiary of Holding 
Company A, without recourse, at a price equal to the cost of the 
installment paper to Corporation X, and with compensation to the latter 
based on the earnings from such paper remaining after certain reserves, 
expenses and charges. The subsidiary bank sold participations in such 
installment paper to the other affiliated banks of Holding Company A 
which desired to participate. Purchases by Corporation X consisted 
mainly of paper insured under Title I of the National Housing Act and, 
in addition, Corporation X purchased time payment contracts covering 
sales of appliances by dealers under contractual arrangements with 
utilities, as well as paper covering home improvements which was not 
insured. Pursuant to certain service agreements, Corporation X made all 
collections, enforced guaranties, filed claims under Title I insurance 
and performed other services for the affiliated banks. Also Corporation 
X rendered to banking subsidiaries of Holding Company A various 
accounting, statistical and advisory services such as payroll, life 
insurance and budget loan installment account.
    (2) In the second case, Corporation Y, a nonbanking subsidiary of a 
bank holding company (Holding Company B, which was also a bank), 
solicited business on behalf of Holding Company B from dealers, 
throughout several adjoining or contiguous States, who made time sales 
and desired to convert their time sales paper into cash; but Corporation 
Y made no loans or purchases of sales contracts and did not discount or 
advance money for time sales obligations. Corporation Y investigated 
credit standings of purchasers obligated on time sale contracts to be 
acquired by Holding Company B, Corporation Y received from dealers the 
papers offered by them and inspected such papers to see that they were 
in order, and transmitted to Holding Company B for its determination to 
purchase, including, in some cases, issuance of drafts in favor of 
dealers in order to facilitate their prompt receipt of payment for 
installment paper purchased by Holding Company B. Corporation Y made 
collections of delinquent paper or delinquent installments, which 
sometimes involved repossession and resale of the automobile or other 
property which secured the paper. Also, upon request of purchasers 
obligated on paper held by Holding Company B, Corporation Y transmitted 
installment payments to Holding Company B. Holding Company B reimbursed 
Corporation Y for its actual costs and expenses in performing the 
services mentioned above, including the salaries and wages of all 
Corporation Y officers and employees.
    (c) While the term ``services'' is sometimes used in a broad and 
general sense, the legislative history of the Bank Holding Company Act 
indicates that in section 4(c)(1) the word was meant to be somewhat more 
limited in its application. An early version of the bill specifically 
exempted companies engaged in serving the bank holding company and its 
subsidiary banks in ``auditing, appraising, investment counseling''. The 
statute as finally enacted does not expressly mention any

[[Page 111]]

specific type of servicing activity for exemption. In recommending the 
change, the Senate Banking and Currency Committee stated that the types 
of services contemplated are ``in the fields of advertising, public 
relations, developing new business, organizations, operations, preparing 
tax returns, personnel, and many others'', which indicates that latitude 
should be given to the range of activities contemplated by this section 
beyond those specifically set forth in the early draft of the bill. 
(84th Cong., 2d Sess., Senate Report 1095, Part 2, p. 3.) It 
nevertheless seems evident that Congress intended such services to be 
types of activities generally comparable to those mentioned above from 
the early bill (``auditing, appraising, investment counseling'') and in 
the excerpt from the Committee Report on the later bill (``advertising, 
public relations, developing new business, organization, operations, 
preparing tax returns, personnel, and many others''). This legislative 
history and the context in which the term ``services'' is used in 
section 4(c)(1) seem to suggest that the term was in general intended to 
refer to servicing operations which a bank could carry on itself, but 
which the bank or its holding company chooses to have done through 
another organization. Moreover, the report of the Senate Banking and 
Currency Committee indicated that the types of servicing permitted under 
section 4(c)(1) are to be distinguished from activities of a 
``financial, fiduciary, or insurance nature'', such as those which might 
be considered for possible exemption under section 4(c)(6) of the Act.
    (d) With respect to the first set of facts, the Board expressed the 
opinion that certain of the activities of Corporation X, such as the 
accounting, statistical and advisory services referred to above, may be 
within the range of servicing activities contemplated by section 
4(c)(1), but that this would not appear to be the case with the main 
activity of Corporation X, which was the purchase of installment paper 
and the resale of such paper at cost, without recourse, to banking 
subsidiaries of Holding Company A. This latter and basic activity of 
Corporation X appeared to involve essentially a financial relationship 
between it and the banking subsidiaries of Holding Company A and 
appeared beyond the category of servicing exemptions contemplated by 
section 4(c)(1) of the Act. Accordingly, it was the Board's view that 
Corporation X could not be regarded as qualifying under section 4 (c)(1) 
as a company engaged ``solely in the business of furnishing services to 
or performing services for'' Holding Company A or subsidiary banks 
thereof.
    (e) With respect to the second set of facts, the Board expressed the 
opinion that some of the activities engaged in by Corporation Y were 
clearly within the range of servicing activities contemplated by section 
4(c)(1). There was some question as to whether or not some of the other 
activities of Corporation Y mentioned above could meet the test, but on 
balance, it seemed that all such activities probably were activities in 
which Holding Company B, which as already indicated was a bank, could 
itself engage, at the present locations of Corporation Y, without being 
engaged in the operation of bank branches at those locations. In the 
circumstances, while the question was not free from doubt, the Board 
expressed the opinion that the activities of Corporation Y were those of 
a company engaged ``solely in the business of furnishing services to or 
performing services for'' Holding Company B within the meaning of 
section 4(c)(1) of the Act, and that, accordingly, the control by 
Holding Company B of shares in Corporation Y was exempted under that 
section.

[23 FR 2675, May 23, 1958. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.107  Acquisition of stock in small business investment company.

    (a) A registered bank holding company requested an opinion by the 
Board of Governors with respect to whether that company and its banking 
subsidiaries may acquire stock in a small business investment company 
organized pursuant to the Small Business Investment Act of 1958.
    (b) It is understood that the bank holding company and its 
subsidiary

[[Page 112]]

banks propose to organize and subscribe for stock in a small business 
investment company which would be chartered pursuant to the Small 
Business Investment Act of 1958 which provides for long-term credit and 
equity financing for small business concerns.
    (c) Section 302(b) of the Small Business Investment Act authorizes 
national banks, as well as other member banks and nonmember insured 
banks to the extent permitted by applicable State law, to invest capital 
in small business investment companies not exceeding one percent of the 
capital and surplus of such banks. Section 4(c)(4) of the Bank Holding 
Company Act exempts from the prohibitions of section 4 of the Act 
``shares which are of the kinds and amounts eligible for investment by 
National banking associations under the provisions of section 5136 of 
the Revised Statutes''. Section 5136 of the Revised Statutes (paragraph 
``Seventh'') in turn provides, in part, as follows:

Except as hereinafter provided or otherwise permitted by law nothing 
herein contained shall authorize the purchase by the association for its 
own account of any shares of stock of any corporation.


Since the shares of a small business investment company are of a kind 
and amount expressly made eligible for investment by a national bank 
under the Small Business Investment Act of 1958, it follows, therefore, 
that the ownership or control of such shares by a bank holding company 
would be exempt from the prohibitions of section 4 of the Bank Holding 
Company Act by virtue of the provisions of section 4(c)(4) of that Act. 
Accordingly, the ownership or control of such shares by the bank holding 
company would be exempt from the prohibitions of section 4 of the Bank 
Holding Company Act.

    (d) An additional question is presented, however, as to whether 
section 6 of the Bank Holding Company Act prohibits banking subsidiaries 
of the bank holding company from purchasing stock in a small business 
investment company where the latter is a ``subsidiary'' under that Act.
    (e) Section 6(a)(1) of the Act makes it unlawful for a bank to 
invest any of its funds in the capital stock of any other subsidiary of 
the bank holding company. However, section 6(a)(1) was, in effect, 
amended by section 302(b) of the Small Business Investment Act (15 
U.S.C. 682) as amended by the Act of June 11, 1960 (Pub. L. 86-502) so 
as to nullify this prohibition when the ``subsidiary'' is a small 
business investment company.
    (f) Accordingly, section 6 of the Bank Holding Company Act does not 
prohibit banking subsidiaries of the bank holding company from 
purchasing stock in a small business investment company organized 
pursuant to the Small Business Investment Act of 1958, where that 
company is or will be a subsidiary of the bank holding company.

[25 FR 7485, Aug. 9, 1960. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.109  ``Services'' under section 4(c)(1) of Bank Holding Company Act.

    (a) The Board of Governors has been requested by a bank holding 
company for an interpretation under section 4(c)(1) of the Bank Holding 
Company Act which, among other things, exempts from the nonbanking 
divestment requirements of section 4(a) of the Act, shares of a company 
engaged ``solely in the business of furnishing services to or performing 
services for'' its bank holding company or subsidiary banks thereof.
    (b) It is understood that a nonbanking subsidiary of the holding 
company engages in writing comprehensive automobile insurance (fire, 
theft, and collision) which is sold only to customers of a subsidiary 
bank of the holding company in connection with the bank's retail 
installment loans; that when payment is made on a loan secured by a lien 
on a motor vehicle, renewal policies are not issued by the insurance 
company; and that the insurance company receives the usual agency 
commissions on all comprehensive automobile insurance written for 
customers of the bank.
    (c) It is also understood that the insurance company writes credit 
life insurance for the benefit of the bank and its installment-loan 
customers; that each insured debtor is covered for an amount equal to 
the unpaid balance of his note to the bank, not to exceed

[[Page 113]]

$5,000; that as the note is reduced by regular monthly payments, the 
amount of insurance is correspondingly reduced so that at all times the 
debtor is insured for the unpaid balance of his note; that each 
insurance contract provides for payment in full of the entire loan 
balance upon the death or permanent disability of the insured borrower; 
and that this credit life insurance is written only at the request of, 
and solely for, the bank's borrowing customers. It is further understood 
that the insurance company engages in no other activity.
    (d) As indicated in Sec. 225.104 (23 FR 2675), the term 
``services,'' while sometimes used in a broad and general sense, appears 
to be somewhat more limited in its application in section 4(c)(1) of the 
Bank Holding Company Act. Unlike an early version of the Senate bill (S. 
2577, before amendment), the act as finally enacted does not expressly 
mention any type of servicing activity for exemption. The legislative 
history of the Act, however, as indicated in the relevant portion of the 
record of the Senate Banking and Currency Committee on amended S. 2577 
(84th Cong., 2d Sess., Senate Report 1095, Part 2, p. 3) makes it 
evident that Congress had in mind the exemption of services comparable 
to the types of activities mentioned expressly in the early Senate bill 
(``auditing, appraising, investment counseling'') and in the Committee 
Report on the later bill (``advertising, public relations, developing 
new business, organization, operations, preparing tax returns, 
personnel, and many others''). Furthermore, this Committee Report 
expressly stated that the provision of section 4(c)(1) with respect to 
``furnishing services to or performing services for'' was not intended 
to supplant the exemption contained under section 4 (c)(6) of the Act.
    (e) The only activity of the insurance company (writing 
comprehensive automobile insurance and credit life insurance) appears to 
involve an insurance relationship between it and a banking subsidiary of 
the holding company which the legislative history clearly indicates does 
not come within the meaning of the phrase ``furnishing services to or 
performing services for'' a bank holding company or its banking 
subsidiaries.
    (f) Accordingly, it is the Board's view that the insurance company 
could not be regarded as qualifying as a company engaged ``solely in the 
business of furnishing services to or performing services for'' the bank 
holding company or banks with respect to which the latter is a bank 
holding company.

[23 FR 9017, Nov. 20, 1958. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.111  Limit on investment by bank holding company system in stock of small business investment companies.

    (a) Under the provisions of section 4(c)(5) of the Bank Holding 
Company Act, as amended (12 U.S.C. 1843), a bank holding company may 
acquire shares of nonbank companies ``which are of the kinds and amounts 
eligible for investment'' by national banks. Pursuant to section 302(b) 
of the Small Business Investment Act of 1958 (15 U.S.C. 682(b)), as 
amended by Title II of the Small Business Act Amendments of 1967 (Pub. 
L. 90-104, 81 Stat. 268, 270), a national bank may invest in stock of 
small business investment companies (SBICs) subject to certain 
restrictions.
    (b) On the basis of the foregoing statutory provisions, it is the 
position of the Board that a bank holding company may acquire direct or 
indirect ownership or control of stock of an SBIC subject to the 
following limits:
    (1) The total direct and indirect investments of a bank holding 
company in stock of SBICs may not exceed:
    (i) With respect to all stock of SBICs owned or controlled directly 
or indirectly by a subsidiary bank, 5 percent of that bank's capital and 
surplus;
    (ii) With respect to all stock of SBICs owned directly by a bank 
holding company that is a bank, 5 percent of that bank's capital and 
surplus; and
    (iii) With respect to all stock of SBICs otherwise owned or 
controlled directly or indirectly by a bank holding company, 5 percent 
of its proportionate interest in the capital and surplus of each 
subsidiary bank (that is, the holding company's percentage of that 
bank's stock times that bank's capital and surplus) less that bank's 
investment in stock of SBICs; and

[[Page 114]]

    (2) A bank holding company may not acquire direct or indirect 
ownership or control of 50 percent or more of the shares of any class of 
equity securities of an SBIC that have actual or potential voting 
rights.
    (c) A bank holding company or a bank subsidiary that acquired direct 
or indirect ownership or control of 50 percent or more of any such class 
of equity securities prior to January 9, 1968, is not required to divest 
to a level below 50 percent. A bank that acquired 50 percent or more 
prior to January 9, 1968, may become a subsidiary in a holding company 
system without any necessity for divesting to a level below 50 percent: 
Provided, That such action does not result in the bank holding company 
acquiring control of a percentage greater than that controlled by such 
bank.


(12 U.S.C. 248. Interprets 12 U.S.C. 1843, 15 U.S.C. 682)

[33 FR 6967, May 9, 1968. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.112  Indirect control of small business concern through convertible debentures held by small business investment company.

    (a) A question has been raised concerning the applicability of 
provisions of the Bank Holding Company Act of 1956 to the acquisition by 
a bank holding company of stock of a small business investment company 
(``SBIC'') organized pursuant to the Small Business Investment Act of 
1958 (``SBI Act'').
    (b) As indicated in the interpretation of the Board (Sec. 225.107) 
published at 23 FR 7813, it is the Board's opinion that, since stock of 
an SBIC is eligible for purchase by national banks and since section 
4(c)(4) of the Holding Company Act exempts stock eligible for investment 
by national banks from the prohibitions of section 4 of that Act, a bank 
holding company may lawfully acquire stock in such an SBIC.
    (c) However, section 304 of the SBI Act provides that debentures of 
a small business concern purchased by a small business investment 
company may be converted at the option of such company into stock of the 
small business concern. The question therefore arises as to whether, in 
the event of such conversion, the parent bank holding company would be 
regarded as having acquired ``direct or indirect ownership or control'' 
of stock of the small business concern in violation of section 4(a) of 
the Holding Company Act.
    (d) The Small Business Investment Act clearly contemplates that one 
of the primary purposes of that Act was to enable SBICs to provide 
needed equity capital to small business concerns through the purchase of 
debentures convertible into stock. Thus, to the extent that a 
stockholder in an SBIC might acquire indirect control of stock of a 
small business concern, such control appears to be a natural and 
contemplated incident of ownership of stock of the SBIC. The Office of 
the Comptroller of the Currency has informally indicated concurrence 
with this interpretation insofar as it affects investments by national 
banks in stock of an SBIC.
    (e) Since the exception as to stock eligible for investment by 
national banks contained in section 4(c)(4) of the Holding Company Act 
was apparently intended to permit a bank holding company to acquire any 
stock that would be eligible for purchase by a national bank, it is the 
Board's view that section 4(a)(1) of the Act does not prohibit a bank 
holding company from acquiring stock of an SBIC, even though ownership 
of such stock may result in the acquisition of indirect ownership or 
control of stock of a small business concern which would not itself be 
eligible for purchase directly by a national bank or a bank holding 
company.

[24 FR 1584, Mar. 4, 1959. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.113  Services under section 4(a) of Bank Holding Company Act.

    (a) The Board of Governors has been requested for an opinion as to 
whether the performance of certain functions by a bank holding company 
for four banks of which it owns less than 25 percent of the voting 
shares is in violation of section 4(a) of the Bank Holding Company Act.
    (b) It is claimed that the holding company is engaged in 
``managing'' four nonsubsidiary banks, for which services it receives 
``management

[[Page 115]]

fees.'' Specifically, the company engages in the following activities 
for the four nonsubsidiary banks: (1) Establishment and supervision of 
loaning policies; (2) direction of the purchase and sale of investment 
securities; (3) selection and training of officer personnel; (4) 
establishment and enforcement of operating policies; and (5) general 
supervision over all policies and practices.
    (c) The question raised is whether these activities are prohibited 
by section 4(a)(2) of the Bank Holding Company Act, which permits a bank 
holding company to engage in only three categories of business: (1) 
Banking; (2) managing or controlling banks; and (3) furnishing services 
to or performing services for any bank of which the holding company owns 
or controls 25 percent or more of the voting shares.
    (d) Clearly, the activities of the company with respect to the four 
nonsubsidiary banks do not constitute ``banking.'' With respect to the 
business of ``managing or controlling'' banks, it is the Board's view 
that such business, within the purview of section 4(a)(2), is 
essentially the exercise of a broad governing influence of the sort 
usually exercised by bank stockholders, as distinguished from direct or 
active participation in the establishment or carrying out of particular 
policies or operations. The latter kinds of activities fall within the 
third category of businesses in which a bank holding company is 
permitted to engage. In the Board's view, the activities enumerated 
above fall in substantial part within that third category.
    (e) Section 4(a)(2), like all other sections of the Holding Company 
Act, must be interpreted in the light of all of its provisions, as well 
as in the light of other sections of the Act. The expression ``managing 
* * * banks,'' if it could be taken by itself, might appear to include 
activities of the sort enumerated. However, such an interpretation of 
those words would virtually nullify the last portion of section 4(a)(2), 
which permits a holding company to furnish services to or perform 
services for ``any bank of which it owns or controls 25 per centum or 
more of the voting shares.''
    (f) Since Congress explicitly authorized the performance of services 
for banks that are at least 25 percent owned by a holding company, it 
obviously intended that the holding company should not perform services 
for banks in which it owns less than 25 percent of the voting shares. 
However, if the second category--``managing or controlling banks''--were 
interpreted to permit the holding company to perform services for any 
bank, including a bank in which it held less than 25 percent of the 
stock (or no stock whatsoever), the last clause of section 4(a)(2) would 
be meaningless.
    (g) It is principally for this reason--that is, to give effective 
meaning to the final clause of section 4(a)(2)--that the Board 
interprets ``managing or controlling banks'' in that provision as 
referring to the exercise of a stockholder's management or control of 
banks, rather than direct and active participation in their operations. 
To repeat, such active participation in operations falls within the 
third category (``furnishing services to or performing services for any 
bank'') and consequently may be engaged in only with respect to banks in 
which the holding company ``owns or controls 25 per centum or more of 
the voting shares.''
    (h) Accordingly, it is the Board's conclusion that, in performing 
the services enumerated, the bank holding company is ``furnishing 
services to or performing services for'' the four banks referred to. 
Under the Act such furnishing or performing of services is permissible 
only if the holding company owns or controls 25 percent of the voting 
shares of each bank receiving such services, and, since the company owns 
less than 25 percent of the voting shares of these banks, it follows 
that these activities are prohibited by section 4(a)(2).
    (i) While this conclusion is required, in the Board's opinion, by 
the language of the statute, it may be noted further that any other 
conclusion would make it possible for bank holding company or any other 
corporation, through arrangements for the ``managing'' of banks in the 
manner here involved, to acquire effective control of banks without 
acquiring bank stocks and thus to

[[Page 116]]

evade the underlying objectives of section 3 of the Act.

[25 FR 281, Jan. 14, 1960. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.115  Applicability of Bank Service Corporation Act in certain bank holding company situations.

    (a) Questions have been presented to the Board of Governors 
regarding the applicability of the recently enacted Bank Service 
Corporation Act (Pub. L. 87-856, approved October 23, 1962) in cases 
involving service corporations that are subsidiaries of bank holding 
companies under the Bank Holding Company Act of 1956. In addition to 
being charged with the administration of the latter Act, the Board is 
named in the Bank Service Corporation Act as the Federal supervisory 
agency with respect to the performance of bank services for State member 
banks.
    (b) Holding company-owned corporation serving only subsidiary banks. 
(1) One question is whether the Bank Service Corporation Act is 
applicable in the case of a corporation, wholly owned by a bank holding 
company, which is engaged in performing ``bank services'', as defined in 
section 1(b) of the Act, exclusively for subsidiary banks of the holding 
company.
    (2) Except as noted below with respect to section 5 thereof, the 
Bank Service Corporation Act is not applicable in this case. This is 
true because none of the stock of the corporation performing the 
services is owned by any bank and the corporation, therefore, is not a 
``bank service corporation'' as defined in section 1(c) of the Act. A 
corporation cannot meet that definition unless part of its stock is 
owned by two or more banks. The situation clearly is unaffected by 
section 2(b) of the Act which permits a corporation that fell within the 
definition initially to continue to function as a bank service 
corporation although subsequently only one of the banks remains as a 
stockholder in the corporation.
    (3) However, although it is not a bank service corporation, the 
corporation in question and each of the banks for which it performs bank 
services are subject to section 5 of the Bank Service Corporation Act. 
That section, which requires the furnishing of certain assurances to the 
appropriate Federal supervisory agency in connection with the 
performance of bank services for a bank, is applicable whether such 
services are performed by a bank service corporation or by others.
    (4) Section 4(a)(1) of the Bank Holding Company Act prohibits the 
acquisition by a bank holding company of ``direct or indirect ownership 
or control'' of shares of a nonbanking company, subject to certain 
exceptions. Section 4(c)(1) of the Act exempts from section 4(a)(1) 
shares of a company engaged ``solely in the business of furnishing 
services to or performing services for'' its bank holding company or 
subsidiary banks thereof. Assuming that the bank services performed by 
the corporation in question are ``services'' of the kinds contemplated 
by section 4(c)(1) of the Bank Holding Company Act (as would be true, 
for example, of the electronic data processing of deposit accounts), the 
holding company's ownership of the corporation's shares in the situation 
described above clearly is permissible under that section of the Act.
    (c) Bank service corporation owned by holding company subsidiaries 
and serving also other banks. (1) The other question concerns the 
applicability of the Bank Service Corporation Act and the Bank Holding 
Company Act in the case of a corporation, all the stock of which is 
owned either by a bank holding company and its subsidiary banks together 
or by the subsidiary banks alone, which is engaged in performing ``bank 
services'', as defined in section 1(b) of the Bank Service Corporation 
Act, for the subsidiary banks and for other banks, as well.
    (2) In contrast to the situation under paragraph (b) of this 
section, the corporation in this case is a ``bank service corporation'' 
within the meaning of section 1(c) of the Bank Service Corporation Act 
because of the ownership by each of the subsidiary banks of a part of 
the corporation's stock. This stock ownership is one of the important 
facts differentiating this case from the first one. Being a bank service 
corporation, the corporation in question is subject to section 3 of the 
Act concerning applications to bank service corporations by competitive 
banks

[[Page 117]]

for bank services, and to section 4 forbidding a bank service 
corporation from engaging in any activity other than the performance of 
bank services for banks. Section 5, mentioned previously and relating to 
``assurances'', also is applicable in this case.
    (3) The other important difference between this case and the 
situation in paragraph (b) of this section is that here the bank service 
corporation performs services for nonsubsidiary banks, as well as for 
subsidiary banks. This is permissible because section 2(a) of the Bank 
Service Corporation Act, which authorizes any two or more banks to 
invest limited amounts in a bank service corporation, removes all 
limitations and prohibitions of Federal law exclusively relating to 
banks that otherwise would prevent any such investment. From the 
legislative history of section 2(a), it is clear that section 6 of the 
Bank Holding Company Act is among the limitations and prohibitions so 
removed. But for such removal, section 6(a)(1) of that Act would make it 
unlawful for any of the subsidiary banks of the bank holding company in 
question to own stock in the bank service corporation subsidiary of the 
holding company, as the exemption in section 6(b)(1) would not apply 
because of the servicing by the bank service corporation of 
nonsubsidiary banks.
    (4) Because the bank service corporation referred to in the question 
is serving banks other than the subsidiary banks, the bank holding 
company is not exempt under section 4(c)(1) of the Bank Holding Company 
Act from the prohibition of acquisition of nonbanking interests in 
section 4(a)(1) of that Act. The bank holding company, however, is 
entitled to the benefit of the exemption in section 4(c)(4) of the Act. 
That section exempts from section 4(a) ``shares which are of the kinds 
and amounts eligible for investment by National banking associations 
under the provisions of section 5136 of the Revised Statutes''. Section 
5136 provides, in part, that: ``Except as hereinafter provided or 
otherwise permitted by law, nothing herein contained shall authorize the 
purchase by the association for its own account of any shares of stock 
of any corporation.'' As the provisions of section 2(a) of the Bank 
Service Corporation Act and its legislative history make it clear that 
shares of a bank service corporation are of a kind eligible for 
investment by national banks under section 5136, it follows that the 
direct or indirect ownership on control of such shares by a bank holding 
company are permissible within the amount limitation discussed in 
paragraph (d) of this section.
    (d) Limit on investment by bank holding company system in stock of 
bank service corporation. (1) In the situation presented by paragraph 
(c) the bank holding company clearly owns or controls, directly or 
indirectly, all of the stock of the bank service corporation. The 
remaining question, therefore, is whether the total direct and indirect 
investment of the bank holding company in the bank service corporation 
exceeds the amount permissible under the Bank Holding Company Act.
    (2) The effect of sections 4(a)(1) and 4(c)(4) of the Bank Holding 
Company Act is to limit the amount of shares of a bank service 
corporation that a bank holding company may own or control, directly or 
indirectly, to the amount eligible for investment by a national bank, as 
previously indicated. Under section 2(a) of the Bank Service Corporation 
Act, the amount of shares of a bank service corporation eligible for 
investment by a national bank may not exceed ``10 per centum [of the 
bank's] * * * paid-in and unimpaired capital and unimpaired surplus''.
    (3) The Board's view is that this aspect of the matter should be 
determined in accordance with the principles set forth in Sec. 225.111, 
as revised (27 FR 12671), involving the application of sections 4(a)(1) 
and 4(c)(4) of the Bank Holding Company Act in the light of section 
302(b) of the Small Business Investment Act limiting the amount eligible 
for investment by a national bank in the shares of a small business 
investment company to two percent of the bank's ``capital and surplus''.
    (4) Except for the differences in the percentage figures, the 
investment limitation in section 302(b) of the Small Business Investment 
Act is essentially the same as the investment limitation in section 2(a) 
of the Bank Service Corporation Act since, as an accounting

[[Page 118]]

matter and for the purposes under consideration, ``capital and surplus'' 
may be regarded as equivalent in meaning to ``paid-in and unimpaired 
capital and unimpaired surplus.'' Accordingly, the maximum permissible 
investment by a bank holding company system in the stock of a bank 
service corporation should be determined in accordance with the formula 
prescribed in Sec. 222.111.

[27 FR 12918, Dec. 29, 1962. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.118  Computer services for customers of subsidiary banks.

    (a) The question has been presented to the Board of Governors 
whether a wholly-owned nonbanking subsidiary (``service company'') of a 
bank holding company, which is now exempt from the prohibitions of 
section 4 of the Bank Holding Company Act of 1956 (``the Act'') because 
its sole business is the providing of services for the holding company 
and the latter's subsidiary banks, would lose its exempt status if it 
should provide data processing services for customers of the subsidiary 
banks.
    (b) The Board understood from the facts presented that the service 
company owns a computer which it utilizes to furnish data processing 
services for the subsidiary banks of its parent holding company. 
Customers of these banks have requested that the banks provide for them 
computerized billing, accounting, and financial records maintenance 
services. The banks wish to utilize the computer services of the service 
company in providing these and other services of a similar nature. It is 
proposed that, in each instance where a subsidiary bank undertakes to 
provide such services, the bank will enter into a contract directly with 
the customer and then arrange to have the service company perform the 
services for it, the bank. In no case will the service company provide 
services for anyone other than its affiliated banks. Moreover, it will 
not hold itself out as, nor will its parent corporation or affiliated 
banks represent it to be, authorized or willing to provide services for 
others.
    (c) Section 4(c)(1) of the Act permits a holding company to own 
shares in ``any company engaged solely * * * in the business of 
furnishing services to or performing services for such holding company 
and banks with respect to which it is a bank holding company * * *.'' 
The Board has ruled heretofore that the term ``services'' as used in 
section 4(c)(1) is to be read as relating to those services (excluding 
``closely related'' activities of ``a financial, fiduciary, or insurance 
nature'' within the meaning of section 4(c)(6)) which a bank itself can 
provide for its customers (Sec. 225.104). A determination as to whether 
a particular service may legitimately be rendered or performed by a bank 
for its customers must be made in the light of applicable Federal or 
State statutory or regulatory provisions. In the case of a State-
chartered bank, the laws of the State in which the bank operates, 
together with any interpretations thereunder rendered by appropriate 
bank authorities, would govern the right of the bank to provide a 
particular service. In the case of a national bank, a similar 
determination would require reference to provisions of Federal law 
relating to the establishment and operation of national banks, as well 
as to pertinent rulings or interpretations promulgated thereunder.
    (d) Accordingly, on the assumption that all of the services to be 
performed are of the kinds that the holding company's subsidiary banks 
may render for their customers under applicable Federal or State law, 
the Board concluded that the rendition of such services by the service 
company for its affiliated banks would not adversely affect its exempt 
status under section 4(c)(1) of the Act.
    (e) In arriving at the above conclusion, the Board emphasized that 
its views were premised explicitly upon the facts presented to it, and 
particularly its understanding that banks are permitted, under 
applicable Federal or State law to provide the proposed computer 
services. The Board emphasized also that in respect to the service 
company's operations, there continues in effect the requirement under 
section 4(c)(1) that the service company engage solely in the business 
of furnishing services to or performing services for the bank holding 
company and its subsidiary banks. The Board added that any substantial 
change in the facts that had been presented might require

[[Page 119]]

re-examination of the service company's status under section 4(c)(1).

[29 FR 12361, Aug. 28, 1964. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.121  Acquisition of Edge corporation affiliate by State member banks of registered bank holding company.

    (a) The Board has been asked whether it is permissible for the 
commercial banking affiliates of a bank holding company registered under 
the Bank Holding Company Act of 1956, as amended, to acquire and hold 
the shares of the holding company's Edge corporation subsidiary 
organized under section 25(a) of the Federal Reserve Act.
    (b) Section 9 of the Bank Holding Company Act amendments of 1966 
(Pub. L. 89-485, approved July 1, 1966) repealed section 6 of the Bank 
Holding Company Act of 1956. That rendered obsolete the Board's 
interpretation of section 6 that was published in the March 1966 Federal 
Reserve Bulletin, page 339 (Sec. 225.120). Thus, so far as Federal 
Banking law applicable to State member banks is concerned, the answer to 
the foregoing question depends on the provisions of section 23A of the 
Federal Reserve Act, as amended by the 1966 amendments to the Bank 
Holding Company Act. By its specific terms, the provisions of section 
23A do not apply to an affiliate organized under section 25(a) of the 
Federal Reserve Act.
    (c) Accordingly, the Board concludes that, except for such 
restrictions as may exist under applicable State law, it would be 
legally permissible by virtue of paragraph 20 of section 9 of the 
Federal Reserve Act for any or all of the State member banks that are 
affiliates of a registered bank holding company to acquire and hold 
shares of the Edge corporation subsidiary of the bank holding company 
within the amount limitation in the last sentence of paragraph 12 of 
section 25(a) of the Federal Reserve Act.


(12 U.S.C. 24, 248, 335, 371c, 611, 618)

[31 FR 10263, July 29, 1966. Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.122  Bank holding company ownership of mortgage companies.

    (a) The Board of Governors recently considered whether a bank 
holding may acquire, either directly or through a subsidiary, the stock 
of a so-called ``mortgage company'' that would be operated on the 
following basis: The company would solicit mortgage loans on behalf of a 
bank in the holding company system, assemble credit information, make 
property inspections and appraisals, and secure title information. The 
company would also participate in the preparation of applications for 
mortgage loans, which it would submit, together with recommendations 
with respect to action thereon, to the bank, which alone would decide 
whether to make any or all of the loans requested. The company would in 
addition solicit investors to purchase mortgage loans from the bank and 
would seek to have such investors contract with the bank for the 
servicing of such loans.
    (b) Under section 4 of the Bank Holding Company Act (12 U.S.C. 
1843), a bank holding company is generally prohibited from acquiring 
``direct or indirect ownership'' of stock of nonbanking corporations. 
The two exceptions principally involved in the question presented are 
with respect to (1) stock that is eligible for investment by a national 
bank (section 4(c)(5) of the Act) and (2) shares of a company 
``furnishing services to or performing services for such bank holding 
company or its banking subsidiaries'' (section 4(c)(1)(C) of the Act).
    (c) The Board has previously indicated its view that a national bank 
is forbidden by the so-called ``stock-purchase prohibition'' of 
paragraph ``Seventh'' of section 5136 of the Revised Statutes (12 U.S.C. 
24) to purchase ``for its own account * * * any shares of stock of any 
corporation'' except (1) to the extent permitted by specific provisions 
of Federal law or (2) as comprised within the concept of ``such 
incidental powers as shall be necessary to carry on the business of 
banking'' referred to in the first sentence of said paragraph 
``Seventh''. There is no specific statutory provision authorizing a 
national bank to purchase stock in a mortgage company, and in the 
Board's view such

[[Page 120]]

purchase may not properly be regarded as authorized under the 
``incidental powers'' clause. (See 1966 Federal Reserve Bulletin 1151; 
12 CFR 208.119.) Accordingly, a bank holding company may not acquire 
stock in a mortgage company on the basis of the section 4(c)(5) 
exemption.
    (d) However, the Board does not believe that such conclusion 
prejudices consideration of the question whether such a company is 
within the section 4(c)(1)(C) ``servicing exemption''. The basic purpose 
of section 4 of the Act is to confine a bank holding company's 
activities to the management and control of banks. In determining 
whether an activity in which a bank could itself engage is within the 
servicing exemption, the question is simply whether such activity may 
appropriately be considered as ``furnishing services to or performing 
services for'' a bank.
    (e) As indicated in the Board's interpretation published in the 1958 
Federal Reserve Bulletin at page 431 (12 CFR 225.104), the legislative 
history of the servicing exemption indicates that it includes the 
following activities: ``auditing, appraising, investment counseling'' 
and ``advertising, public relations, developing new business, 
organization, operations, preparing tax returns, and personnel''. The 
legislative history further indicates that some other activities also 
are within the scope of the exemption. However, the types of servicing 
permitted under such exemption must be distinguished from activities of 
a ``financial fiduciary, or insurance nature'', such as those that might 
be considered for possible exemption under section 4(c)(8) of the Act.
    (f) In considering the interrelation of these exemptions in the 
light of the purpose of the prohibition against bank holding company 
interests in nonbanking organizations, the Board has concluded that the 
appropriate test for determining whether a mortgage company may be 
considered as within the servicing exemption is whether the company will 
perform as principal any banking activities--such as receiving deposits, 
paying checks, extending credit, conducting a trust department, and the 
like. In other words, if the mortgage company is to act merely as an 
adjunct to a bank for the purpose of facilitating the banks operations, 
the company may appropriately be considered as within the scope of the 
servicing exemption. 1
---------------------------------------------------------------------------

    1 Insofar as the 1958 interpretation referred to above 
suggested that the branch banking laws are an appropriate general test 
for determining the scope of the servicing exemption, such 
interpretation is hereby modified. In view of the different purposes to 
be served by the branch banking laws and by section 4 of the Bank 
Holding Company Act, the Board has concluded that basing determinations 
under the latter solely on the basis of determinations under the former 
is inappropriate.
---------------------------------------------------------------------------

    (g) On this basis the Board concluded that, insofar as the Bank 
Holding Company Act is concerned, a bank holding company may acquire, 
either directly or through a subsidiary, the stock of a mortgage company 
whose functions are as described in the question presented. On the other 
hand, in the Board's view, a bank holding company may not acquire, on 
the basis of the servicing exemption, a mortgage company whose functions 
include such activities as extending credit for its own account, 
arranging interim financing, entering into mortgage service contracts on 
a fee basis, or otherwise performing functions other than solely on 
behalf of a bank.


(12 U.S.C. 248)

[32 FR 15004, Oct. 3, 1967, as amended at 35 FR 19662, Dec. 29, 1970. 
Redesignated at 36 FR 21666, Nov. 12, 1971]



Sec. 225.123  Activities closely related to banking.

    (a) Effective June 15, 1971, the Board of Governors has amended 
Sec. 225.4(a) of Regulation Y to implement its regulatory authority 
under section 4(c)(8) of the Bank Holding Company Act. In some respects 
activities determined by the Board to be closely related to banking are 
described in general terms that will require interpretation from time to 
time. The Board's views on some questions that have arisen are set forth 
below.
    (b) Section 225.4(a) states that a company whose ownership by a bank 
holding company is authorized on the basis of that section may engage 
solely in

[[Page 121]]

specified activities. That limitation refers only to activities the 
authority for which depends on section 4(c)(8) of the Act. It does not 
prevent a holding company from establishing one subsidiary to engage, 
for example, in activities specified in Sec. 225.4(a) and also in 
activities that fall within the scope of section 4(c)(1)(C) of the Act--
the ``servicing'' exemption.
    (c) The amendments to Sec. 225.4(a) do not apply to restrict the 
activities of a company previously approved by the Board on the basis of 
section 4(c)(8) of the Act. Activities of a company authorized on the 
basis of section 4(c)(8) either before the 1970 Amendments or pursuant 
to the amended Sec. 225.4(a) may be shifted in a corporate 
reorganization to another company within the holding company system 
without complying with the procedures of Sec. 225.4(b), as long as all 
the activities of such company are permissible under one of the 
exemptions in section 4 of the Act.
    (d) Under the procedures in Sec. 225.4(a)(c), a holding company that 
wishes to change the location at which it engages in activities 
authorized pursuant to Sec. 225.4(a) must publish notice in a newspaper 
of general circulation in the community to be served. The Board does not 
regard minor changes in location as within the coverage of that 
requirement. A move from one site to another within a 1-mile radius 
would constitute such a minor change if the new site is in the same 
State.
    (e) Data processing. In providing packaged data processing and 
transmission services for banking, financial and economic data for 
installation on the premises of the customer, as authorized by 
Sec. 225.4(a)(8)(ii), a bank holding company should limit its activities 
to providing facilities that perform banking functions, such as check 
collection, or other similar functions for customers that are depository 
or other similar institutions, such as mortgage companies. In addition, 
the Board regards the following as incidental activities necessary to 
carry on the permissible activities in this area:
    (1) Providing excess capacity, not limited to the processing or 
transmission of banking, financial or economic data on data processing 
or transmission equipment or facilities used in connection with 
permissible data processing and data transmission activities, where:
    (A) Equipment is not purchased solely for the purpose of creating 
excess capacity;
    (B) Hardware is not offered in connection therewith; and
    (C) Facilities for the use of the excess capacity do not include the 
provision of any software, other than systems software (including 
language), network communications support, and the operating personnel 
and documentation necessary for the maintenance and use of these 
facilities.
    (2) Providing by-products of permissible data processing and data 
transmission activities, where not designed, or appreciably enhanced, 
for the purpose of marketability.
    (3) Furnishing any data processing service upon request of a 
customer if such data processing service is not otherwise reasonably 
available in the relevant market area; and

In order to eliminate or reduce to an insignificant degree any 
possibility of unfair competition where services, facilities, by-
products or excess capacity are provided by a bank holding company's 
nonbank subsidiary or related entity, the entity providing the services, 
facilities, by-products and/or excess capacity should have separate 
books and financial statements, and should provide these books and 
statements to any new or renewal customer requesting financial data. 
Consolidated or other financial statements of the bank holding company 
should not be provided unless specifically requested by the customer.


(Interprets and applies 12 U.S.C. 1843 (c)(8))

[36 FR 10778, June 3, 1971, as amended at 36 FR 11806, June 19, 1971. 
Redesignated at 36 FR 21666, Nov. 12, 1971 and amended at 40 FR 13477, 
Mar. 27, 1975; 47 FR 37372, Aug. 26, 1982; 52 FR 45161, Nov. 25, 1987]



Sec. 225.124  Foreign bank holding companies.

    (a) Effective December 1, 1971, the Board of Governors has added a 
new Sec. 225.4(g) to Regulation Y implementing its authority under 
section 4(c)(9) of the Bank Holding Company Act. The Board's views on 
some questions that

[[Page 122]]

have arisen in connection with the meaning of terms used in 
Sec. 225.4(g) are set forth in paragraphs (b) through (g) of this 
section.
    (b) The term ``activities'' refers to nonbanking activities and does 
not include the banking activities that foreign banks conduct in the 
United States through branches or agencies licensed under the banking 
laws of any State of the United States or the District of Columbia.
    (c) A company (including a bank holding company) will not be deemed 
to be engaged in ``activities'' in the United States merely because it 
exports (or imports) products to (or from) the United States, or 
furnishes services or finances goods or services in the United States, 
from locations outside the United States. A company is engaged in 
``activities'' in the United States if it owns, leases, maintains, 
operates, or controls any of the following types of facilities in the 
United States:
    (1) A factory,
    (2) A wholesale distributor or purchasing agency,
    (3) A distribution center,
    (4) A retail sales or service outlet,
    (5) A network of franchised dealers,
    (6) A financing agency, or
    (7) Similar facility for the manufacture, distribution, purchasing, 
furnishing, or financing of goods or services locally in the United 
States.

A company will not be considered to be engaged in ``activities'' in the 
United States if its products are sold to independent importers, or are 
distributed through independent warehouses, that are not controlled or 
franchised by it.
    (d) In the Board's opinion, section 4 (a)(1) of the Bank Holding 
Company Act applies to ownership or control of shares of stock as an 
investment and does not apply to ownership or control of shares of stock 
in the capacity of an underwriter or dealer in securities. Underwriting 
or dealing in shares of stock are nonbanking activities prohibited to 
bank holding companies by section 4(a)(2) of the Act, unless otherwise 
exempted. Under Sec. 225.4(g) of Regulation Y, foreign bank holding 
companies are exempt from the prohibitions of section 4 of the Act with 
respect to their activities outside the United States; thus foreign bank 
holding companies may underwrite or deal in shares of stock (including 
shares of United States issuers) to be distributed outside the United 
States, provided that shares so acquired are disposed of within a 
reasonable time.
    (e) A foreign bank holding company does not ``indirectly'' own 
voting shares by reason of the ownership or control of such voting 
shares by any company in which it has a noncontrolling interest. A 
foreign bank holding company may, however, ``indirectly'' control such 
voting shares if its noncontrolling interest in such company is 
accompanied by other arrangements that, in the Board's judgment, result 
in control of such shares by the bank holding company. The Board has 
made one exception to this general approach. A foreign bank holding 
company will be considered to indirectly own or control voting shares of 
a bank if that bank holding company acquires more than 5 percent of any 
class of voting shares of another bank holding company. A bank holding 
company may make such an acquisition only with prior approval of the 
Board.
    (f) A company is ``indirectly'' engaged in activities in the United 
States if any of its subsidiaries (whether or not incorporated under the 
laws of this country) is engaged in such activities. A company is not 
``indirectly'' engaged in activities in the United States by reason of a 
noncontrolling interest in a company engaged in such activities.
    (g) Under the foregoing rules, a foreign bank holding company may 
have a noncontrolling interest in a foreign company that has a U.S. 
subsidiary (but is not engaged in the securities business in the United 
States) if more than half of the foreign company's consolidated assets 
and revenues are located and derived outside the United States. For the 
purpose of such determination, the assets and revenues of the United 
States subsidiary would be counted among the consolidated assets and 
revenues of the foreign company to the extent required or permitted by 
generally accepted accounting principles in the United States. The 
foreign bank holding company would not, however, be permitted to 
``indirectly'' control voting shares of the said U.S. subsidiary, as 
might be the case if there

[[Page 123]]

are other arrangements accompanying its noncontrolling interest in the 
foreign parent company that, in the Board's judgment, result in control 
of such shares by the bank holding company.


(Interprets and applies 12 U.S.C. 1843 (a) (1), (2), and (c)(9))

[36 FR 21808, Nov. 16, 1971]



Sec. 225.125  Investment adviser activities.

    (a) Effective February 1, 1972, the Board of Governors amended 
Sec. 225.4(a) of Regulation Y to add ``serving as investment adviser, as 
defined in section 2(a)(20) of the Investment Company Act of 1940, to an 
investment company registered under that Act'' to the list of activities 
it has determined to be so closely related to banking or managing or 
controlling banks as to be a proper incident thereto. During the course 
of the Board's consideration of this amendment several questions arose 
as to the scope of such activity, particularly in view of certain 
restrictions imposed by sections 16, 20, 21, and 32 of the Banking Act 
of 1933 (12 U.S.C. 24, 377, 378, 78) (sometimes referred to hereinafter 
as the ``Glass-Steagall Act provisions'') and the U.S. Supreme Court's 
decision in Investment Company Institute v. Camp, 401 U.S. 617 (1971). 
The Board's views with respect to some of these questions are set forth 
below.
    (b) It is clear from the legislative history of the Bank Holding 
Company Act Amendments of 1970 (84 Stat. 1760) that the Glass-Steagall 
Act provisions were not intended to be affected thereby. Accordingly, 
the Board regards the Glass-Steagall Act provisions and the Board's 
prior interpretations thereof as applicable to a holding company's 
activities as an investment adviser. Consistently with the spirit and 
purpose of the Glass-Steagall Act, this interpretation applies to all 
bank holding companies registered under the Bank Holding Company Act 
irrespective of whether they have subsidiaries that are member banks.
    (c) Under Sec. 225.4(a)(5), as amended, bank holding companies 
(which term, as used herein, includes both their bank and nonbank 
subsidiaries) may, in accordance with the provisions of Sec. 225.4 (b), 
act as investment advisers to various types of investment companies, 
such as ``open-end'' investment companies (commonly referred to as 
``mutual funds'') and ``closed-end'' investment companies. Briefly, a 
mutual fund is an investment company which, typically, is continuously 
engaged in the issuance of its shares and stands ready at any time to 
redeem the securities as to which it is the issuer; a closed-end 
investment company typically does not issue shares after its initial 
organization except at infrequent intervals and does not stand ready to 
redeem its shares.
    (d) The Board intends that a bank holding company may exercise all 
functions that are permitted to be exercised by an ``investment 
adviser'' under the Investment Company Act of 1940, except to the extent 
limited by the Glass-Steagall Act provisions, as described, in part, 
hereinafter.
    (e) The Board recognizes that presently most mutual funds are 
organized, sponsored and managed by investment advisers with which they 
are affiliated and that their securities are distributed to the public 
by such affiliated investment advisers, or subsidiaries or affiliates 
thereof. However, the Board believes that (1) The Glass-Steagall Act 
provisions do not permit a bank holding company to perform all such 
functions, and (2) It is not necessary for a bank holding company to 
perform all such functions in order to engage effectively in the 
described activity.
    (f) In the Board's opinion, the Glass-Steagall Act provisions, as 
interpreted by the U.S. Supreme Court, forbid a bank holding company to 
sponsor, organize, or control a mutual fund. However, the Board does not 
believe that such restrictions apply to closed-end investment companies 
as long as such companies are not primarily or frequently engaged in the 
issuance, sale, and distribution of securities. A bank holding company 
should not act as investment adviser to an investment company that has a 
name similar to the name of the holding company or any of its subsidiary 
banks, unless the prospectus of the investment company contains the 
disclosures required in paragraph (h) of this section. In no case should 
a bank holding company act as

[[Page 124]]

investment adviser to an investment company that has either the same 
name as the name of the holding company or any of its subsidiary banks, 
or a name that contains the word ``bank.''
    (g) In view of the potential conflicts of interests that may exist, 
a bank holding company and its bank and nonbank subsidiaries should not 
purchase in their sole discretion, in a fiduciary capacity (including as 
managing agent), securities of any investment company for which the bank 
holding company acts as investment adviser unless, the purchase is 
specifically authorized by the terms of the instrument creating the 
fiduciary relationship, by court order, or by the law of the 
jurisdiction under which the trust is administered.
    (h) Under section 20 of the Glass-Steagall Act, a member bank is 
prohibited from being affiliated with a company that directly, or 
through a subsidiary, engages principally in the issue, flotation, 
underwriting, public sale, or distribution of securities. A bank holding 
company or its nonbank subsidiary may not engage, directly or 
indirectly, in the underwriting, public sale or distribution of 
securities of any investment company for which the holding company or 
any nonbank subsidiary provides investment advice except in compliance 
with the terms of section 20, and only after obtaining the Board's 
approval under section 4 of the Bank Holding Company Act and subject to 
the limitations and disclosures required by the Board in those cases. 
The Board has determined, however, that the conduct of securities 
brokerage activities by a bank holding company or its nonbank 
subsidiaries, when conducted individually or in combination with 
investment advisory activities, is not deemed to be the underwriting, 
public sale, or distribution of securities prohibited by the Glass-
Steagall Act, and the U.S. Supreme Court has upheld that determination. 
See Securities Industry Ass'n v. Board of Governors, 468 U.S. 207 
(1984); see also Securities Industry Ass'n v. Board of Governors, 821 
F.2d 810 (D.C. Cir. 1987), cert. denied, 484 U.S. 1005 (1988). 
Accordingly, the Board believes that a bank holding company or any of 
its nonbank subsidiaries that has been authorized by the Board under the 
Bank Holding Company Act to conduct securities brokerage activities 
(either separately or in combination with investment advisory 
activities) may act as agent, upon the order and for the account of 
customers of the holding company or its nonbank subsidiary, to purchase 
or sell shares of an investment company for which the bank holding 
company or any of its subsidiaries acts as an investment adviser. In 
addition, a bank holding company or any of its nonbank subsidiaries that 
has been authorized by the Board under the Bank Holding Company Act to 
provide investment advice to third parties generally (either separately 
or in combination with securities brokerage services) may provide 
investment advice to customers with respect to the purchase or sale of 
shares of an investment company for which the holding company or any of 
its subsidiaries acts as an investment adviser. In the event that a bank 
holding company or any of its nonbank subsidiaries provides brokerage or 
investment advisory services (either separately or in combination) to 
customers in the situations described above, at the time the service is 
provided the bank holding company should instruct its officers and 
employees to caution customers to read the prospectus of the investment 
company before investing and must advise customers in writing that the 
investment company's shares are not insured by the Federal Deposit 
Insurance Corporation, and are not deposits, obligations of, or endorsed 
or guaranteed in any way by, any bank, unless that happens to be the 
case. The holding company or nonbank subsidiary must also disclose in 
writing to the customer the role of the company or affiliate as adviser 
to the investment company. These disclosures may be made orally so long 
as written disclosure is provided to the customer immediately 
thereafter. To the extent that a bank owned by a bank holding company 
engages in providing advisory or brokerage services to bank customers in 
connection with an investment company advised by the bank holding 
company or a nonbank affiliate, but is not required by the bank's 
primary regulator to make disclosures comparable to the disclosures 
required to be made by bank holding

[[Page 125]]

companies providing such services, the bank holding company should 
require its subsidiary bank to make the disclosures required in this 
paragraph to be made by a bank holding company that provides such 
advisory or brokerage services.
    (i) Acting in such capacities as registrar, transfer agent, or 
custodian for an investment company is not a selling activity and is 
permitted under Sec. 225.4(a)(4) of Regulation Y. However, in view of 
potential conflicts of interests, a bank holding company which acts both 
as custodian and investment adviser for an investment company should 
exercise care to maintain at a minimal level demand deposit accounts of 
the investment company which are placed with a bank affiliate and should 
not invest cash funds of the investment company in time deposit accounts 
(including certificates of deposit) of any bank affiliate.

[37 FR 1464, Jan. 29, 1972, as amended by Reg. Y, 57 FR 30391, July 9, 
1992; 61 FR 45875, Aug. 30, 1996; Reg. Y, 62 FR 9343, Feb. 28, 1997]



Sec. 225.126  Activities not closely related to banking.

    Pursuant to section 4(c)(8) of the Bank Holding Company Act and 
Sec. 225.4(a) of Regulation Y, the Board of Governors has determined 
that the following activities are not so closely related to banking or 
managing or controlling banks as to be a proper incident thereto:
    (a) Insurance premium funding--that is, the combined sale of mutual 
funds and insurance.
    (b) Underwriting life insurance that is not sold in connection with 
a credit transaction by a bank holding company, or a subsidiary thereof.
    (c) Real estate brokerage (see 1972 Fed. Res. Bulletin 428).
    (d) Land development (see 1972 Fed. Res. Bulletin 429).
    (e) Real estate syndication.
    (f) Management consulting (see 1972 Fed. Res. Bulletin 571).
    (g) Property management (see 1972 Fed. Res. Bulletin 652).


[Reg. Y, 37 FR 20329, Sept. 29, 1972; 37 FR 21938, Oct. 17, 1972, as 
amended at 54 FR 37302, Sept. 8, 1989]



Sec. 225.127  Investment in corporations or projects designed primarily to promote community welfare.

    (a) Under Sec. 225.25(b)(6) of Regulation Y, a bank holding company 
may, in accordance with the provisions of Sec. 225.23, engage in 
``making equity and debt investments in corporations or projects 
designed primarily to promote community welfare, such as the economic 
rehabilitation and development of low-income areas.'' The Board included 
that activity among those the Board has determined to be so closely 
related to banking or managing or controlling banks as be a proper 
incident thereto, in order to permit bank holding companies to fulfill 
their civic responsibilities. As indicated hereinafter in this 
interpretation, the Board intends Sec. 225.25(b)(6) to enable bank 
holding companies to take an active role in the quest for solutions to 
the Nation's social problems. Although the interpretation primarily 
focuses on low- and moderate-income housing, it is not intended to limit 
projects under Sec. 225.25(b)(6) to that area. Other investments 
primarily designed to promote community welfare are considered 
permissible, but have not been defined in order to provide bank holding 
companies flexibility in approaching community problems. For example, 
bank holding companies may utilize this flexibility to provide new and 
creative approaches to the promotion of employment opportunities for 
low-income persons. Bank holding companies possess a unique combination 
of financial and managerial resources making them particularly suited 
for a meaningful and substantial role in remedying our social ills. 
Section 225.25(b)(6) is intended to provide an opportunity for them to 
assume such a role.
    (b) Under the authority of Sec. 225.25(b)(6), a bank holding company 
may invest in community development corporations established pursuant to 
Federal or State law. A bank holding company may also participate in 
other civic projects, such as a municipal parking facility sponsored by 
a local civic organization as a means to promote greater public use of 
the community's facilities.
    (c) Within the category of permissible investments under 
Sec. 225.25(b)(6)

[[Page 126]]

are investments in projects to construct or rehabilitate multifamily 
low- or moderate-income housing with respect to which a mortgage is 
insured under section 221(d)(3), 221(d)(4), or 236 of the National 
Housing Act (12 U.S.C. 1701) and investments in projects to construct or 
rehabilitate low- or moderate-income housing which is financed or 
assisted by direct loan, tax abatement, or insurance under provisions of 
State or local law, similar to the aforementioned Federal programs, 
provided that, with respect to all such projects the owner is, by 
statute, regulation, or regulatory authority, limited as to the rate of 
return on his investment in the project, as to rentals or occupancy 
charges for units in the project, and in such other respects as would be 
a ``limited dividend corporation'' (as defined by the Secretary of 
Housing and Urban Development).
    (d) Investments in other projects that may be considered to be 
designed primarily to promote community welfare include but are not 
limited to: (1) Projects for the construction or rehabilitation of 
housing for the benefit of persons of low- or moderate-income, (2) 
projects for the construction or rehabilitation of ancillary local 
commercial facilities necessary to provide goods or services principally 
to persons residing in low- or moderate-income housing, and (3) projects 
designed explicitly to create improved job opportunities for low- or 
moderate-income groups (for example, minority equity investments, on a 
temporary basis, in small or medium-sized locally-controlled businesses 
in low-income urban or other economically depressed areas). In the case 
of de novo projects, the copy of the notice with respect to such other 
projects which is to be furnished to Reserve Banks in accordance with 
the provisions of Sec. 225.23 should be accompanied by a memorandum 
which demonstrates that such projects meet the objectives of 
Sec. 225.25(b)(6).
    (e) Investments in corporations or projects organized to build or 
rehabilitate high-income housing, or commercial, office, or industrial 
facilities that are not designed explicitly to create improved job 
opportunities for low-income persons shall be presumed not to be 
designed primarily to promote community welfare, unless there is 
substantial evidence to the contrary, even though to some extent the 
investment may benefit the community.
    (f) Section 6 of the Depository Institutions Disaster Relief Act of 
1992 permits state member banks (12 U.S.C. 338a) and national banks (12 
U.S.C. 24 (Eleventh)) to invest in the stock of community development 
corporations that are designed primarily to promote the public welfare 
of low- and moderate-income communities and persons in the areas of 
housing, services and employment. The Board and the Office of the 
Comptroller of the Currency have adopted rules that permit state member 
banks and national banks to make certain investments without prior 
approval. The Board believes that these rules are consistent with the 
Board's interpretation of, and decisions regarding, the scope of 
community welfare activities permissible for bank holding companies. 
Accordingly, approval received by a bank holding company to conduct 
activities designed to promote the community welfare under section 
4(c)(8) of the Bank Holding Company Act (12 U.S.C. 1843(c)(8)) and 
Sec. 225.25(b)(6) of the Board's Regulation Y (12 CFR 225.25(b)(6)) 
includes approval to engage, either directly or through a subsidiary, in 
the following activities, up to five percent of the bank holding 
company's total consolidated capital stock and surplus, without 
additional Board or Reserve Bank approval:
    (1) Invest in and provide financing to a corporation or project or 
class of corporations or projects that the Board previously has 
determined is a public welfare project pursuant to paragraph 23 of 
section 9 of the Federal Reserve Act (12 U.S.C. 338a);
    (2) Invest in and provide financing to a corporation or project that 
the Office of the Comptroller of the Currency previously has determined, 
by order or regulation, is a public welfare investment pursuant to 
section 5136 of the Revised Statutes (12 U.S.C. 24 (Eleventh));
    (3) Invest in and provide financing to a community development 
financial institution pursuant to section 103(5) of the Community 
Development Banking

[[Page 127]]

and Financial Institutions Act of 1994 (12 U.S.C. 4702(5));
    (4) Invest in, provide financing to, develop, rehabilitate, manage, 
sell, and rent residential property if a majority of the units will be 
occupied by low- and moderate-income persons or if the property is a 
``qualified low-income building'' as defined in section 42(c)(2) of the 
Internal Revenue Code (26 U.S.C. 42(c)(2));
    (5) Invest in, provide financing to, develop, rehabilitate, manage, 
sell, and rent nonresidential real property or other assets located in a 
low- or moderate-income area provided the property is used primarily for 
low- and moderate-income persons;
    (6) Invest in and provide financing to one or more small businesses 
located in a low- or moderate-income area to stimulate economic 
development;
    (7) Invest in, provide financing to, develop, and otherwise assist 
job training or placement facilities or programs designed primarily for 
low- and moderate-income persons;
    (8) Invest in and provide financing to an entity located in a low- 
or moderate-income area if that entity creates long-term employment 
opportunities, a majority of which (based on full time equivalent 
positions) will be held by low- and moderate-income persons; and
    (9) Provide technical assistance, credit counseling, research, and 
program development assistance to low- and moderate-income persons, 
small businesses, or nonprofit corporations to help achieve community 
development.
    (g) For purposes of paragraph (f) of this section, low- and 
moderate-income persons or areas means individuals and communities whose 
incomes do not exceed 80 percent of the median income of the area 
involved, as determined by the U.S. Department of Housing and Urban 
Development. Small businesses are businesses that are smaller than the 
maximum size eligibility standards established by the Small Business 
Administration (SBA) for the Small Business Investment Company and 
Development Company Programs or the SBA section 7A loan program; and 
specifically include those businesses that are majority-owned by members 
of minority groups or by women.
    (h) For purposes of paragraph (f) of this section, five percent of 
the total consolidated capital stock and surplus of a bank holding 
company includes its total investment in projects described in paragraph 
(f) of this section, when aggregated with similar types of investments 
made by depository institutions controlled by the bank holding company. 
The term total consolidated capital stock and surplus of the bank 
holding company means total equity capital and the allowance for loan 
and lease losses. For bank holding companies that file the FR Y-9C 
(Consolidated Financial Statements for Bank Holding Companies), these 
items are readily ascertained from Schedule HC--Consolidated Balance 
Sheet (total equity capital (line 27h) and allowance for loan and lease 
losses (line 4b)). For bank holding companies filing the FR Y-SP (Parent 
Company Only Financial Statements for Small Bank Holding Companies), an 
approximation of these items is ascertained from the Balance Sheet 
(total equity capital (line 16e)) and allowance for loan and lease 
losses (line 3b)) and from the Report of Condition for Insured Banks 
(Schedule RC--Balance Sheet (line 4b)).

[37 FR 11316, June 7, 1972; 37 FR 13336, July 7, 1972, as amended at 
Reg. Y, 59 FR 63713, Dec. 9, 1994]



Sec. 225.129  Activities closely related to banking.

    Courier activities. The Board's amendment of Sec. 225.4(a), which 
adds courier services to the list of closely related activities is 
intended to permit holding companies to transport time critical 
materials of limited intrinsic value of the types utilized by banks and 
bank-related firms in performing their business activities. Such 
transportation activities are of particular importance in the check 
clearing process of the banking system, but are also important to the 
performance of other activities, including the processing of 
financially-related economic data. The authority is not intended to 
permit holding companies to engage generally in the provision of 
transportation services.
    During the course of the Board's proceedings pertaining to courier 
services,

[[Page 128]]

objections were made that courier activities were not a proper incident 
to banking because of the possibility that holding companies would or 
had engaged in unfair competitive practices. The Board believes that 
adherence to the following principles will eliminate or reduce to an 
insignificant degree any possibility of unfair competition:
    a. A holding company courier subsidiary established under section 
4(c)(8) should be a separate, independent corporate entity, not merely a 
servicing arm of a bank.
    b. As such, the subsidiary should exist as a separate, profit-
oriented operation and should not be subsidized by the holding company 
system.
    c. Services performed should be explicitly priced, and shall not be 
paid for indirectly, for example, on the basis of deposits maintained at 
or loan arrangements with affiliated banks.

Accordingly, entry of holding companies into courier activities on the 
basis of section 4(c)(8) will be conditioned as follows:
    1. The courier subsidiary shall perform services on an explicit fee 
basis and shall be structured as an individual profit center designed to 
be operated on a profitable basis. The Board may regard operating losses 
sustained over an extended period as being inconsistent with continued 
authority to engage in courier activities.
    2. Courier services performed on behalf of an affiliate's customer 
(such as the carriage of incoming cash letters) shall be paid for by the 
customer. Such payments shall not be made indirectly, for example, on 
the basis of imputed earnings on deposits maintained at or of loan 
arrangements with subsidiaries of the holding company. Concern has also 
been expressed that bank-affiliated courier services will be utilized to 
gain a competitive advantage over firms competing with other holding 
company affiliates. To reduce the possibility that courier affiliates 
might be so employed, the Board will impose the following third 
condition:
    3. The courier subsidiary shall, when requested by any bank or any 
data processing firm providing financially-related data processing 
services which firm competes with a banking or data processing 
subsidiary of Applicant, furnish comparable service at comparable rates, 
unless compliance with such request would be beyond the courier 
subsidiary's practical capacity. In this regard, the courier subsidiary 
should make known to the public its minimum rate schedule for services 
and its general pricing policies thereto. The courier subsidiary is also 
expected to maintain for a reasonable period of time (not less than two 
years) each request denied with the reasons for such denial.

[38 FR 32126, Nov. 21, 1973, as amended at 40 FR 36309, Aug. 20, 1975]



Sec. 225.130  Issuance and sale of short-term debt obligations by bank holding companies.

    For text of interpretation, see Sec. 250.221 of this chapter.

[38 FR 35231, Dec. 26, 1973]



Sec. 225.131  Activities closely related to banking.

    (a) Bank management consulting advice. The Board's amendment of 
Sec. 225.4(a), which adds bank management consulting advice to the list 
of closely related activities, described in general terms the nature of 
such activity. This interpretation is intended to explain in greater 
detail certain of the terms in the amendment.
    (b) It is expected that bank management consulting advice would 
include, but not be limited to, advice concerning: Bank operations, 
systems and procedures; computer operations and mechanization; 
implementation of electronic funds transfer systems; site planning and 
evaluation; bank mergers and the establishment of new branches; 
operation and management of a trust department; international banking; 
foreign exchange transactions; purchasing policies and practices; cost 
analysis, capital adequacy and planning; auditing; accounting 
procedures; tax planning; investment advice (as authorized in 
Sec. 225.4(a)(5)); credit policies and administration, including credit 
documentation, evaluation, and debt collection; product development, 
including specialized lending provisions; marketing operations, 
including research, market development and advertising programs; 
personnel operations,

[[Page 129]]

including recruiting, training, evaluation and compensation; and 
security measures and procedures.
    (c) In permitting bank holding companies to provide management 
consulting advice to nonaffiliated ``banks'', the Board intends such 
advice to be given only to an institution that both accepts deposits 
that the depositor has a legal right to withdraw on demand and engages 
in the business of making commercial loans. It is also intended that 
such management consulting advice may be provided to the ``operations 
subsidiaries'' of a bank, since such subsidiaries perform functions that 
a bank is empowered to perform directly at locations at which the bank 
is authorized to engage in business (Sec. 250.141 of this chapter).
    (d) Although a bank holding company providing management consulting 
advice is prohibited by the regulation from owning or controlling, 
directly or indirectly, any equity securities in a client bank, this 
limitation does not apply to shares of a client bank acquired, directly 
or indirectly, as a result of a default on a debt previously contracted. 
This limitation is also inapplicable to shares of a client bank acquired 
by a bank holding company, directly or indirectly, in a fiduciary 
capacity: Provided, That the bank holding company or its subsidiary does 
not have sole discretionary authority to vote such shares or shares held 
with sole voting rights constitute not more than five percent of the 
outstanding voting shares of a client bank.

[39 FR 8318, Mar. 5, 1974; 39 FR 21120, June 19, 1974]



Sec. 225.132  Acquisition of assets.

    (a) From time to time questions have arisen as to whether and under 
what circumstances a bank holding company engaged in nonbank activities, 
directly or indirectly through a subsidiary, pursuant to section 4(c)(8) 
of the Bank Holding Company Act of 1956, as amended (12 U.S.C. 
1843(c)(3)), may acquire the assets and employees of another company, 
without first obtaining Board approval pursuant to section 4(c) (8) and 
the Board's Regulation Y (12 CFR 225.4(b)).
    (b) In determining whether Board approval is required in connection 
with the acquisition of assets, it is necessary to determine (a) whether 
the acquisition is made in the ordinary course of business 1 
or (b) whether it constitutes the acquisition, in whole or in part, of a 
going concern. 2 
---------------------------------------------------------------------------

    1 Section 225.4(c)(3) of the Board's Regulation Y (12 CFR 
225.4(c)(3)) generally prohibits a bank holding company or its 
subsidiary engaged in activities pursuant to authority of section 
4(c)(8) of the Act from being a party to any merger ``or acquisition of 
assets other than in the ordinary course of business'' without prior 
Board approval.
    2 In accordance with the provisions of section 4(c)(8) of 
the Act and Sec. 225.4(b) of Regulation Y, the acquisition of a going 
concern requires prior Board approval.
---------------------------------------------------------------------------

    (c) The following examples illustrate transactions where prior Board 
approval will generally be required:
    (1) The transaction involves the acquisition of all or substantially 
all of the assets of a company, or a subsidiary, division, department or 
office thereof.
    (2) The transaction involves the acquisition of less than 
``substantially all'' of the assets of a company, or a subsidiary, 
division, department or office thereof, the operations of which are 
being terminated or substantially discontinued by the seller, but such 
asset acquisition is significant in relation to the size of the same 
line of nonbank activity of the holding company (e.g., consumer finance 
mortgage banking, data processing). For purposes of this interpretation, 
an acquisition would generally be presumed to be significant if the book 
value of the nonbank assets being acquired exceeds 50 percent of the 
book value of the nonbank assets of the holding company or nonbank 
subsidiary comprising the same line of activity.
    (3) The transaction involves the acquisition of assets for resale 
and the sale of such assets is not a normal business activity of the 
acquiring holding company.
    (4) The transaction involves the acquisition of the assets of a 
company, or a subsidiary, division, department or office thereof, and a 
major purpose of the transaction is to hire some of the seller's 
principal employees who are expert, skilled and experienced in the

[[Page 130]]

business of the company being acquired.
    (d) In some cases it may be difficult, due to the wide variety of 
circumstances involving possible acquisition of assets, to determine 
whether such acquisitions require prior Board approval. Bank holding 
companies are encouraged to contact their local Reserve Bank for 
guidance where doubt exists as to whether such an acquisition is in the 
ordinary course of business or an acquisition, in whole or in part, of a 
going concern.

[39 FR 35128, Sept. 30, 1974, as amended at Reg. Y, 57 FR 28779, June 
29, 1992]



Sec. 225.133  Computation of amount invested in foreign corporations under general consent procedures.

    For text of this interpretation, see Sec. 211.111 of this 
subchapter.

[40 FR 43199, Sept. 19, 1975]



Sec. 225.134  Escrow arrangements involving bank stock resulting in a violation of the Bank Holding Company Act.

    (a) In connection with a recent application to become a bank holding 
company, the Board considered a situation in which shares of a bank were 
acquired and then placed in escrow by the applicant prior to the Board's 
approval of the application. The facts indicated that the applicant 
company had incurred debt for the purpose of acquiring bank shares and 
immediately after the purchase the shares were transferred to an 
unaffiliated escrow agent with instructions to retain possession of the 
shares pending Board action on the company's application to become a 
bank holding company. The escrow agreement provided that, if the 
application were approved by the Board, the escrow agent was to return 
the shares to the applicant company; and, if the application were 
denied, the escrow agent was to deliver the shares to the applicant 
company's shareholders upon their assumption of debt originally incurred 
by the applicant in the acquisition of the bank shares. In addition, the 
escrow agreement provided that, while the shares were held in escrow, 
the applicant could not exercise voting or any other ownership rights 
with respect to those shares.
    (b) On the basis of the above facts, the Board concluded that the 
company had violated the prior approval provisions of section 3 of the 
Bank Holding Company Act (``Act'') at the time that it made the initial 
acquisition of bank shares and that, for purposes of the Act, the 
company continued to control those shares in violation of the Act. In 
view of these findings, individuals and bank holding companies should 
not enter into escrow arrangements of the type described herein, or any 
similar arrangement, without securing the prior approval of the Board, 
since such action could constitute a violation of the Act.
    (c) While the above represents the Board's conclusion with respect 
to the particular escrow arrangement involved in the proposal presented, 
the Board does not believe that the use of an escrow arrangement would 
always result in a violation of the Act. For example, it appears that a 
transaction whereby bank shares are placed in escrow pending Board 
action on an application would not involve a violation of the Act so 
long as title to such shares remains with the seller during the pendency 
of the application; there are no other indicia that the applicant 
controls the shares held in escrow; and, in the event of a Board denial 
of the application, the escrow agreement provides that the shares would 
be returned to the seller.

[41 FR 9859, Mar. 8, 1976. Correctly designated at 41 FR 12009, Mar. 23, 
1976]



Sec. 225.136  Utilization of foreign subsidiaries to sell long-term debt obligations in foreign markets and to transfer the proceeds to their United States 
          parent(s) for domestic purposes.

    For text of this interpretation, see Sec. 211.112 of this 
subchapter.

[42 FR 752, Jan. 4, 1977]



Sec. 225.137  Acquisitions of shares pursuant to section 4(c)(6) of the Bank Holding Company Act.

    (a) The Board has received a request for an interpretation of 
section 4(c)(6) of the Bank Holding Company Act

[[Page 131]]

(``Act'') 1 in connection with a proposal under which a 
number of bank holding companies would purchase interests in an 
insurance company to be formed for the purpose of underwriting or 
reinsuring credit life and credit accident and health insurance sold in 
connection with extensions of credit by the stockholder bank holding 
companies and their affiliates.
---------------------------------------------------------------------------

    1 It should be noted that every Board Order granting 
approval under section 4(c)(8) of the Act contains the following 
paragraph:
    ``This determination is subject . . . to the Board's authority to 
require such modification or termination of the activities of a holding 
company or any of its subsidiaries as the Board finds necessary to 
assure compliance with the provisions and purposes of the Act and the 
Board's regulations and orders issued thereunder, or to prevent evasion 
thereof.''
    The Board believes that, even apart from this Interpretation, this 
language preserves the authority of the Board to require the revisions 
contemplated in this Interpretation.
---------------------------------------------------------------------------

    (b) Each participating holding company would own no more than 5 
percent of the outstanding voting shares of the company. However, the 
investment of each holding company would be represented by a separate 
class of voting security, so that each stockholder would own 100 percent 
of its respective class. The participating companies would execute a 
formal ``Agreement Among Stockholders'' under which each would agree to 
use its best efforts at all times to direct or recommend to customers 
and clients the placement of their life, accident and health insurance 
directly or indirectly with the company. Such credit-related insurance 
placed with the company would be identified in the records of the 
company as having been originated by the respective stockholder. A 
separate capital account would be maintained for each stockholder 
consisting of the original capital contribution increased or decreased 
from time to time by the net profit or loss resulting from the insurance 
business attributable to each stockholder. Thus, each stockholder would 
receive a return on its investment based upon the claims experience and 
profitability of the insurance business that it had itself generated. 
Dividends declared by the board of directors of the company would be 
payable to each stockholder only out of the earned surplus reflected in 
the respective stockholder's capital account.
    (c) It has been requested that the Board issue an interpretation 
that section 4(c)(6) of the Act provides an exemption under which 
participating bank holding companies may acquire such interests in the 
company without prior approval of the Board.
    (d) On the basis of a careful review of the documents submitted, in 
light of the purposes and provisions of the Act, the Board has concluded 
that section 4(c)(6) of the Act is inapplicable to this proposal and 
that a bank holding company must obtain the approval of the Board before 
participating in such a proposal in the manner described. The Board's 
conclusion is based upon the following considerations:
    (1) Section 2(a)(2)(A) of the Act provides that a company is deemed 
to have control over a second company if it owns or controls ``25 per 
centum or more of any class of voting securities'' of the second 
company. In the case presented, the stock interest of each participant 
would be evidenced by a different class of stock and each would 
accordingly, own 100 percent of a class of voting securities of the 
company. Thus, each of the stockholders would be deemed to ``control'' 
the company and prior Board approval would be required for each 
stockholder's acquisition of stock in the company.

The Board believes that this application of section 2(a)(2)(A) of the 
Act is particularly appropriate on the facts presented here. The company 
is, in practical effect, a conglomeration of separate business ventures 
each owned 100 percent by a stockholder the value of whose economic 
interest in the company is determined by reference to the profits and 
losses attributable to its respective class of stock. Furthermore, it is 
the Board's opinion that this application of section 2(a)(2)(A) is not 
inconsistent with section 4(c)(6). Even assuming that section (4)(c)(6) 
is intended to refer to all outstanding voting shares, and not merely 
the outstanding shares of a particular class of securities, section 
4(c)(6) must be viewed as permitting ownership of 5 percent of a 
company's voting stock only when that ownership does not

[[Page 132]]

constitute ``control'' as otherwise defined in the Act. For example, it 
is entirely possible that a company could exercise a controlling 
influence over the management and policies of a second company, and thus 
``control'' that company under the Act's definitions, even though it 
held less than 5 percent of the voting stock of the second company. To 
view section 4(c)(6) as an unqualified exemption for holdings of less 
than 5 percent would thus create a serious gap in the coverage of the 
Act.
    (2) The Board believes that section 4(c)(6) should properly be 
interpreted as creating an exemption from the general prohibitions in 
section 4 on ownership of stock in nonbank companies only for passive 
investments amounting to not more than 5 percent of a company's 
outstanding stock, and that the exemption was not intended to allow a 
group of holding companies, through concerted action, to engage in an 
activity as entrepreneurs. Section 4 of the Act, of course, prohibits 
not only owning stock in nonbank companies, but engaging in activities 
other than banking or those activities permitted by the Board under 
section 4(c)(8) as being closely related to banking. Thus, if a holding 
company may be deemed to be engaging in an activity through the medium 
of a company in which it owns less than 5 percent of the voting stock it 
may nevertheless require Board approval, despite the section 4(c)(6) 
exemption.
    (e) To accept the argument that section 4(c)(6) is an unqualified 
grant of permission to a bank holding company to own 5 percent of the 
shares of any nonbanking company irrespective of the nature or extent of 
the holding company's participation in the affairs of the nonbanking 
company would, in the Board's view, create the potential for serious and 
widespread evasion of the Act's controls over nonbanking activities. 
Such a construction would allow a group of 20 bank holding companies--or 
even a single bank holding company and one or more nonbank companies--to 
engage in entrepreneurial joint ventures in businesses prohibited to 
bank holding companies, a result the Board believes to be contrary to 
the intent of Congress.
    (f) In this proposal, each of the participating stockholders must be 
viewed as engaging in the business of insurance underwriting. Each 
stockholder would agree to channel to the company the insurance business 
it generates, and the value of the interest of each stockholder would be 
determined by reference to the profitability of the business generated 
by that stockholder itself. There is no sharing or pooling among 
stockholders of underwriting risks assumed by the company, and profit or 
loss from investments is allocated on the basis of each bank holding 
company's allocable underwriting profit or loss. The interest of each 
stockholder is thus clearly that of an entrepreneur rather than that of 
an investor.
    (g) Accordingly, on the basis of the factual situation before the 
Board, and for the reasons summarized above, the Board has concluded 
that section 4(c)(6) of the Act cannot be interpreted to exempt the 
ownership of 5 percent of the voting stock of a company under the 
circumstances described, and that a bank holding company wishing to 
become a stockholder in a company under this proposal would be required 
to obtain the Board's approval to do so.

[42 FR 1263, Jan. 6, 1977; 42 FR 2951, Jan. 14, 1977]



Sec. 225.138  Statement of policy concerning divestitures by bank holding companies.

    (a) From time to time the Board of Governors receives requests from 
companies subject to the Bank Holding Company Act, or other laws 
administered by the Board, to extend time periods specified either by 
statute or by Board order for the divestiture of assets held or 
activities engaged in by such companies. Such divestiture requirements 
may arise in a number of ways. For example, divestiture may be ordered 
by the Board in connection with an acquisition found to have been made 
in violation of law. In other cases the divestiture may be pursuant to a 
statutory requirement imposed at the time and amendment to the Act was 
adopted, or it may be required as a result of a foreclosure upon 
collateral

[[Page 133]]

held by the company or a bank subsidiary in connection with a debt 
previously contracted in good faith. Certain divestiture periods may be 
extended in the discretion of the Board, but in other cases the Board 
may be without statutory authority, or may have only limited authority, 
to extend a specified divestiture period.
    (b) In the past, divestitures have taken many different forms, and 
the Board has followed a variety of procedures in enforcing divestiture 
requirements. Because divestitures may occur under widely disparate 
factual circumstances, and because such forced dispositions may have the 
potential for causing a serious adverse economic impact upon the 
divesting company, the Board believes it is important to maintain a 
large measure of flexibility in dealing with divestitures. For these 
reasons, there can be no fixed rule as to the type of divestiture that 
will be appropriate in all situations. For example, where divestiture 
has been ordered to terminate a control relationship created or 
maintained in violation of the Act, it may be necessary to impose 
conditions that will assure that the unlawful relationship has been 
fully terminated and that it will not arise in the future. In other 
circumstances, however, less stringent conditions may be appropriate.
    (1) Avoidance of delays in divestitures. Where a specific time 
period has been fixed for accomplishing divestiture, the affected 
company should endeavor and should be encouraged to complete the 
divestiture as early as possible during the specific period. There will 
generally be substantial advantages to divesting companies in taking 
steps to plan for and accomplish divestitures well before the end of the 
divestiture period. For example, delays may impair the ability of the 
company to realize full value for the divested assets, for as the end of 
the divestiture period approaches the ``forced sale'' aspect of the 
divestiture may lead potential buyers to withhold firm offers and to 
bargain for lower prices. In addition, because some prospective 
purchasers may themselves require regulatory approval to acquire the 
divested property, delay by the divesting company may--by leaving 
insufficient time to obtain such approvals--have the effect of narrowing 
the range of prospective purchases. Thus, delay in planning for 
divestiture may increase the likelihood that the company will seek an 
extension of the time for divestiture if difficulty is encountered in 
securing a purchaser, and in certain situations, of course, the Board 
may be without statutory authority to grant extensions.
    (2) Submissions and approval of divestiture plans. When a 
divestiture requirement is imposed, the company affected should 
generally be asked to submit a divestiture plan promptly for review and 
approval by the Reserve Bank or the Board. Such a requirement may be 
imposed pursuant to the Board's authority under section 5(b) of the Bank 
Holding Company Act to issue such orders as may be necessary to enable 
the Board to administer and carry out the purposes of the Act and 
prevent evasions thereof. A divestiture plan should be as specific as 
possible, and should indicate the manner in which divestiture will be 
accomplished--for example, by a bulk sale of the assets to a third 
party, by ``spinoff'' or distribution of shares to the shareholders of 
the divesting company, or by termination of prohibited activities. In 
addition, the plan should specify the steps the company expects to take 
in effecting the divestiture and assuring its completeness, and should 
indicate the time schedule for taking such steps. In appropriate 
circumstances, the divestiture plan should make provision for assuring 
that ``controlling influence'' relationships, such as management or 
financial interlocks, will not continue to exist.
    (3) Periodic progress reports. A company subject to a divestiture 
requirement should generally be required to submit regular periodic 
reports detailing the steps it has taken to effect divestiture. Such a 
requirement may be imposed pursuant to the Board's authority under 
section 5(b) of the Bank Holding Company Act, referred to above, as well 
as its authority under section 5(c) of the Act to require reports for 
the purpose of keeping the Board informed as to whether the Act and 
Board regulations and order thereunder are being complied with. Reports 
should set forth in detail such matters

[[Page 134]]

as the identities of potential buyers who have been approached by the 
company, the dates of discussions with potential buyers and the 
identities of the individuals involved in such discussions, the terms of 
any offers received, and the reasons for rejecting any offers. In 
addition, the reports should indicate whether the company has employed 
brokers, investment bankers or others to assist in the divestiture, or 
its reasons for not doing so, and should describe other efforts by the 
company to seek out possible purchasers. The purpose of requiring such 
reports is to insure that substantial and good faith efforts being made 
by the company to satisfy its divestiture obligations. The frequency of 
such reports may vary depending upon the nature of the divestiture and 
the period specified for divestiture. However, such reports should 
generally not be required less frequently than every three months, and 
may in appropriate cases be required on a monthly or even more frequent 
basis. Progress reports as well as divestiture plans should be afforded 
confidential treatment.
    (4) Extensions of divestiture periods. Certain divestiture periods--
such as December 31, 1980 deadline for divestitures required by the 1970 
Amendments to the Bank Holding Company Act--are not extendable. In such 
cases it is imperative that divestiture be accomplished in a timely 
manner. In certain other cases, the Board may have discretion to extend 
a statutorily prescribed divestiture period within specified limits. For 
example, under section 4(c)(2) of the Act the Board may extend for three 
one-year periods the two-year period in which a bank subsidiary of a 
holding company is otherwise required to divest shares acquired in 
satisfaction of a debt previously contracted in good faith. In such 
cases, however, when the permissible extensions expire the Board no 
longer has discretion to grant further extensions. In still other cases, 
where a divestiture period is prescribed by the Board, in the exercise 
of its regulatory judgment, the Board may have broader discretion to 
grant extensions. Where extensions of specified divestiture periods are 
permitted by law, extensions should not be granted except under 
compelling circumstances. Neither unfavorable market conditions, nor the 
possibility that the company may incur some loss, should alone be viewed 
as constituting such circumstances--particularly if the company has 
failed to take earlier steps to accomplish a divestiture under more 
favorable circumstances. Normally, a request for an extension will not 
be considered unless the company has established that it has made 
substantial and continued good faith efforts to accomplish the 
divestiture within the prescribed period. Furthermore, requests for 
extensions of divestiture periods must be made sufficiently in advance 
of the expiration of the prescribed period both to enable the Board to 
consider the request in an orderly manner and to enable the company to 
effect a timely divestiture in the event the request for extension is 
denied. Companies subject to divestiture requirements should be aware 
that a failure to accomplish a divestiture within the prescribed period 
may in and of itself be viewed as a separate violation of the Act.
    (5) Use of trustees. In appropriate cases a company subject to a 
divestiture requirement may be required to place the assets subject to 
divestiture with an independent trustee under instructions to accomplish 
a sale by a specified date, by public auction if necessary. Such a 
trustee may be given the responsibility for exercising the voting rights 
with respect to shares being divested. The use of such a trustee may be 
particularly appropriate where the divestiture is intended to terminate 
a control relationship established or maintained in violation of law, or 
where the divesting company has demonstrated an inability or 
unwillingness to take timely steps to effect a divestiture.
    (6) Presumptions of control. Bank holding companies contemplating a 
divestiture should be mindful of section 2(g)(3) of the Bank Holding 
Company Act, which creates a presumption of continued control over the 
transferred assets where the transferee is indebted to the transferor, 
or where certain interlocks exist, as well as Sec. 225.2 of Regulation 
Y, which sets forth certain additional control presumptions. Where one 
of these presumptions has

[[Page 135]]

arisen with respect to divested assets, the divestiture will not be 
considered as complete until the presumption has been overcome. It 
should be understood that the inquiry into the termination of control 
relationships is not limited by the statutory and regulatory 
presumptions of control, and that the Board may conclude that a control 
relationship still exists even though the presumptions do not apply.
    (7) Role of the Reserve Banks. The Reserve Banks have a 
responsibility for supervising and enforcing divestitures. Specifically, 
in coordination with Board staff they should review divestiture plans to 
assure that proposed divestitures will result in the termination of 
control relationships and will not create unsafe or unsound conditions 
in any bank or bank holding company; they should monitor periodic 
progress reports to assure that timely steps are being taken to effect 
divestitures; and they should prompt companies to take such steps when 
it appears that progress is not being made. Where Reserve Banks have 
delegated authority to extend divestiture periods, that authority should 
be exercised consistently with this policy statement.

[42 FR 10969, Feb. 25, 1977]



Sec. 225.139  Presumption of continued control under section 2(g)(3) of the Bank Holding Company Act.

    (a) Section 2(g)(3) of the Bank Holding Company Act (the ``Act'') 
establishes a statutory presumption that where certain specified 
relationships exist between a transferor and transferee of shares, the 
transferor (if it is a bank holding company, or a company that would be 
such but for the transfer) continues to own or control indirectly the 
transferred shares. 1 This presumption arises by operation of 
law, as of the date of the transfer, without the need for any order or 
determination by the Board. Operation of the presumption may be 
terminated only by the issuance of a Board determination, after 
opportunity for hearing, ``that the transferor is not in fact capable of 
controlling the transferee.'' 2
---------------------------------------------------------------------------

    1 The presumption arises where the transferee ``is indebted to 
the transferor, or has one or more officers, directors, trustees, or 
beneficiaries in common with or subject to control by the transferor.''
    2 The Board has delegated to its General Counsel the 
authority to issue such determinations, 12 CFR 265.2(b)(1).
---------------------------------------------------------------------------

    (b) The purpose of section 2(g)(3) is to provide the Board an 
opportunity to assess the effectiveness of divestitures in certain 
situations in which there may be a risk that the divestiture will not 
result in the complete termination of a control relationship. By 
presuming control to continue as a matter of law, section 2(g)(3) 
operates to allow the effectiveness of the divestiture to be assessed 
before the divesting company is permitted to act on the assumption that 
the divestiture is complete. Thus, for example, if a holding company 
divests its banking interest under circumstances where the presumption 
of continued control arises, the divesting company must continue to 
consider itself bound by the Act until an appropriate order is entered 
by the Board dispelling the presumption. Section 2(g)(3) does not 
establish a substantive rule that invalidates transfers to which it 
applies, and in a great many cases the Board has acted favorably on 
applications to have the presumption dispelled. It merely provides a 
procedural opportunity for Board consideration of the effect of such 
transfers in advance of their being deemed effective. Whether or not the 
statutory presumption arises, the substantive test for assessing the 
effectiveness of a divestiture is the same--that is, the Board must be 
assured that all control relationships between the transferor and the 
transferred property have been terminated and will not be reestablished. 
3
---------------------------------------------------------------------------

    3 It should be noted, however, that the Board will require 
termination of any interlocking management relationships between the 
divesting company and the transferee or the divested company as a 
precondition of finding that a divestiture is complete. Similarly, the 
retention of an economic interest in the divested company that would 
create an incentive for the divesting company to attempt to influence 
the management of the divested company will preclude a finding that the 
divestiture is complete. (See the Board's Order in the matter of 
``International Bank'', 1977 Federal Reserve Bulletin 1106, 1113.)

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[[Page 136]]

    (c) In the course of administering section 2(g)(3) the Board has had 
several occasions to consider the scope of that section. In addition, 
questions have been raised by and with the Board's staff as to coverage 
of the section. Accordingly, the Board believes it would be useful to 
set forth the following interpretations of section 2(g)(3):
    (1) The terms transferor and transferee, as used in section 2(g)(3), 
include parents and subsidiaries of each. Thus, for example, where a 
transferee is indebted to a subsidiary of the transferor, or where a 
specified interlocking relationship exists between the transferor or 
transferee and a subsidiary of the other (or between subsidiaries of 
each), the presumption arises. Similarly, if a parent of the transferee 
is indebted to a parent of the transferor, the presumption arises. The 
presumption of continued control also arises where an interlock or debt 
relationship is retained between the divesting company and the company 
being divested, since the divested company will be or may be viewed as a 
subsidiary of the transferee or group of transferees.
    (2) The terms officers, directors, and trustees, as used in section 
2(g)(3), include persons performing functions normally associated with 
such positions (including general partners in a partnership and limited 
partners having a right to participate in the management of the affairs 
of the partnership) as well as persons holding such positions in an 
advisory or honorary capacity. The presumption arises not only where the 
transferee or transferred company has an officer, director or trustee in 
common with the transferor, but where the transferee himself holds such 
a position with the transferor.4 It should be noted that 
where a transfer takes the form of a pro-rata distribution, or spin-off, 
of shares to a company's shareholders, officers and directors of the 
transferor company are likely to receive a portion of such shares. The 
presumption of continued control would, of course, attach to any shares 
transferred to officers and directors of the divesting company, whether 
by spinoff or outright sale. However, the presumption will be of legal 
significance--and will thus require an application under section 
2(g)(3)--only where the total number of shares subject to the 
presumption exceeds one of the applicable thresholds in the Act. For 
example, where officers and directors of a one-bank holding company 
receive in the aggregate 25 percent or more of the stock of a bank 
subsidiary being divested by the holding company, the holding company 
would be presumed to continue to control the divested bank. In such a 
case it would be necessary for the divesting company to demonstrate that 
it no longer controls either the divested bank or the officer/director 
transferees. However, if officers and directors were to receive in the 
aggregate less than 25 percent of the bank's stock (and no other shares 
were subject to the presumption), section 2(g)(3) would not have the 
legal effect of presuming continued control of the bank. 5 In 
the case of a divestiture of nonbank shares, an application under 
section 2(g)(3) would be required whenever officers and directors of the 
divesting company received in the aggregate more than 5 percent of the 
shares of the company being divested.
---------------------------------------------------------------------------

    4 It has been suggested that the words in common with in 
section 2(g)(3) evidence an intent to make the presumption applicable 
only where the transferee is a company having an interlock with the 
transferor. Such an interpretation would, in the Board's view, create an 
unwarranted gap in the coverage of section 2(g)(3). Furthermore, because 
the presumption clearly arises where the transferee is an individual who 
is indebted to the transferor such an interpretation would result in an 
illogical internal inconsistency in the statute.
    5 Of course, the fact that section 2(g)(3) would not 
operate to presume continued control would not necessarily mean that 
control had in fact been terminated if control could be exercised 
through other means.
---------------------------------------------------------------------------

    (3) Although section 2(g)(3) refers to transfers of shares it is 
not, in the Board's view, limited to disposition of corporate stock. 
General or limited partnership interests, for example, are included 
within the term shares. Furthermore, the transfer of all or 
substantially all of the assets of a company, or the transfer of such a 
significant volume of assets that the transfer may in effect constitute 
the disposition

[[Page 137]]

of a separate activity of the company, is deemed by the Board to involve 
a transfer of shares of that company.
    (4) The term indebtedness giving rise to the presumption of 
continued control under section 2(g)(3) of the Act is not limited to 
debt incurred in connection with the transfer; it includes any debt 
outstanding at the time of transfer from the transferee to the 
transferor or its subsidiaries. However, the Board believes that not 
every kind of indebtedness was within the contemplation of the Congress 
when section 2(g)(3) was adopted. Routine business credit of limited 
amounts and loans for personal or household purposes are generally not 
the kinds of indebtedness that, standing alone, support a presumption 
that the creditor is able to control the debtor. Accordingly, the Board 
does not regard the presumption of section 2(g)(3) as applicable to the 
following categories of credit, provided the extensions of credit are 
not secured by the transferred property and are made in the ordinary 
course of business of the transferor (or its subsidiary) that is 
regularly engaged in the business of extending credit:
    (i) Consumer credit extended for personal or household use to an 
individual transferee; (ii) student loans made for the education of the 
individual transferee or a spouse or child of the transferee; (iii) a 
home mortgage loan made to an individual transferee for the purchase of 
a residence for the individual's personal use and secured by the 
residence; and (iv) loans made to companies (as defined in section 2(b) 
of the Act) in an aggregate amount not exceeding ten per cent of the 
total purchase price (or if not sold, the fair market value) of the 
transferred property. The amounts and terms of the preceding categories 
of credit should not differ substantially from similar credit extended 
in comparable circumstances to others who are not transferees. It should 
be understood that, while the statutory presumption in situations 
involving these categories of credit may not apply, the Board is not 
precluded in any case from examining the facts of a particular transfer 
and finding that the divestiture of control was ineffective based on the 
facts of record.
    (d) Section 2(g)(3) provides that a Board determination that a 
transferor is not in fact capable of controlling a transferee shall be 
made after opportunity for hearing. It has been the Board's routine 
practice since 1966 to publish notice in the Federal Register of 
applications filed under section 2(g)(3) and to offer interested parties 
an opportunity for a hearing. Virtually without exception no comments 
have been submitted on such applications by parties other than the 
applicant and, with the exception of one case in which the request was 
later withdrawn, no hearings have been requested in such cases. Because 
the Board believes that the hearing provision in section 2(g)(3) was 
intended as a protection for applicants who are seeking to have the 
presumption overcome by a Board order, a hearing would not be of use 
where an application is to be granted. In light of the experience 
indicating that the publication of Federal Register notice of such 
applications has not served a useful purpose, the Board has decided to 
alter its procedures in such cases. In the future, Federal Register 
notice of section 2(g)(3) applications will be published only in cases 
in which the Board's General Counsel, acting under delegated authority, 
has determined not to grant such an application and has referred the 
matter to the Board for decision.6

    6 It should be noted that in the event a third party should 
take exception to a Board order under section 2(g)(3) finding that 
control has been terminated, any rights such party might have would not 
be prejudiced by the order. If such party brought facts to the Board's 
attention indicating that control had not been terminated the Board 
would have ample authority to revoke its order and take necessary 
remedial action.
    Orders issued under section 2(g)(3) are published in the Federal 
Reserve ``Bulletin.''

---------------------------------------------------------------------------
(12 U.S.C. 1841, 1844)

[43 FR 6214, Feb. 14, 1978; 43 FR 15147, Apr. 11, 1978; 43 FR 15321, 
Apr. 12, 1978, as amended at 45 FR 8280, Feb. 7, 1980; 45 FR 11125, Feb. 
20, 1980]



Sec. 225.140  Disposition of property acquired in satisfaction of debts previously contracted.

    (a) The Board recently considered the permissibility, under section 
4 of the

[[Page 138]]

Bank Holding Company Act, of a subsidiary of a bank holding company 
acquiring and holding assets acquired in satisfaction of a debt 
previously contracted in good faith (a ``dpc'' acquisition). In the 
situation presented, a lending subsidiary of a bank holding company made 
a ``dpc'' acquisition of assets and transferred them to a wholly-owned 
subsidiary of the bank holding company for the purpose of effecting an 
orderly divestiture. The question presented was whether such ``dpc'' 
assets could be held indefinitely by a bank holding company subsidiary 
as incidental to its permissible lending activity.
    (b) While the Board believes that ``dpc'' acquisitions may be 
regarded as normal, necessary and incidental to the business of lending, 
the Board does not believe that the holding of assets acquired ``dpc'' 
without any time restrictions is appropriate from the standpoint of 
prudent banking and in light of the prohibitions in section 4 of the Act 
against engaging in nonbank activities. If a nonbanking subsidiary of a 
bank holding company were permitted, either directly or through a 
subsidiary, to hold ``dpc'' assets of substantial amount over an 
extended period of time, the holding of such property could result in an 
unsafe or unsound banking practice or in the holding company engaging in 
an impermissible activity in connection with the assets, rather than 
liquidating them.
    (c) The Board notes that section 4(c)(2) of the Bank Holding Company 
Act provides an exemption from the prohibitions of section 4 of the Act 
for bank holding company subsidiaries to acquire shares ``dpc''. It also 
provides that such ``dpc'' shares may be held for a period of two years, 
subject to the Board's authority to grant three one-year extensions up 
to a maximum of five years.1 Viewed in light of the 
Congressional policy evidenced by section 4(c)(2), the Board believes 
that a lending subsidiary of a bank holding company or the holding 
company itself, should be permitted, as an incident to permissible 
lending activities, to make acquisitions of ``dpc'' assets. Consistent 
with the principles underlying the provisions of section 4(c)(2) of the 
Act and as a matter of prudent banking practice, such assets may be held 
for no longer than five years from the date of acquisition. Within the 
divestiture period it is expected that the company will make good faith 
efforts to dispose of ``dpc'' shares or assets at the earliest 
practicable date. While no specific authorization is necessary to hold 
such assets for the five-year period, after two years from the date of 
acquisition of such assets, the holding company should report annually 
on its efforts to accomplish divestiture to its Reserve Bank. The 
Reserve Bank will monitor the efforts of the company to effect an 
orderly divestiture, and may order divestiture before the end of the 
five-year period if supervisory concerns warrant such action.
---------------------------------------------------------------------------

    1 The Board notes that where the dpc shares or other 
similar interests represent less than 5 percent of the total of such 
interests outstanding, they may be retained on the basis of section 
4(c)(6), even if originally acquired dpc.
---------------------------------------------------------------------------

    (d) The Board recognizes that there are instances where a company 
may encounter particular difficulty in attempting to effect an orderly 
divestiture of ``dpc'' real estate holdings within the divestiture 
period, notwithstanding its persistent good faith efforts to dispose of 
such property. In the Depository Institutions Deregulation and Monetary 
Control Act of 1980, (Pub. L. 96-221) Congress, recognizing that real 
estate possesses unusual characteristics, amended the National Banking 
Act to permit national banks to hold real estate for five years and for 
an additional five-year period subject to certain conditions. Consistent 
with the policy underlying the recent Congressional enactment, and as a 
matter of supervisory policy, a bank holding company may be permitted to 
hold real estate acquired ``dpc'' beyond the initial five-year period 
provided that the value of the real estate on the books of the company 
has been written down to fair market value, the carrying costs are not 
significant in relation to the overall financial position of the 
company, and the company has made good faith efforts to effect 
divestiture. Companies holding real estate for this extended period are 
expected to make active efforts to dispose of it, and should keep the 
Reserve Bank advised

[[Page 139]]

on a regular basis concerning their ongoing efforts. Fair market value 
should be derived from appraisals, comparable sales or some other 
reasonable method. In any case, ``dpc'' real estate would not be 
permitted to be held beyond 10 years from the date of its acquisition.
    (e) With respect to the transfer by a subsidiary of other ``dpc'' 
shares or assets to another company in the holding company system, 
including a section 4(c)(1)(D) liquidating subsidiary, or to the holding 
company itself, such transfers would not alter the original divestiture 
period applicable to such shares or assets at the time of their 
acquisition. Moreover, to ensure that assets are not carried at inflated 
values for extended periods of time, the Board expects, in the case of 
all such intracompany transfers, that the shares or assets will be 
transferred at a value no greater than the fair market value at the time 
of transfer and that the transfer will be made in a normal arms-length 
transaction.
    (f) With regard to ``dpc'' assets acquired by a banking subsidiary 
of a holding company, so long as the assets continue to be held by the 
bank itself, the Board will regard them as being solely within the 
regulatory authority of the primary supervisor of the bank.

(12 U.S.C. 1843 (c)(1)(d), (c)(2), (c)(8), and 1844 (b); 12 U.S.C. 1818)

[45 FR 49905, July 28, 1980]



Sec. 225.141  Operations subsidiaries of a bank holding company.

    In orders approving the retention by a bank holding company of a 
4(c)(8) subsidiary, the Board has stated that it would permit, without 
any specific regulatory approval, the formation of a wholly owned 
subsidiary of an approved 4(c)(8) company to engage in activities that 
such a company could itself engage in directly through a division or 
department. (Northwestern Financial Corporation, 65 Federal Reserve 
Bulletin 566 (1979).) Section 4(a)(2) of the Act provides generally that 
a bank holding company may engage directly in the business of managing 
and controlling banks and permissible nonbank activities, and in 
furnishing services directly to its subsidiaries. Even though section 4 
of the Act generally prohibits the acquisition of shares of nonbanking 
organizations, the Board does not believe that such prohibition should 
apply to the formation by a holding company of a wholly-owned subsidiary 
to engage in activities that it could engage in directly. Accordingly, 
as a general matter, the Board will permit without any regulatory 
approval a bank holding company to form a wholly-owned subsidiary to 
perform servicing activities for subsidiaries that the holding company 
itself could perform directly or through a department or a division 
under section 4(a)(2) of the Act. The Board believes that permitting 
this type of subsidiary is not inconsistent with the nonbanking 
prohibitions of section 4 of the Act, and is consistent with the 
authority in section 4(c)(1)(C) of the Act, which permits a bank holding 
company, without regulatory approval, to form a subsidiary to perform 
services for its banking subsidiaries. The Board notes, however, that a 
servicing subsidiary established by a bank holding company in reliance 
on this interpretation will be an affiliate of the subsidiary bank of 
the holding company for the purposes of the lending restrictions of 
section 23A of the Federal Reserve Act. (12 U.S.C. 371c)

(12 U.S.C. 1843(a)(2) and 1844(b))

[45 FR 54326, July 15, 1980]



Sec. 225.142  Statement of policy concerning bank holding companies engaging in futures, forward and options contracts on U.S. Government and agency securities 
          and money market instruments.

    (a) Purpose of financial contract positions. In supervising the 
activities of bank holding companies, the Board has adopted and 
continues to follow the principle that bank holding companies should 
serve as a source of strength for their subsidiary banks. Accordingly, 
the Board believes that any positions that bank holding companies or 
their nonbank subsidiaries take in financial contracts should reduce 
risk exposure, that is, not be speculative.
    (b) Establishment of prudent written policies, appropriate 
limitations and internal controls and audit programs. If the parent 
organization or nonbank subsidiary is taking or intends to take 
positions in financial contracts, that

[[Page 140]]

company's board of directors should approve prudent written policies and 
establish appropriate limitations to insure that financial contract 
activities are performed in a safe and sound manner with levels of 
activity reasonably related to the organization's business needs and 
capacity to fulfill obligations. In addition, internal controls and 
internal audit programs to monitor such activity should be established. 
The board of directors, a duly authorized committee thereof or the 
internal auditors should review periodically (at least monthly) all 
financial contract positions to insure conformity with such policies and 
limits. In order to determine the company's exposure, all open positions 
should be reviewed and market values determined at least monthly, or 
more often, depending on volume and magnitude of positions.
    (c) Formulating policies and recording financial contracts. In 
formulating its policies and procedures, the parent holding company may 
consider the interest rate exposure of its nonbank subsidiaries, but not 
that of its bank subsidiaries. As a matter of policy, the Board believes 
that any financial contracts executed to reduce the interest rate 
exposure of a bank affiliate of a holding company should be reflected on 
the books and records of the bank affiliate (to the extent required by 
the bank policy statements), rather than on the books and records of the 
parent company. If a bank has an interest rate exposure that management 
believes requires hedging with financial contracts, the bank should be 
the direct beneficiary of any effort to reduce that exposure. The Board 
also believes that final responsibility for financial contract 
transactions for the account of each affiliated bank should reside with 
the management of that bank.
    (d) Accounting. The joint bank policy statements of March 12, 1980 
include accounting guidelines for banks that engage in financial 
contract activities. Since the Financial Accounting Standards Board is 
presently considering accounting standards for contract activities, no 
specific accounting requirements for financial contracts entered into by 
parent bank holding companies and nonbank subsidiaries are being 
mandated at this time. The Board expects to review further developments 
in this area.
    (e) Board to monitor bank holding company transactions in financial 
contracts. The Board intends to monitor closely bank holding company 
transactions in financial contracts to ensure that any such activity is 
consistent with maintaining a safe and sound banking system. In any 
cases where bank holding companies are found to be engaging in 
speculative practices, the Board is prepared to institute appropriate 
action under the Financial Institutions Supervisory Act of 1966, as 
amended.
    (f) Federal Reserve Bank notification. Bank holding companies should 
furnish written notification to their District Federal Reserve Bank 
within 10 days after financial contract activities are begun by the 
parent or a nonbank subsidiary. Holding companies in which the parent or 
a nonbank subsidiary currently engage in financial contract activity 
should furnish notice by March 31, 1983.

(Secs. 5(b) and 8 of the Bank Holding Company Act (12 U.S.C. 1844 and 
1847); sec. 8(b) of the Financial Institutions Supervisory Act (12 
U.S.C. 1818(b))

[48 FR 7720, Feb. 24, 1983]



Sec. 225.143  Policy statement on nonvoting equity investments by bank holding companies.

    (a) Introduction. (1) In recent months, a number of bank holding 
companies have made substantial equity investments in a bank or bank 
holding company (the ``acquiree'') located in states other than the home 
state of the investing company through acquisition of preferred stock or 
nonvoting common shares of the acquiree. Because of the evident interest 
in these types of investments and because they raise substantial 
questions under the Bank Holding Company Act (the ``Act''), the Board 
believes it is appropriate to provide guidance regarding the consistency 
of such arrangements with the Act.
    (2) This statement sets out the Board's concerns with these 
investments, the considerations the Board will take into account in 
determining whether the investments are consistent with the Act, and the 
general scope of

[[Page 141]]

arrangements to be avoided by bank holding companies. The Board 
recognizes that the complexity of legitimate business arrangements 
precludes rigid rules designed to cover all situations and that 
decisions regarding the existence or absence of control in any 
particular case must take into account the effect of the combination of 
provisions and covenants in the agreement as a whole and the particular 
facts and circumstances of each case. Nevertheless, the Board believes 
that the factors outlined in this statement provide a framework for 
guiding bank holding companies in complying with the requirements of the 
Act.
    (b) Statutory and regulatory provisions. (1) Under section 3(a) of 
the Act, a bank holding company may not acquire direct or indirect 
ownership or control of more than 5 per cent of the voting shares of a 
bank without the Board's prior approval. (12 U.S.C. 1842(a)(3)). In 
addition, this section of the Act provides that a bank holding company 
may not, without the Board's prior approval, acquire control of a bank: 
That is, in the words of the statute, ``for any action to be taken that 
causes a bank to become a subsidiary of a bank holding company.'' (12 
U.S.C. 1842(a)(2)). Under the Act, a bank is a subsidiary of a bank 
holding company if:
    (i) The company directly or indirectly owns, controls, or holds with 
power to vote 25 per cent or more of the voting shares of the bank;
    (ii) The company controls in any manner the election of a majority 
of the board of directors of the bank; or
    (iii) The Board determines, after notice and opportunity for 
hearing, that the company has the power, directly or indirectly, to 
exercise a controlling influence over the management or policies of the 
bank. (12 U.S.C. 1841(d)).
    (2) In intrastate situations, the Board may approve bank holding 
company acquisitions of additional banking subsidiaries. However, where 
the acquiree is located outside the home state of the investing bank 
holding company, section 3(d) of the Act prevents the Board from 
approving any application that will permit a bank holding company to 
``acquire, directly or indirectly, any voting shares of, interest in, or 
all or substantially all of the assets of any additional bank.'' (12 
U.S.C. 1842(d)(1)).
    (c) Review of agreements. (1) In apparent expectation of statutory 
changes that might make interstate banking permissible, bank holding 
companies have sought to make substantial equity investments in other 
bank holding companies across state lines, but without obtaining more 
than 5 per cent of the voting shares or control of the acquiree. These 
investments involve a combination of the following arrangements:
    (i) Options on, warrants for, or rights to convert nonvoting shares 
into substantial blocks of voting securities of the acquiree bank 
holding company or its subsidiary bank(s);
    (ii) Merger or asset acquisition agreements with the out-of-state 
bank or bank holding company that are to be consummated in the event 
interstate banking is permitted;
    (iii) Provisions that limit or restrict major policies, operations 
or decisions of the acquiree; and
    (iv) Provisions that make acquisition of the acquiree or its 
subsidiary bank(s) by a third party either impossible or economically 
impracticable.

The various warrants, options, and rights are not exercisable by the 
investing bank holding company unless interstate banking is permitted, 
but may be transferred by the investor either immediately or after the 
passage of a period of time or upon the occurrence of certain events.
    (2) After a careful review of a number of these agreements, the 
Board believes that investments in nonvoting stock, absent other 
arrangements, can be consistent with the Act. Some of the agreements 
reviewed appear consistent with the Act since they are limited to 
investments of relatively moderate size in nonvoting equity that may 
become voting equity only if interstate banking is authorized.
    (3) However, other agreements reviewed by the Board raise 
substantial problems of consistency with the control provisions of the 
Act because the investors, uncertain whether or when interstate banking 
may be authorized, have evidently sought to assure the soundness of 
their investments, prevent takeovers by others, and allow for

[[Page 142]]

sale of their options, warrants, or rights to a person of the investor's 
choice in the event a third party obtains control of the acquiree or the 
investor otherwise becomes dissatisfied with its investment. Since the 
Act precludes the investors from protecting their investments through 
ownership or use of voting shares or other exercise of control, the 
investors have substituted contractual agreements for rights normally 
achieved through voting shares.
    (4) For example, various covenants in certain of the agreements seek 
to assure the continuing soundness of the investment by substantially 
limiting the discretion of the acquiree's management over major policies 
and decisions, including restrictions on entering into new banking 
activities without the investor's approval and requirements for 
extensive consultations with the investor on financial matters. By their 
terms, these covenants suggest control by the investing company over the 
management and policies of the acquiree.
    (5) Similarly, certain of the agreements deprive the acquiree bank 
holding company, by covenant or because of an option, of the right to 
sell, transfer, or encumber a majority or all of the voting shares of 
its subsidiary bank(s) with the aim of maintaining the integrity of the 
investment and preventing takeovers by others. These long-term 
restrictions on voting shares fall within the presumption in the Board's 
Regulation Y that attributes control of shares to any company that 
enters into any agreement placing long-term restrictions on the rights 
of a holder of voting securities. (12 CFR 225.2(b)(4)).
    (6) Finally, investors wish to reserve the right to sell their 
options, warrants or rights to a person of their choice to prevent being 
locked into what may become an unwanted investment. The Board has taken 
the position that the ability to control the ultimate disposition of 
voting shares to a person of the investor's choice and to secure the 
economic benefits therefrom indicates control of the shares under the 
Act.1 Moreover, the ability to transfer rights to large 
blocks of voting shares, even if nonvoting in the hands of the investing 
company, may result in such a substantial position of leverage over the 
management of the acquiree as to involve a structure that inevitably 
results in control prohibited by the Act.
---------------------------------------------------------------------------

    1 See Board letter dated March 18, 1982, to C. A. 
Cavendes, Sociedad Financiera.
---------------------------------------------------------------------------

    (d) Provisions that avoid control. (1) In the context of any 
particular agreement, provisions of the type described above may be 
acceptable if combined with other provisions that serve to preclude 
control. The Board believes that such agreements will not be consistent 
with the Act unless provisions are included that will preserve 
management's discretion over the policies and decisions of the acquiree 
and avoid control of voting shares.
    (2) As a first step towards avoiding control, covenants in any 
agreement should leave management free to conduct banking and 
permissible nonbanking activities. Another step to avoid control is the 
right of the acquiree to ``call'' the equity investment and options or 
warrants to assure that covenants that may become inhibiting can be 
avoided by the acquiree. This right makes such investments or agreements 
more like a loan in which the borrower has a right to escape covenants 
and avoid the lender's influence by prepaying the loan.
    (3) A measure to avoid problems of control arising through the 
investor's control over the ultimate disposition of rights to 
substantial amounts of voting shares of the acquiree would be a 
provision granting the acquiree a right of first refusal before 
warrants, options or other rights may be sold and requiring a public and 
dispersed distribution of these rights if the right of first refusal is 
not exercised.
    (4) In this connection, the Board believes that agreements that 
involve rights to less than 25 percent of the voting shares, with a 
requirement for a dispersed public distribution in the event of sale, 
have a much greater prospect of achieving consistency with the Act than 
agreements involving a greater percentage. This guideline is drawn by 
analogy from the provision in the Act that ownership of 25 percent or 
more of the voting securities of a bank constitutes control of the bank.

[[Page 143]]

    (5) The Board expects that one effect of this guideline would be to 
hold down the size of the nonvoting equity investment by the investing 
company relative to the acquiree's total equity, thus avoiding the 
potential for control because the investor holds a very large proportion 
of the acquiree's total equity. Observance of the 25 percent guideline 
will also make provisions in agreements providing for a right of first 
refusal or a public and widely dispersed offering of rights to the 
acquiree's shares more practical and realistic.
    (6) Finally, certain arrangements should clearly be avoided 
regardless of other provisions in the agreement that are designed to 
avoid control. These are:
    (i) Agreements that enable the investing bank holding company (or 
its designee) to direct in any manner the voting of more than 5 per cent 
of the voting shares of the acquiree;
    (ii) Agreements whereby the investing company has the right to 
direct the acquiree's use of the proceeds of an equity investment by the 
investing company to effect certain actions, such as the purchase and 
redemption of the acquiree's voting shares; and
    (iii) The acquisition of more than 5 per cent of the voting shares 
of the acquiree that ``simultaneously'' with their acquisition by the 
investing company become nonvoting shares, remain nonvoting shares while 
held by the investor, and revert to voting shares when transferred to a 
third party.
    (e) Review by the Board. This statement does not constitute the 
exclusive scope of the Board's concerns, nor are the considerations with 
respect to control outlined in this statement an exhaustive catalog of 
permissible or impermissible arrangements. The Board has instructed its 
staff to review agreements of the kind discussed in this statement and 
to bring to the Board's attention those that raise problems of 
consistency with the Act. In this regard, companies are requested to 
notify the Board of the terms of such proposed merger or asset 
acquisition agreements or nonvoting equity investments prior to their 
execution or consummation.

[47 FR 30966, July 16, 1982]



Sec. 225.145  Limitations established by the Competitive Equality Banking Act of 1987 on the activities and growth of nonbank banks.

    (a) Introduction. Effective August 10, 1987, the Competitive 
Equality Banking Act of 1987 (``CEBA'') redefined the term ``bank'' in 
the Bank Holding Company Act (``BHC Act'' or ``Act'') to include any 
bank the deposits of which are insured by the Federal Deposit Insurance 
Corporation as well as any other institution that accepts demand or 
checkable deposit accounts and is engaged in the business of making 
commercial loans. 12 U.S.C. 1841(c). CEBA also contained a grandfather 
provision for certain companies affected by this redefinition. CEBA 
amended section 4 of the BHC Act to permit a company that on March 5, 
1987, controlled a nonbank bank (an institution that became a bank as a 
result of enactment of CEBA) and that was not a bank holding company on 
August 9, 1987, to retain its nonbank bank and not be treated as a bank 
holding company for purposes of the BHC Act if the company and its 
subsidiary nonbank bank observe certain limitations imposed by CEBA.\1\ 
Certain of these limitations are codified in section 4(f)(3) of the BHC 
Act and generally restrict nonbank banks from commencing new activities 
or certain cross-marketing activities with affiliates after March 5, 
1987, or permitting overdrafts for affiliates or incurring overdrafts on 
behalf of affiliates at a Federal Reserve Bank. 12 U.S.C. 1843(f)(3).\2\ 
The Board's views regarding

[[Page 144]]

the meaning and scope of these limitations are set forth below and in 
provisions of the Board's Regulation Y (12 CFR 225.52).
---------------------------------------------------------------------------

    \1\ 12 U.S.C. 1843(f). Such a company is treated as a bank holding 
company, however, for purposes of the anti-tying provisions in section 
106 of the BHC Act Amendments of 1970 (12 U.S.C. 1971 et seq.) and the 
insider lending limitations of secton 22(h) of the Federal Reserve Act 
(12 U.S.C. 375b). The company is also subject to certain examination and 
enforcement provisions to assure compliance with CEBA.
    \2\ CEBA also prohibits, with certain limited exceptions, a company 
controlling a grandfathered nonbank bank from acquiring control of an 
additional bank or thrift institution or acquiring, directly or 
indirectly after March 5, 1987, more than 5 percent of the assets or 
shares of a bank or thrift institution. 12 U.S.C. 1843(f)(2).
---------------------------------------------------------------------------

    (b) Congressional findings. (1) At the outset, the Board notes that 
the scope and application of the Act's limitations on nonbank banks must 
be guided by the Congressional findings set out in section 4(f)(3) of 
the BHC Act. Congress was aware that these nonbank banks had been 
acquired by companies that engage in a wide range of nonbanking 
activities, such as retailing and general securities activities that are 
forbidden to bank holding companies under section 4 of the BHC Act. In 
section 4(f)(3), Congress found that nonbank banks controlled by 
grandfathered nonbanking companies may, because of their relationships 
with affiliates, be involved in conflicts of interest, concentration of 
resources, or other effects adverse to bank safety and soundness. 
Congress also found that nonbank banks may be able to compete unfairly 
against banks controlled by bank holding companies by combining banking 
services with financial services not permissible for bank holding 
companies. Section 4(f)(3) states that the purpose of the nonbank bank 
limitations is to minimize any such potential adverse effects or 
inequities by restricting the activities of nonbank banks until further 
Congressional action in the area of bank powers could be undertaken. 
Similarly, the Senate Report accompanying CEBA states that the 
restrictions CEBA places on nonbank banks ``will help prevent existing 
nonbank banks from changing their basic character * * * while Congress 
considers proposals for comprehensive legislation; from drastically 
eroding the separation of banking and commerce; and from increasing the 
potential for unfair competition, conflicts of interest, undue 
concentration of resources, and other adverse effects.'' S. Rep. No. 
100-19, 100th Cong., 1st Sess. 12 (1987). See also H. Rep. No. 100-261, 
100th Cong., 1st Sess. 124 (1987) (the ``Conference Report'').
    (2) Thus, Congress explicitly recognized in the statute itself that 
nonbanking companies controlling grandfathered nonbank banks, which 
include the many of the nation's largest commercial and financial 
organizations, were being accorded a significant competitive advantage 
that could not be matched by bank holding companies because of the 
general prohibition against nonbanking activities in section 4 of the 
BHC Act. Congress recognized that this inequality in regulatory approach 
could inflict serious competitive harm on regulated bank holding 
companies as the grandfathered entities sought to exploit potential 
synergies between banking and commercial products and services. See 
Conference Report at 125-126. The basic and stated purpose of the 
restrictions on grandfathered nonbank banks is to minimize these 
potential anticompetitive effects.
    (3) The Board believes that the specific CEBA limitations should be 
implemented in light of these Congressional findings and the legislative 
intent reflected in the plain meaning of the terms used in the statute. 
In those instances when the language of the statute did not provide 
clear guidance, legislative materials and the Congressional intent 
manifested in the overall statutory structure were considered. The Board 
also notes that prior precedent requires that grandfather exceptions in 
the BHC Act, such as the nonbank bank limitations and particularly the 
exceptions thereto, are to be interpreted narrowly in order to ensure 
the proper implementation of Congressional intent.\3\
---------------------------------------------------------------------------

    \3\ E.g., Maryland National Corporation, 73 Federal Reserve Bulletin 
310, 313-314 (1987). Cf., Spokane & Inland Empire Railroad Co. v. United 
States, 241 U.S. 344, 350 (1915).
---------------------------------------------------------------------------

    (c) Activity limitation--(1) Scope of activity. (i) The first 
limitation established under section 4(f)(3) provides that a nonbank 
bank shall not ``engage in any activity in which such bank was not 
lawfully engaged as of March 5, 1987.'' The term activity as used in 
this provision of CEBA is not defined. The structure and placement of 
the CEBA activity restriction within section 4 of the BHC Act and its 
legislative history do, however, provide direction as to certain 
transactions that Congress intended to treat as separate activities, 
thereby providing guidance as to the meaning Congress intended to 
ascribe

[[Page 145]]

to the term generally. First, it is clear that the term activity was not 
meant to refer to banking as a single activity. To the contrary, the 
term must be viewed as distinguishing between deposit taking and lending 
activities and treating demand deposit-taking as a separate activity 
from general deposit-taking and commercial lending as separate from the 
general lending category.
    (ii) Under the activity limitation, a nonbank bank may engage only 
in activities in which it was ``lawfully engaged'' as of March 5, 1987. 
As of that date, a nonbank bank could not have been engaged in both 
demand deposit-taking and commercial lending activity without placing it 
and its parent holding company in violation of the BHC Act. Thus, under 
the activity limitations, a nonbank bank could not after March 5, 1987, 
commence the demand deposit-taking or commercial lending activity that 
it did not conduct as of March 5, 1987. The debates and Senate and 
Conference Reports on CEBA confirm that Congress intended the activity 
limitation to prevent a grandfathered nonbank bank from converting 
itself into a full-service bank by both offering demand deposits and 
engaging in the business of making commercial loans.\4\ Thus, these 
types of transactions provide a clear guide as to the type of banking 
transactions that would constitute activities under CEBA and the degree 
of specificity intended by Congress in interpreting that term.
---------------------------------------------------------------------------

    \4\ Conference Report at 124-25; S. Rep. No. 100-19 at 12, 32; H. 
Rep. No. 99-175, 99th Cong., 1st Sess. 3 (1985) (``the activities 
limitation is to prevent an institution engaged in a limited range of 
functions from expanding into new areas and becoming, in essence, a 
full-service bank''); 133 Cong. Rec. S4054 (daily ed. March 27, 1987); 
(Comments of Senator Proxmire).
---------------------------------------------------------------------------

    (iii) It is also clear that the activity limitation was not intended 
simply to prevent a nonbank bank from both accepting demand deposits and 
making commercial loans; it has a broader scope and purpose. If Congress 
had meant the term to refer to just these two activities, it would have 
used the restriction it used in another section of CEBA dealing with 
nonbank banks owned by bank holding companies which has this result, 
i.e., the nonbank bank could not engage in any activity that would have 
caused it to become a bank under the prior bank definition in the Act. 
See 12 U.S.C. 1843(g)(1)(A). Indeed, an earlier version of CEBA under 
consideration by the Senate Banking Committee contained such a provision 
for nonbank banks owned by commercial holding companies, which was 
deleted in favor of the broader activity limitation actually enacted. 
Committee Print No. 1, (Feb. 17, 1987). In this regard, both the Senate 
Report and Conference Report refer to demand deposit-taking and 
commercial lending as examples of activities that could be affected by 
the activity limitation, not as the sole activities to be limited by the 
provision.\5\
---------------------------------------------------------------------------

    \5\ Conference Report at 124-125; S. Rep. No. 100-19 at 32.
---------------------------------------------------------------------------

    (iv) Finally, additional guidance as to the meaning of the term 
activity is provided by the statutory context in which the term appears. 
The activity limitation is contained in section 4 of the BHC Act, which 
regulates the investments and activities of bank holding companies and 
their nonbank subsidiaries. The Board believes it reasonable to conclude 
that by placing the CEBA activity limitation in section 4 of the BHC 
Act, Congress meant that Board and judicial decisions regarding the 
meaning of the term activity in that section be looked to for guidance. 
This is particularly appropriate given the fact that grandfathered 
nonbank banks, whether owned by bank holding companies or unregulated 
holding companies, were treated as nonbank companies and not banks 
before enactment of CEBA.
    (v) This interpretation of the term activity draws support from 
comments by Senator Proxmire during the Senate's consideration of the 
provision that the term was not intended to apply ``on a product-by-
product, customer-by-customer basis.'' 133 Cong. Rec. S4054-5 (daily ed. 
March 27, 1987). This is the same manner in which the Board has 
interpreted the term activity in the nonbanking provision of section 4 
as referring to generic categories

[[Page 146]]

of activities, not to discrete products and services.
    (vi) Accordingly, consistent with the terms and purposes of the 
legislation and the Congressional intent to minimize unfair competition 
and the other adverse effects set out in the CEBA findings, the Board 
concludes that the term activity as used in section 4(f)(3) means any 
line of banking or nonbanking business. This definition does not, 
however, envision a product-by-product approach to the activity 
limitation. The Board believes it would be helpful to describe the 
application of the activity limitation in the context of the following 
major categories of activities: deposit-taking, lending, trust, and 
other activities engaged in by banks.
    (2) Deposit-taking activities. (i) With respect to deposit-taking, 
the Board believes that the activity limitation in section 4(f)(3) 
generally refers to three types of activity: demand deposit-taking; non-
demand deposit-taking with a third party payment capability; and time 
and savings deposit-taking without third party payment powers. As 
previously discussed, it is clear from the terms and intent of CEBA that 
the activity limitation would prevent, and was designed to prevent, 
nonbank banks that prior to the enactment of CEBA had refrained from 
accepting demand deposits in order to avoid coverage as a bank under the 
BHC Act, from starting to take these deposits after enactment of CEBA 
and thus becoming full-service banks. Accordingly, CEBA requires that 
the taking of demand deposits be treated as a separate activity.
    (ii) The Board also considers nondemand deposits withdrawable by 
check or other similar means for payment to third parties or others to 
constitute a separate line of business for purposes of applying the 
activity limitation. In this regard, the Board has previously recognized 
that this line of businesss constitutes a permissible but separate 
activity under section 4 of the BHC Act. Furthermore, the offering of 
accounts with transaction capability requires different expertise and 
systems than non-transaction deposit-taking and represented a distinct 
new activity that traditionally separated banks from thrift and similar 
institutions.
    (iii) Support for this view may also be found in the House Banking 
Committee report on proposed legislation prior to CEBA that contained a 
similar prohibition on new activities for nonbank banks. In discussing 
the activity limitation, the report recognized a distinction between 
demand deposits and accounts with transaction capability and those 
without transaction capability:

    With respect to deposits, the Committee recognizes that it is 
legitimate for an institution currently involved in offering demand 
deposits or other third party transaction accounts to make use of new 
technologies that are in the process of replacing the existing check-
based, paper payment system. Again, however, the Committee does not 
believe that technology should be used as a lever for an institution 
that was only incidentally involved in the payment system to transform 
itself into a significant offeror of transaction account capability.\6\
---------------------------------------------------------------------------

    \6\ H. Rep. No. 99-175, 99th Cong., 1st Sess. 13 (1985).
---------------------------------------------------------------------------

    (iv) Finally, this distinction between demand and nondemand 
checkable accounts and accounts not subject to withdrawal by check was 
specifically recognized by Congress in the redefinition of the term bank 
in CEBA to include an institution that takes demand deposits or 
``deposits that the depositor may withdraw by check or other means for 
payment to third parties or others'' as well as in various exemptions 
from that definition for trust companies, credit card banks, and certain 
industrial banks.\7\
---------------------------------------------------------------------------

    \7\ See 12 U.S.C. 1841(c)(2) (D), (F), (H), and (I).
---------------------------------------------------------------------------

    (v) Thus, an institution that as of March 5, 1987, offered only time 
and savings accounts that were not withdrawable by check for payment to 
third parties could not thereafter begin offering accounts with 
transaction capability, for example, NOW accounts or other types of 
transaction accounts.
    (3) Lending. As noted, the CEBA activity limitation does not treat 
lending as a single activity; it clearly distinguishes between 
commercial and other types of lending. This distinction is also 
reflected in the definition of bank in the BHC Act in effect both prior 
to

[[Page 147]]

and after enactment of CEBA as well as in various of the exceptions from 
this definition. In addition, commercial lending is a specialized form 
of lending involving different techniques and analysis from other types 
of lending. Based upon these factors, the Board would view commercial 
lending as a separate and distinct activity for purposes of the activity 
limitation in section 4(f)(3). The Board's decisions under section 4 of 
the BHC Act have not generally differentiated between types of 
commercial lending, and thus the Board would view commercial lending as 
a single activity for purposes of CEBA. Thus, a nonbank bank that made 
commercial loans as of March 5, 1987, could make any type of commercial 
loan thereafter.
    (i) Commercial lending. For purposes of the activity limitation, a 
commercial loan is defined in accordance with the Supreme Court's 
decision in Board of Governors v. Dimension Financial Corporation, 474 
U.S. 361 (1986), as a direct loan to a business customer for the purpose 
of providing funds for that customer's business. In this regard, the 
Board notes that whether a particular transaction is a commercial loan 
must be determined not from the face of the instrument, but from the 
application of the definition of commercial loan in the Dimension 
decision to that transaction. Thus, certain transactions of the type 
mentioned in the Board's ruling at issue in Dimension and in the Senate 
and Conference Reports in the CEBA legislation \8\ would be commercial 
loans if they meet the test for commercial loans established in 
Dimension. Under this test, a commercial loan would not include, for 
example, an open-market investment in a commercial entity that does not 
involve a borrower-lender relationship or negotiation of credit terms, 
such as a money market transaction.
---------------------------------------------------------------------------

    \8\ S. Rep. No. 100-19 at 31; Conference Report at 123.
---------------------------------------------------------------------------

    (ii) Other lending. Based upon the guidance in the Act as to the 
degree of specificity required in applying the activity limitation with 
respect to lending, the Board believes that, in addition to commercial 
lending, there are three other types of lending activities: consumer 
mortgage lending, consumer credit card lending, and other consumer 
lending. Mortgage lending and credit card lending are recognized, 
discrete lines of banking and business activity, involving techniques 
and processes that are different from and more specialized than those 
required for general consumer lending. For example, these activities 
are, in many cases, conducted by specialized institutions, such as 
mortgage companies and credit card institutions, or through separate 
organizational structures within an institution, particularly in the 
case of mortgage lending. Additionally, the Board's decisions under 
section 4 of the Act have recognized mortgage banking and credit card 
lending as separate activities for bank holding companies. The Board's 
Regulation Y reflects this specialization, noting as examples of 
permissible lending activity: consumer finance, credit card and mortgage 
lending. 12 CFR 225.25(b)(1). Finally, CEBA itself recognizes the 
specialized nature of credit card lending by exempting an institution 
specializing in that activity from the bank definition. For purpose of 
the activity limitation, a consumer mortgage loan will mean any loan to 
an individual that is secured by real estate and that is not a 
commercial loan. A credit card loan would be any loan made to an 
individual by means of a credit card that is not a commercial loan.
    (4) Trust activities. Under section 4 of the Act, the Board has 
historically treated trust activities as a single activity and has not 
differentiated the function on the basis of whether the customer was an 
individual or a business. See 12 CFR 225.25(b)(3). Similarly, the trust 
company exemption from the bank definition in CEBA makes no distinction 
between various types of trust activities. Accordingly, the Board would 
view trust activities as a separate activity without additional 
differentiation for purposes of the activity limitation in section 
4(f)(3).
    (5) Other activities. With respect to activities other than the 
various traditional deposit-taking, lending or trust activities, the 
Board believes it appropriate, for the reasons discussed above,

[[Page 148]]

to apply the activity limitation in section 4(f)(3) as the term activity 
generally applies in other provisions of section 4 of the BHC Act. Thus, 
a grandfathered nonbank bank could not, for example, commence after 
March 5, 1987, any of the following activities (unless it was engaged in 
such an activity as of that date): discount securities brokerage, full-
service securities brokerage investment advisory services, underwriting 
or dealing in government securities as permissible for member banks, 
foreign exchange transaction services, real or personal property 
leasing, courier services, data processing for third parties, insurance 
agency activities,\9\ real estate development, real estate brokerage, 
real estate syndication, insurance underwriting, management consulting, 
futures commission merchant, or activities of the general type listed in 
Sec. 225.25(b) of Regulation Y.
---------------------------------------------------------------------------

    \9\ In this area, section 4 of the Act does not treat all insurance 
agency activities as a single activity. Thus, for example, the Act 
treats the sale of credit-related life, accident and health insurance as 
a separate activity from general insurance agency activities. See 12 
U.S.C. 1843(c)(8).
---------------------------------------------------------------------------

    (6) Meaning of engaged in. In order to be engaged in an activity, a 
nonbank bank must demonstrate that it had a program in place to provide 
a particular product or service included within the grandfathered 
activity to a customer and that it was in fact offering the product or 
service to customers as of March 5, 1987. Thus, a nonbank bank is not 
engaged in an activity as of March 5, 1987, if the product or service in 
question was in a planning state as of that date and had not been 
offered or delivered to a customer. Consistent with prior Board 
interpretations of the term activity in the grandfather provisions of 
section 4, the Board does not believe that a company may be engaged in 
an activity on the basis of a single isolated transaction that was not 
part of a program to offer the particular product or to conduct in the 
activity on an ongoing basis. For example, a nonbank bank that held an 
interest in a single real estate project would not thereby be engaged in 
real estate development for purposes of this provision, unless evidence 
was presented indicating the interest was held under a program to 
commence a real estate development business.
    (7) Meaning of as of The Board believes that the grandfather date 
``as of March 5, 1987'' as used throughout section 4(f)(3) should refer 
to activities engaged in on March 5, 1987, or a reasonably short period 
preceding this date not exceeding 13 months. 133 Cong. Rec. S3957 (daily 
ed. March 26, 1987). (Remarks of Senators Dodd and Proxmire). Activities 
that the institution had terminated prior to March 5, 1988, however, 
would not be considered to have been conducted or engaged in as of March 
5. For example, if within 13 months of March 5, 1987, the nonbank bank 
had terminated its commercial lending activity in order to avoid the 
bank definition in the Act, the nonbank bank could not recommence that 
activity after enactment of CEBA.
    (d) Cross-marketing limitation--(1) In general. Section 4(f)(3) also 
limits cross-marketing activities by nonbank banks and their affiliates. 
Under this provision, a nonbank bank may not offer or market a product 
or service of an affiliate unless the product or service may be offered 
by bank holding companies generally under section 4(c)(8) of the BHC 
Act. In addition, a nonbank bank may not permit any of its products or 
services to be offered or marketed by or through a nonbank affiliate 
unless the affiliate engages only in activities permissible for a bank 
holding company under section 4(c)(8). These limitations are subject to 
an exception for products or services that were being so offered or 
marketed as of March 5, 1987, but only in the same manner in which they 
were being offered or marketed as of that date.
    (2) Examples of impermissible cross-marketing. The Conference Report 
illustrates the application of this limitation to the following two 
covered transactions: (i) products and services of an affiliate that 
bank holding companies may not offer under the BHC Act, and (ii) 
products and services of the nonbank bank. In the first case, the 
restrictions would prohibit, for example, a company from marketing life 
insurance or automotive supplies through its affiliate nonbank bank 
because these products are not generally

[[Page 149]]

permissible under the BHC Act. Conference Report at 126. In the second 
case, a nonbank bank may not permit its products or services to be 
offered or marketed through a life insurance affiliate or automobile 
parts retailer because these affiliates engage in activities prohibited 
under the BHC Act. Id.
    (3) Permissible cross-marketing. On the other hand, a nonbank bank 
could offer to its customers consumer loans from an affiliated mortgage 
banking or consumer finance company. These affiliates could likewise 
offer their customers the nonbank bank's products or services provided 
the affiliates engaged only in activities permitted for bank holding 
companies under the closely-related-to-banking standard of section 
4(c)(8) of the BHC Act. If the affiliate is engaged in both permissible 
and impermissible activities within the meaning of section 4(c)(8) of 
the BHC Act, however, the affiliate could not offer or market the 
nonbank bank's products or services.
    (4) Product approach to cross-marketing restriction. (i) Unlike the 
activity restrictions, the cross-marketing restrictions of CEBA apply by 
their terms to individual products and services. Thus, an affiliate of a 
nonbank bank that was engaged in activities that are not permissible for 
bank holding companies and that was marketing a particular product or 
service of a nonbank bank on the grandfather date could continue to 
market that product and, as discussed below, could change the terms and 
conditions of the loan. The nonbank affiliate could not, however, begin 
to offer or market another product or service of the nonbank bank.
    (ii) The Board believes that the term product or service must be 
interpreted in light of its accepted ordinary commercial usage. In some 
instances, commercial usage has identified a group of products so 
closely related that they constitute a product line (e.g., certificates 
of deposit) and differences in versions of the product (e.g., a one-year 
certificate of deposit) simply represent a difference in the terms of 
the product.\10\ This approach is consistent with the treatment in 
CEBA's legislative history of certificates of deposit as a product line 
rather than each particular type of CD as a separate product.\11\
---------------------------------------------------------------------------

    \10\ American Bankers Association, Banking Terminology (1981).
    \11\ During the Senate debates on CEBA, Senator Proxmire in response 
to a statement from Senator Cranston that the joint-marketing 
restrictions do not lock into place the specific terms or conditions of 
the particular grandfathered product or service, stated:
    That is correct. For example, if a nonbank bank was jointly 
marketing on March 5, 1987, a 3 year, $5,000 certificate of deposit, 
this bill would not prohibit offering in the same manner a 1 year, 
$2,000 certificate of deposit with a different interest rate. 133 Cong. 
Rec. S3959 (daily ed. March 26, 1987).
---------------------------------------------------------------------------

    (iii) In the area of consumer lending, the Board believes the 
following provide examples of different consumer loan products: mortgage 
loans to finance the purchase of the borrower's residence, unsecured 
consumer loans, consumer installment loans secured by the personal 
property to be purchased (e.g. automobile, boat or home appliance 
loans), or second mortgage loans.\12\ Under this interpretation, a 
nonbank bank that offered automobile loans through a nonbank affiliate 
on the grandfather date could market boat loans, appliance loans or any 
type of secured consumer installment loan through that affiliate. It 
could not, however, market unsecured consumer loans, home mortgage loans 
or other types of consumer loans.
---------------------------------------------------------------------------

    \12\ In this regard, the Supreme Court in United States v. 
Philadelphia National Bank, noted that ``the principal banking products 
are of course various types of credit, for example: unsecured personal 
and business loans, mortgage loans, loans secured by securities or 
accounts receivable, automobile installment and consumer goods, 
installment loans, tuition financing, bank credit cards, revolving 
credit funds.'' 374 U.S. 321, 326 n.5 (1963).
---------------------------------------------------------------------------

    (iv) In other areas, the Board believes that the determination as to 
what constitutes a product or service should be made on a case-by-case 
basis consistent with the principles that the terms product or service 
must be interpreted in accordance with their ordinary commercial usage 
and must be narrower in scope than the definition of activity. 
Essentially, the concept applied in this analysis is one of permitting 
the continuation of the specific product marketing activity that was 
undertaken as

[[Page 150]]

of March 5, 1987. Thus, for example, while insurance underwriting may 
constitute a separate activity under CEBA, a nonbank bank could not 
market a life insurance policy issued by the affiliate if on the 
grandfather date it had only marketed homeowners' policies issued by the 
affiliate.
    (5) Change in terms and conditions permitted. (i) The cross-
marketing restrictions would not limit the ability of the institution to 
change the specific terms and conditions of a particular grandfathered 
product or service. The Conference Report indicates a legislative intent 
not to lock into place the specific terms or conditions of a 
grandfathered product or service. Conference Report at 126. For example, 
a nonbank bank marketing a three-year, $5,000 certificate of deposit 
through an affiliate under the exemption could offer a one-year $2,000 
certificate of deposit with a different interest rate after the 
grandfather date. See footnote 11 above. Modifications that alter the 
type of product, however, are not permitted. Thus, a nonbank bank that 
marketed through affiliates on March 5, 1987, only certificates of 
deposit could not commence marketing MMDA's or NOW accounts after the 
grandfather date.
    (ii) General changes in the character of the product or service as 
the result of market or technological innovation are similarly permitted 
to the extent that they do not transform a grandfathered product into a 
new product. Thus, an unsecured line of credit could not be modified to 
include a lien on the borrower's residence without becoming a new 
product.
    (6) Meaning of offer or market. In the Board's opinion, the terms 
offer or market in the cross-marketing restrictions refer to the 
presentation to a customer of an institution's products or service 
through any type of program, including telemarketing, advertising 
brochures, direct mailing, personal solicitation, customer referrals, or 
joint-marketing agreements or presentations. An institution must have 
offered or actually marketed the product or service on March 5 or 
shortly before that date (as discussed above) to qualify for the 
grandfather privilege. Thus, if the cross-marketing program was in the 
planning stage on March 5, 1987, the program would not quality for 
grandfather treatment under CEBA.
    (7) Limitations on cross-marketing to in the same manner. (i) The 
cross-marketing restriction in section 4(f)(3) contains a grandfather 
provision that permits products or services that would otherwise be 
prohibited from being offered or marketed under the provision to 
continue to be offered or marketed by a particular entity if the 
products or services were being so offered or marketed as of March 5, 
1987, but ``only in the same manner in which they were being offered or 
marketed as of that date.'' Thus, to qualify for the grandfather 
provision, the manner of offering or marketing the otherwise prohibited 
product or service must remain the same as on the grandfather date.
    (ii) In interpreting this provision, the Board notes that Congress 
designed the joint-marketing restrictions to prevent the significant 
risk to the public posed by the conduct of such activities by insured 
banks affiliated with companies engaged in general commerce, to ensure 
objectivity in the credit-granting process and to ``minimize the unfair 
competitive advantage that grandfathered commercial companies owning 
nonbank banks might otherwise engage over regulated bank holding 
companies and our competing commercial companies that have no subsidiary 
bank.'' Conference Report at 125-126. The Board believes that 
determinations regarding the manner of cross-marketing of a particular 
product or service may best be accomplished by applying the limitation 
to the particular facts in each case consistent with the stated purpose 
of this provision of CEBA and the general principle that grandfather 
restrictions and exceptions to general prohibitions must be narrowly 
construed in order to prevent the exception from nullifying the rule. 
Essentially, as in the scope of the term ``product or service'', the 
guiding principle of Congressional intent with respect to this term is 
to permit only the continuation of the specific types of cross-marketing 
activity that were undertaken as of March 5, 1987.
    (8) Eligibility for cross-marketing grandfather exemption. The 
Conference Report also clarifies that entitlement to

[[Page 151]]

an exemption to continue to cross-market products and services otherwise 
prohibited by the statute applies only to the specific company that was 
engaged in the activity as of March 5, 1987. Conference Report at 126. 
Thus, an affiliate that was not engaged in cross-marketing products or 
services as of the grandfather date may not commence these activities 
under the exemption even if such activities were being conducted by 
another affiliate. Id.; see also S. Rep. No. 100-19 at 33-34.
    (e) Eligibility for grandfathered nonbank bank status. In reviewing 
the reports required by CEBA, the Board notes that a number of 
institutions that had not commenced business operations on August 10, 
1987, the date of enactment of CEBA, claimed grandfather privileges 
under section 4(f)(3) of CEBA. To qualify for grandfather privileges 
under section 4(f)(3), the institution must have ``bec[o]me a bank as a 
result of the enactment of [CEBA]'' and must have been controlled by a 
nonbanking company on March 5, 1987. 12 U.S.C. 1843(f)(1)(A). An 
institution that did not have FDIC insurance on August 10, 1987, and 
that did not accept demand deposits or transaction accounts or engage in 
the business of commercial lending on that date, would not have become a 
bank as a result of enactment of CEBA. Thus, institutions that had not 
commenced operations on August 10, 1987, could not qualify for 
grandfather privileges under section 4(f)(3) of CEBA. This view is 
supported by the activity limitations of section 4(f)(3), which, as 
noted, limit the activities of grandfathered nonbank banks to those in 
which they were lawfully engaged as of March 5, 1987. A nonbank bank 
that had not commenced conducting business activities on March 5, 1987, 
could not after enactment of CEBA engage in any activities under this 
provision.

[Reg. Y, 53 FR 37746, Sept. 28, 1988, as amended by Reg. Y, 62 FR 9343, 
Feb. 28, 1997]

                          Conditions to Orders



Sec. 225.200  Conditions to Board's section 20 orders.

    (a) Introduction. Under section 20 of the Glass-Steagall Act (12 
U.S.C. 377) and section 4(c)(8) of the Bank Holding Company Act (12 
U.S.C. 1843(c)(8)), a nonbank subsidiary of a bank holding company may 
to a limited extent underwrite and deal in securities for which 
underwriting and dealing by a member bank is prohibited. Pursuant to the 
Securities Act of 1933 and the Securities Exchange Act of 1934, these 
so-called section 20 subsidiaries are required to register with the SEC 
as broker-dealers and are subject to all the financial reporting, anti-
fraud and financial responsibility rules applicable to broker-dealers. 
In addition, transactions between insured depository institutions and 
their section 20 affiliates are restricted by sections 23A and 23B of 
the Federal Reserve Act (12 U.S.C. 371c and 371c-1). The Board expects a 
section 20 subsidiary, like any other subsidiary of a bank holding 
company, to be operated prudently. Doing so would include observing 
corporate formalities (such as the maintenance of separate accounting 
and corporate records), and instituting appropriate risk management, 
including independent trading and exposure limits consistent with parent 
company guidelines.
    (b) Conditions. As a condition of each order approving establishment 
of a section 20 subsidiary, a bank holding company shall comply with the 
following conditions.
    (1) Capital. (i) A bank holding company shall maintain adequate 
capital on a fully consolidated basis. If operating a section 20 
authorized to underwrite and deal in all types of debt and equity 
securities, a bank holding company shall maintain strong capital on a 
fully consolidated basis.
    (ii) In the event that a bank or thrift affiliate of a section 20 
subsidiary shall become less than well capitalized (as defined in 
section 38 of the Federal Deposit Insurance Act, 12 U.S.C. 1831o), and 
the bank holding company shall fail to restore it promptly to the well 
capitalized level, the Board may, in its discretion, reimpose the 
funding, credit extension and credit enhancement firewalls contained in 
its 1989 order allowing underwriting and dealing in bank-

[[Page 152]]

ineligible securities,1 or order the bank holding company to 
divest the section 20 subsidiary.
---------------------------------------------------------------------------

    \1\ Firewalls 5-8, 19, 21 and 22 of J.P. Morgan & Co., The Chase 
Manhattan Corp., Bankers Trust New York Corp., Citicorp, and Security 
Pacific Corp., 75 Federal Reserve Bulletin 192, 214-16 (1989).
---------------------------------------------------------------------------

    (iii) A foreign bank that operates a branch or agency in the United 
States shall maintain strong capital on a fully consolidated basis at 
levels above the minimum levels required by the Basle Capital Accord. In 
the event that the Board determines that the foreign bank's capital has 
fallen below these levels and the foreign bank fails to restore its 
capital position promptly, the Board may, in its discretion, reimpose 
the funding, credit extension and credit enhancement firewalls contained 
in its 1990 order allowing foreign banks to underwrite and deal in bank-
ineligible securities,2 or order the foreign bank to divest 
the section 20 subsidiary.
---------------------------------------------------------------------------

    \2\ Firewalls 5-8, 19, 21 and 22 of Canadian Imperial Bank of 
Commerce, The Royal Bank of Canada, Barclays PLC and Barclays Bank PLC, 
76 Federal Reserve Bulletin 158, (1990).
---------------------------------------------------------------------------

    (2) Internal controls. (i) Each bank holding company or foreign bank 
shall cause its subsidiary banks, thrifts, branches or agencies 
3 to adopt policies and procedures, including appropriate 
limits on exposure, to govern their participation in transactions 
underwritten or arranged by a section 20 affiliate.
---------------------------------------------------------------------------

    \3\ The terms ``branch'' and ``agency'' refer to a U.S. branch and 
agency of a foreign bank.
---------------------------------------------------------------------------

    (ii) Each bank holding company or foreign bank shall ensure that an 
independent and thorough credit evaluation has been undertaken in 
connection with participation by a bank, thrift, or branch or agency in 
such transactions, and that adequate documentation of that evaluation is 
maintained for review by examiners of the appropriate federal banking 
agency and the Federal Reserve.
    (3) Interlocks restriction. (i) Directors, officers or employees of 
a bank or thrift subsidiary of a bank holding company, or a bank or 
thrift subsidiary or branch or agency of a foreign bank, shall not serve 
as a majority of the board of directors or the chief executive officer 
of an affiliated section 20 subsidiary.
    (ii) Directors, officers or employees of a section 20 subsidiary 
shall not serve as a majority of the board of directors or the chief 
executive officer of an affiliated bank or thrift subsidiary or branch 
or agency, except that the manager of a branch or agency may act as a 
director of the underwriting subsidiary.
    (iii) For purposes of this standard, the manager of a branch or 
agency of a foreign bank generally will be considered to be the chief 
executive officer of the branch or agency.
    (4) Customer disclosure--(i) Disclosure to section 20 customers. A 
section 20 subsidiary shall provide, in writing, to each of its retail 
customers,4 at the time an investment account is opened, the 
same minimum disclosures, and obtain the same customer acknowledgment, 
described in the Interagency Statement on Retail Sales of Nondeposit 
Investment Products (Statement) as applicable in such situations. These 
disclosures must be provided regardless of whether the section 20 
subsidiary is itself engaged in activities through arrangements with a 
bank that is covered by the Statement.
---------------------------------------------------------------------------

    \4\ For purposes of this operating standard, a retail customer is 
any customer that is not an ``accredited investor'' as defined in 17 CFR 
230.501(a).
---------------------------------------------------------------------------

    (ii) Disclosures accompanying investment advice. A director, 
officer, or employee of a bank, thrift, branch or agency may not express 
an opinion on the value or the advisability of the purchase or the sale 
of a bank-ineligible security that he or she knows is being underwritten 
or dealt in by a section 20 affiliate unless he or she notifies the 
customer of the affiliate's role.
    (5) Intra-day credit. Any intra-day extension of credit to a section 
20 subsidiary by an affiliated bank, thrift, branch or agency shall be 
on market terms consistent with section 23B of the Federal Reserve Act.
    (6) Restriction on funding purchases of securities during 
underwriting period. No bank, thrift, branch or agency shall knowingly 
extend credit to a customer secured by, or for the purpose of 
purchasing, any bank-ineligible security

[[Page 153]]

that a section 20 affiliate is underwriting or has underwritten within 
the past 30 days, unless:
    (i) The extension of credit is made pursuant to, and consistent with 
any conditions imposed in a preexisting line of credit that was not 
established in contemplation of the underwriting; or
    (ii) The extension of credit is made in connection with clearing 
transactions for the section 20 affiliate.
    (7) Reporting requirement. (i) Each bank holding company or foreign 
bank shall submit quarterly to the appropriate Federal Reserve Bank any 
FOCUS report filed with the NASD or other self-regulatory organizations, 
and any information required by the Board to monitor compliance with 
these operating standards and section 20 of the Glass-Steagall Act, on 
forms provided by the Board.
    (ii) In the event that a section 20 subsidiary is required to 
furnish notice concerning its capitalization to the Securities and 
Exchange Commission pursuant to 17 CFR 240.17a-11, a copy of the notice 
shall be filed concurrently with the appropriate Federal Reserve Bank.
    (8) Foreign banks. A foreign bank shall ensure that any extension of 
credit by its branch or agency to a section 20 affiliate, and any 
purchase by such branch or agency, as principal or fiduciary, of 
securities for which a section 20 affiliate is a principal underwriter, 
conforms to sections 23A and 23B of the Federal Reserve Act, and that 
its branches and agencies not advertise or suggest that they are 
responsible for the obligations of a section 20 affiliate, consistent 
with section 23B(c) of the Federal Reserve Act.

[62 FR 45306, Aug. 27, 1997, as amended by Reg. Y, 63 FR 14804, Mar. 27, 
1998]

  Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding 
                      Companies: Risk-Based Measure

                               I. Overview

    The Board of Governors of the Federal Reserve System has adopted a 
risk-based capital measure to assist in the assessment of the capital 
adequacy of bank holding companies (banking organizations).\1\ The 
principal objectives of this measure are to: (i) Make regulatory capital 
requirements more sensitive to differences in risk profiles among 
banking organizations; (ii) factor off-balance sheet exposures into the 
assessment of capital adequacy; (iii) minimize disincentives to holding 
liquid, low-risk assets; and (iv) achieve greater consistency in the 
evaluation of the capital adequacy of major banking organizations 
throughout the world.\2\
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    \1\ Supervisory ratios that relate capital to total assets for bank 
holding companies are outlined in appendices B and D of this part.
    \2\ The risk-based capital measure is based upon a framework 
developed jointly by supervisory authorities from the countries 
represented on the Basle Committee on Banking Regulations and 
Supervisory Practices (Basle Supervisors' Committee) and endorsed by the 
Group of Ten Central Bank Governors. The framework is described in a 
paper prepared by the BSC entitled ``International Convergence of 
Capital Measurement,'' July 1988.
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    The risk-based capital guidelines include both a definition of 
capital and a framework for calculating weighted risk assets by 
assigning assets and off-balance sheet items to broad risk categories. 
An institution's risk-based capital ratio is calculated by dividing its 
qualifying capital (the numerator of the ratio) by its weighted risk 
assets (the denominator).\3\ The definition of qualifying capital is 
outlined below in section II, and the procedures for calculating 
weighted risk assets are discussed in section III. Attachment I 
illustrates a sample calculation of weighted risk assets and the risk-
based capital ratio.
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    \3\ Banking organizations will initially be expected to utilize 
period-end amounts in calculating their risk-based capital ratios. When 
necessary and appropriate, ratios based on average balances may also be 
calculated on a case-by-case basis. Moreover, to the extent banking 
organizations have data on average balances that can be used to 
calculate risk-based ratios, the Federal Reserve will take such data 
into account.
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    In addition, when certain organizations that engage in trading 
activities calculate their risk-based capital ratio under this appendix 
A, they must also refer to appendix E of this part, which incorporates 
capital charges for certain market risks into the risk-based capital 
ratio. When calculating their risk-based capital ratio under this 
appendix A, such organizations are required to refer to appendix E of 
this part for supplemental rules to determine qualifying and excess 
capital, calculate risk-weighted assets, calculate market risk 
equivalent assets, and calculate risk-based capital ratios adjusted for 
market risk.

[[Page 154]]

    The risk-based capital guidelines also establish a schedule for 
achieving a minimum supervisory standard for the ratio of qualifying 
capital to weighted risk assets and provide for transitional 
arrangements during a phase-in period to facilitate adoption and 
implementation of the measure at the end of 1992. These interim 
standards and transitional arrangements are set forth in section IV.
    The risk-based guidelines apply on a consolidated basis to bank 
holding companies with consolidated assets of $150 million or more. For 
bank holding companies with less than $150 million in consolidated 
assets, the guidelines will be applied on a bank-only basis unless: (a) 
The parent bank holding company is engaged in nonbank activity involving 
significant leverage;\4\ or (b) the parent company has a significant 
amount of outstanding debt that is held by the general public.
---------------------------------------------------------------------------

    \4\ A parent company that is engaged in significant off-balance 
sheet activities would generally be deemed to be engaged in activities 
that involve significant leverage.
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    The risk-based guidelines are to be used in the inspection and 
supervisory process as well as in the analysis of applications acted 
upon by the Federal Reserve. Thus, in considering an application filed 
by a bank holding company, the Federal Reserve will take into account 
the organization's risk-based capital ratio, the reasonableness of its 
capital plans, and the degree of progress it has demonstrated toward 
meeting the interim and final risk-based capital standards.
    The risk-based capital ratio focuses principally on broad categories 
of credit risk, although the framework for assigning assets and off-
balance sheet items to risk categories does incorporate elements of 
transfer risk, as well as limited instances of interest rate and market 
risk. The risk-based ratio does not, however, incorporate other factors 
that can affect an organization's financial condition. These factors 
include overall interest rate exposure; liquidity, funding and market 
risks; the quality and level of earnings; investment or loan portfolio 
concentrations; the quality of loans and investments; the effectiveness 
of loan and investment policies; and management's ability to monitor and 
control financial and operating risks.
    In addition to evaluating capital ratios, an overall assessment of 
capital adequacy must take account of these other factors, including, in 
particular, the level and severity of problem and classified assets. For 
this reason, the final supervisory judgment on an organization's capital 
adequacy may differ significantly from conclusions that might be drawn 
solely from the level of the organization's risk-based capital ratio.
    The risk-based capital guidelines establish minimum ratios of 
capital to weighted risk assets. In light of the considerations just 
discussed, banking organizations generally are expected to operate well 
above the minimum risk-based ratios. In particular, banking 
organizations contemplating significant expansion proposals are expected 
to maintain strong capital levels substantially above the minimum ratios 
and should not allow significant diminution of financial strength below 
these strong levels to fund their expansion plans. Institutions with 
high or inordinate levels of risk are also expected to operate above 
minimum capital standards. In all cases, institutions should hold 
capital commensurate with the level and nature of the risks to which 
they are exposed. Banking organizations that do not meet the minimum 
risk-based standard, or that are otherwise considered to be inadequately 
capitalized, are expected to develop and implement plans acceptable to 
the Federal Reserve for achieving adequate levels of capital within a 
reasonable period of time.
    The Board will monitor the implementation and effect of these 
guidelines in relation to domestic and international developments in the 
banking industry. When necessary and appropriate, the Board will 
consider the need to modify the guidelines in light of any significant 
changes in the economy, financial markets, banking practices, or other 
relevant factors.

  II. Definition of Qualifying Capital for the Risk Based Capital Ratio

    An institution's qualifying total capital consists of two types of 
capital components: ``core capital elements'' (comprising Tier 1 
capital) and ``supplementary capital elements'' (comprising Tier 2 
capital). These capital elements and the various limits, restrictions, 
and deductions to which they are subject, are discussed below and are 
set forth in Attachment II.
    To qualify as an element of Tier 1 or Tier 2 capital, a capital 
instrument may not contain or be covered by any convenants, terms, or 
restrictions that are inconsistent with safe and sound banking 
practices.
    Redemptions of permanent equity or other capital instruments before 
stated maturity could have a significant impact on an organization's 
overall capital structure. Consequently, an organization considering 
such a step should consult with the Federal Reserve before redeeming any 
equity or debt capital instrument (prior to maturity) if such redemption 
could have a material effect on the level or composition of the 
organization's capital base.\5\
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    \5\ Consultation would not ordinarily be necessary if an instrument 
were redeemed with the proceeds of, or replaced by, a like amount of a 
similar or higher quality capital instrument and the organization's 
capital position is considered fully adequate by the Federal Reserve. In 
the case of limited-life Tier 2 instruments, consultation would 
generally be obviated if the new security is of equal or greater 
maturity than the one it replaces.

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[[Page 155]]

                 A. The Components of Qualifying Capital

    1. Core capital elements (Tier 1 capital). The Tier 1 component of 
an institution's qualifying capital must represent at least 50 percent 
of qualifying total capital and may consist of the following items that 
are defined as core capital elements:
    (i) Common stockholders' equity.
    (ii) Qualifying noncumulative perpetual preferred stock (including 
related surplus).
    (iii) Qualifying cumulative perpetual preferred stock (including 
related surplus), subject to certain limitations described below.
    (iv) Minority interest in the equity accounts of consolidated 
subsidiaries.
    Tier 1 capital is generally defined as the sum of core capital 
elements \6\ less goodwill and other intangible assets required to be 
deducted in accordance with section II.B.1.b. of this appendix.
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    \6\ During the transition period and subject to certain limitations 
set forth in section IV below, Tier 1 capital may also include items 
defined as supplementary capital elements.
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    a. Common stockholders' equity. For purposes of calculating the 
risk-based capital ratio, common stockholders' equity is limited to 
common stock; related surplus; and retained earnings, including capital 
reserves and adjustments for the cumulative effect of foreign currency 
translation, net of any treasury stock; less net unrealized holding 
losses on available-for-sale equity securities with readily determinable 
fair values. For this purpose, net unrealized holding gains on such 
equity securities and net unrealized holding gains (losses) on 
available-for-sale debt securities are not included in common 
stockholders' equity.
    b. Perpetual preferred stock. Perpetual preferred stock is defined 
as preferred stock that does not have a maturity date, that cannot be 
redeemed at the option of the holder of the instrument, and that has no 
other provisions that will require future redemption of the issue. 
Consistent with these provisions, any perpetual preferred stock with a 
feature permitting redemption at the option of the issuer may qualify as 
capital only if the redemption is subject to prior approval of the 
Federal Reserve. In general, preferred stock will qualify for inclusion 
in capital only if it can absorb losses while the issuer operates as a 
going concern (a fundamental characteristic of equity capital) and only 
if the issuer has the ability and legal right to defer or eliminate 
preferred dividends.
    Perpetual preferred stock in which the dividend is reset 
periodically based, in whole or in part, upon the banking organization's 
current credit standing (that is, auction rate perpetual preferred 
stock, including so-called Dutch auction money market, and remarketable 
preferred) will not qualify for inclusion in Tier 1 capital.\7\ Such 
instruments, however, qualify for inclusion in Tier 2 capital.
---------------------------------------------------------------------------

    \7\ Adjustable rate perpetual preferred stock (that is, perpetual 
preferred stock in which the dividend rate is not affected by the 
issuer's credit standing or financial condition but is adjusted 
periodically according to a formula based solely on general market 
interest rates) may be included in Tier 1 up to the limits specified for 
perpetual preferred stock.
---------------------------------------------------------------------------

    For bank holding companies, both cumulative and noncumulative 
perpetual preferred stock qualify for inclusion in Tier 1. However, the 
aggregate amount of cumulative perpetual preferred stock that may be 
included in a holding company's tier 1 is limited to one-third of the 
sum of core capital elements, excluding the cumulative perpetual 
preferred stock (that is, items i, ii, and iv above). Stated 
differently, the aggregate amount may not exceed 25 percent of the sum 
of all core capital elements, including cumulative perpetual preferred 
stock (that is, items, i, ii, iii, and iv above). Any cumulative 
perpetual preferred stock outstanding in excess of this limit may be 
included in tier 2 capital without any sublimits within that tier (see 
discussion below).
    While the guidelines allow for the inclusion of noncumulative 
perpetual preferred stock and limited amounts of cumulative perpetual 
preferred stock in tier 1, it is desirable from a supervisory standpoint 
that voting common equity remain the dominant form of tier 1 capital. 
Thus, bank holding companies should avoid overreliance on preferred 
stock or nonvoting equity elements within tier 1.
    c. Minority interest in equity accounts of consolidated 
subsidiaries. This element is included in Tier 1 because, as a general 
rule, it represents equity that is freely available to absorb losses in 
operating subsidiaries. While not subject to an explicit sublimit within 
Tier 1, banking organizations are expected to avoid using minority 
intererst in the equity accounts of consolidated subsidiaries as an 
avenue for introducing into their capital structures elements that might 
not otherwise qualify as Tier 1 capital or that would, in effect, result 
in an excessive reliance on preferred stock within Tier 1.

[[Page 156]]

    2. Supplementary capital elements (Tier 2 capital). The Tier 2 
component of an institution's qualifying total capital may consist of 
the following items that are defined as supplementary capital elements:
    (i) Allowance for loan and lease losses (subject to limitations 
discussed below);
    (ii) Perpetual preferred stock and related surplus (subject to 
conditions discussed below);
    (iii) Hybrid capital instruments (as defined below), perpetual debt 
and mandatory convertible debt securities;
    (iv) Term subordinated debt and intermediate-term preferred stock, 
including related surplus (subject to limitations discussed below);
    (v) Unrealized holding gains on equity securities (subject to 
limitations discussed in section II.A.2.e. of this appendix).
    The maximum amount of Tier 2 capital that may be included in an 
organization's qualifying total capital is limited to 100 percent of 
Tier 1 capital (net of goodwill and other intangible assets required to 
be deducted in accordance with section II.B.1.b. of this appendix).
    The elements of supplementary capital are discussed in greater 
detail below.\8\
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    \8\ [Reserved]
---------------------------------------------------------------------------

    a. Allowance for loan and lease losses. Allowances for loan and 
lease losses are reserves that have been established through a charge 
against earnings to absorb future losses on loans or lease financing 
receivables. Allowances for loan and lease losses exclude ``allocated 
transfer risk reserves,'' \9\ and reserves created against identified 
losses.
---------------------------------------------------------------------------

    \9\ Allocated transfer risk reserves are reserves that have been 
established in accordance with Section 905(a) of the International 
Lending Supervision Act of 1983, 12 U.S.C. 3904(a), against certain 
assets whose value U.S. supervisory authorities have found to be 
significantly impaired by protracted transfer risk problems.
---------------------------------------------------------------------------

    During the transition period, the risk-based capital guidelines 
provide for reducing the amount of this allowance that may be included 
in an institution's total capital. Initially, it is unlimited. However, 
by year-end 1990, the amount of the allowance for loan and lease losses 
that will qualify as capital will be limited to 1.5 percent of an 
institution's weighted risk assets. By the end of the transition period, 
the amount of the allowance qualifying for inclusion in Tier 2 capital 
may not exceed 1.25 percent of weighted risk assets.\10\
---------------------------------------------------------------------------

    \10\ The amount of the allowance for loan and lease losses that may 
be included in Tier 2 capital is based on a percentage of gross weighted 
risk assets. A banking organization may deduct reserves for loan and 
lease losses in excess of the amount permitted to be included in Tier 2 
capital, as well as allocated transfer risk reserves, from the sum of 
gross weighted risk assets and use the resulting net sum of weighted 
risk assets in computing the denominator of the risk-based capital 
ratio.
---------------------------------------------------------------------------

    b. Perpetual preferred stock. Perpetual preferred stock, as noted 
above, is defined as preferred stock that has no maturity date, that 
cannot be redeemed at the option of the holder, and that has no other 
provisions that will require future redemption of the issue. Such 
instruments are eligible for inclusion in Tier 2 capital without 
limit.\11\
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    \11\ Long-term preferred stock with an original maturity of 20 years 
or more (including related surplus) will also qualify in this category 
as an element of Tier 2. If the holder of such an instrument has a right 
to require the issuer to redeem, repay, or repurchase the instrument 
prior to the original stated maturity, maturity would be defined, for 
risk-based capital purposes, as the earliest possible date on which the 
holder can put the instrument back to the issuing banking organization.
---------------------------------------------------------------------------

    c. Hybrid capital instruments, perpetual debt, and mandatory 
convertible debt securities. Hybrid capital instruments include 
instruments that are essentially permanent in nature and that have 
certain characteristics of both equity and debt. Such instruments may be 
included in Tier 2 without limit. The general criteria hybrid capital 
instruments must meet in order to qualify for inclusion in Tier 2 
capital are listed below:
    (1) The instrument must be unsecured; fully paid-up and subordinated 
to general creditors. If issued by a bank, it must also be subordinated 
to claims or depositors.
    (2) The instrument must not be redeemable at the option of the 
holder prior to maturity, except with the prior approval of the Federal 
Reserve. (Consistent with the Board's criteria for perpetual debt and 
mandatory convertible securities, this requirement implies that holders 
of such instruments may not accelerate the payment of principal except 
in the event of bankruptcy, insolvency, or reorganization.)
    (3) The instrument must be available to participate in losses while 
the issuer is operating as a going concern. (Term subordinated debt 
would not meet this requirement.) To satisfy this requirement, the 
instrument must convert to common or perpetual preferred stock in the 
event that the accumulated losses exceed the sum of the retained 
earnings and capital surplus accounts of the issuer.
    (4) The instrument must provide the option for the issuer to defer 
interest payments if: a) the issuer does not report a profit in the

[[Page 157]]

preceding annual period (defined as combined profits for the most recent 
four quarters), and b) the issuer eliminates cash dividends on common 
and preferred stock.
    Perpetual debt and mandatory convertible debt securities that meet 
the criteria set forth in 12 CFR part 225, appendix B, also qualify as 
unlimited elements of Tier 2 capital for bank holding companies.
    d. Subordinated debt and intermediate-term preferred stock. (i) The 
aggregate amount of term subordinated debt (excluding mandatory 
convertible debt) and intermediate-term preferred stock that may be 
treated as supplementary capital is limited to 50 percent of Tier 1 
capital (net of goodwill and other intangible assets required to be 
deducted in accordance with section II.B.1.b. of this appendix). Amounts 
in excess of these limits may be issued and, while not included in the 
ratio calculation, will be taken into account in the overall assessment 
of an organization's funding and financial condition.
    (ii) Subordinated debt and intermediate-term preferred stock must 
have an original weighted average maturity of at least five years to 
qualify as supplementary capital.12 (If the holder has the 
option to require the issuer to redeem, repay, or repurchase the 
instrument prior to the stated maturity, maturity would be defined, for 
risk-based capital purposes, as the earliest possible date on which the 
holder can put the instrument back to the issuing banking organization.) 
13 In the case of subordinated debt, the instrument must be 
unsecured and must clearly state on its face that it is not a deposit 
and is not insured by a Federal agency. Bank holding company debt must 
be subordinated in the right of payment to all senior indebtedness of 
the company.
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    \12\ Unsecured term debt issued by bank holding companies prior to 
March 12, 1988, and qualifying as secondary capital at the time of 
issuance continues to qualify as an element of supplementary capital 
under the risk-based framework, subject to the 50 percent of Tier 1 
capital limitation. Bank holding company term debt issued on or after 
March 12, 1988, must be subordinated in order to qualify as capital.
    \13\ As a limited-life capital instrument approaches maturity it 
begins to take on characteristics of a short-term obligation. For this 
reason, the outstanding amount of term subordinated debt and limited-
life preferred stock eligible for inclusion in Tier 2 is reduced, or 
discounted, as these instruments approach maturity: one-fifth of the 
original amount (less redemptions) is excluded each year during the 
instrument's last five years before maturity. When the remaining 
maturity is less than one year, the instrument is excluded from Tier 2 
capital.
---------------------------------------------------------------------------

    e. Unrealized gains on equity securities and unrealized gains 
(losses) on other assets. Up to 45 percent of pretax net unrealized 
holding gains (that is, the excess, if any, of the fair value over 
historical cost) on available-for-sale equity securities with readily 
determinable fair values may be included in supplementary capital. 
However, the Federal Reserve may exclude all or a portion of these 
unrealized gains from Tier 2 capital if the Federal Reserve determines 
that the equity securities are not prudently valued. Unrealized gains 
(losses) on other types of assets, such as bank premises and available-
for-sale debt securities, are not included in supplementary capital, but 
the Federal Reserve may take these unrealized gains (losses) into 
account as additional factors when assessing an institution's overall 
capital adequacy.
    f. Revaluation reserves. i. Such reserves reflect the formal balance 
sheet restatement or revaluation for capital purposes of asset carrying 
values to reflect current market values. The Federal Reserve generally 
has not included unrealized asset appreciation in capital ratio 
calculations, although it has long taken such values into account as a 
separate factor in assessing the overall financial strength of a banking 
organization.
    ii. Consistent with long-standing supervisory practice, the excess 
of market values over book values for assets held by bank holding 
companies will generally not be recognized in supplementary capital or 
in the calculation of the risk-based capital ratio. However, all bank 
holding companies are encouraged to disclose their equivalent of 
premises (building) and security revaluation reserves. The Federal 
Reserve will consider any appreciation, as well as any depreciation, in 
specific asset values as additional considerations in assessing overall 
capital strength and financial condition.

            B. Deductions from Capital and Other Adjustments

    Certain assets are deducted from an organization's capital for the 
purpose of calculating the risk-based capital ratio.\14\ These assets 
include:
---------------------------------------------------------------------------

    \14\ Any assets deducted from capital in computing the numerator of 
the ratio are not included in weighted risk assets in computing the 
denominator of the ratio.
---------------------------------------------------------------------------

    (i)(a) Goodwill--deducted from the sum of core capital elements.
    (b) Certain identifiable intangible assets, that is, intangible 
assets other than goodwill--deducted from the sum of core capital 
elements in accordance with section II.B.1.b. of this appendix.
    (ii) Investments in banking and finance subsidiaries that are not 
consolidated for accounting or supervisory purposes, and investments in 
other designated subsidiaries or

[[Page 158]]

associated companies at the discretion of the Federal Reserve--deducted 
from total capital components (as described in greater detail below).
    (iii) Reciprocal holdings of capital instruments of banking 
organizations--deducted from total capital components.
    (iv) Deferred tax assets--portions are deducted from the sum of core 
capital elements in accordance with section II.B.4. of this Appendix A.
    1. Goodwill and other intangible assets--a. Goodwill. Goodwill is an 
intangible asset that represents the excess of the purchase price over 
the fair market value of identifiable assets acquired less liabilities 
assumed in acquisitions accounted for under the purchase method of 
accounting. Any goodwill carried on the balance sheet of a bank holding 
company after December 31, 1992, will be deducted from the sum of core 
capital elements in determining Tier 1 capital for ratio calculation 
purposes. Any goodwill in existence before March 12, 1988, is 
``grandfathered'' during the transition period and is not deducted from 
core capital elements until after December 31, 1992. However, bank 
holding company goodwill acquired as a result of a merger or acquisition 
that was consummated on or after March 12, 1988, is deducted 
immediately.
    b. Other intangible assets. i. All servicing assets, including 
servicing assets on assets other than mortgages (i.e., nonmortgage 
servicing assets) are included in this Appendix A as identifiable 
intangible assets. The only types of identifiable intangible assets that 
may be included in, that is, not deducted from, an organization's 
capital are readily marketable mortgage servicing assets, nonmortgage 
servicing assets, and purchased credit card relationships. The total 
amount of these assets included in capital, in the aggregate, cannot 
exceed 100 percent of Tier 1 capital. Nonmortgage servicing assets and 
purchased credit card relationships are subject, in the aggregate, to a 
sublimit of 25 percent of Tier 1 capital.15
---------------------------------------------------------------------------

    \15\ Amounts of mortgage servicing assets, nonmortgage servicing 
assets, and purchased credit card relationships in excess of these 
limitations, as well as all other identifiable intangible assets, 
including core deposit intangibles and favorable leaseholds, are to be 
deducted from an organization's core capital elements in determining 
Tier 1 capital. However, identifiable intangible assets (other than 
mortgage servicing assets, and purchased credit card relationships) 
acquired on or before February 19, 1992, generally will not be deducted 
from capital for supervisory purposes, although they will continue to be 
deducted for applications purposes.
---------------------------------------------------------------------------

    ii. For purposes of calculating these limitations on mortgage 
servicing assets, nonmortgage servicing assets, and purchased credit 
card relationships, Tier 1 capital is defined as the sum of core capital 
elements, net of goodwill, and net of all identifiable intangible assets 
and similar assets other than mortgage servicing assets, nonmortgage 
servicing assets, and purchased credit card relationships, regardless of 
the date acquired, but prior to the deduction of deferred tax assets.
    iii. The amount of mortgage servicing assets, nonmortgage servicing 
assets, and purchased credit card relationships that a bank holding 
company may include in capital shall be the lesser of 90 percent of 
their fair value, as determined in accordance with this section, or 100 
percent of their book value, as adjusted for capital purposes in 
accordance with the instructions to the Consolidated Financial 
Statements for Bank Holding Companies (FR Y-9C Report). If both the 
application of the limits on mortgage servicing assets, nonmortgage 
servicing assets, and purchased credit card relationships and the 
adjustment of the balance sheet amount for these intangibles would 
result in an amount being deducted from capital, the bank holding 
company would deduct only the greater of the two amounts from its core 
capital elements in determining Tier 1 capital.
    iv. Bank holding companies may elect to deduct disallowed servicing 
assets on a basis that is net of any associated deferred tax liability. 
Deferred tax liabilities netted in this manner cannot also be netted 
against deferred tax assets when determining the amount of deferred tax 
assets that are dependent upon future taxable income.
    v. Bank holding companies must review the book value of all 
intangible assets at least quarterly and make adjustments to these 
values as necessary. The fair value of mortgage servicing assets, 
nonmortgage servicing assets, and purchased credit card relationships 
also must be determined at least quarterly. This determination shall 
include adjustments for any significant changes in original valuation 
assumptions, including changes in prepayment estimates or account 
attrition rates. Examiners will review both the book value and the fair 
value assigned to these assets, together with supporting documentation, 
during the inspection process. In addition, the Federal Reserve may 
require, on a case-by-case basis, an independent valuation of an 
organization's intangible assets or similar assets.
    vi. The treatment of identifiable intangible assets set forth in 
this section generally will be used in the calculation of a bank holding 
company's capital ratios for supervisory and applications purposes. 
However, in making an overall assessment of an organization's capital 
adequacy for applications purposes, the Board may, if it deems 
appropriate, take into account the quality and composition of an 
organization's capital, together with the

[[Page 159]]

quality and value of its tangible and intangible assets.
    vii. Consistent with long-standing Board policy, banking 
organizations experiencing substantial growth, whether internally or by 
acquisition, are expected to maintain strong capital positions 
substantially above minimum supervisory levels, without significant 
reliance on intangible assets.
    2. Investments in certain subsidiaries-- a. Unconsolidated banking 
or finance subsidiaries. The aggregate amount of investments in banking 
or finance subsidiaries \16\ whose financial statements are not 
consolidated for accounting or regulatory reporting purposes, regardless 
of whether the investment is made by the parent bank holding company or 
its direct or indirect subsidiaries, will be deducted from the 
consolidated parent banking organization's total capital components.\17\ 
Generally, investments for this purpose are defined as equity and debt 
capital investments and any other instruments that are deemed to be 
capital in the particular subsidiary.
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    \16\ For this purpose, a banking and finance subsidiary generally is 
defined as any company engaged in banking or finance in which the parent 
institution holds directly or indirectly more than 50 percent of the 
outstanding voting stock, or which is otherwise controlled or capable of 
being controlled by the parent institution.
    \17\ An exception to this deduction would be made in the case of 
shares acquired in the regular course of securing or collecting a debt 
previously contracted in good faith. The requirements for consolidation 
are spelled out in the instructions to the FR Y-9C Report.
---------------------------------------------------------------------------

    Advances (that is, loans, extensions of credit, guarantees, 
commitments, or any other forms of credit exposure) to the subsidiary 
that are not deemed to be capital will generally not be deducted from an 
organization's capital. Rather, such advances generally will be included 
in the parent banking organization's consolidated assets and be assigned 
to the 100 percent risk category, unless such obligations are backed by 
recognized collateral or guarantees, in which case they will be assigned 
to the risk category appropriate to such collateral or guarantees. These 
advances may, however, also be deducted from the consolidated parent 
banking organization's capital if, in the judgment of the Federal 
Reserve, the risks stemming from such advances are comparable to the 
risks associated with capital investments or if the advances involve 
other risk factors that warrant such an adjustment to capital for 
supervisory purposes. These other factors could include, for example, 
the absence of collateral support.
    Inasmuch as the assets of unconsolidated banking and finance 
subsidiaries are not fully reflected in a banking organization's 
consolidated total assets, such assets may be viewed as the equivalent 
of off-balance sheet exposures since the operations of an unconsolidated 
subsidiary could expose the parent organization and its affiliates to 
considerable risk. For this reason, it is generally appropriate to view 
the capital resources invested in these unconsolidated entities as 
primarily supporting the risks inherent in these off-balance sheet 
assets, and not generally available to support risks or absorb losses 
elsewhere in the organization.
    b. Other subsidiaries and investments. The deduction of investments, 
regardless of whether they are made by the parent bank holding company 
or by its direct or indirect subsidiaries, from a consolidated banking 
organization's capital will also be applied in the case of any 
subsidiaries, that, while consolidated for accounting purposes, are not 
consolidated for certain specified supervisory or regulatory purposes, 
such as to facilitate functional regulation. For this purpose, aggregate 
capital investments (that is, the sum of any equity or debt instruments 
that are deemed to be capital) in these subsidiaries will be deducted 
from the consolidated parent banking organization's total capital 
components.\18\
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    \18\ Investments in unconsolidated subsidiaries will be deducted 
from both Tier 1 and Tier 2 capital. As a general rule, one-half (50 
percent) of the aggregate amount of capital investments will be deducted 
from the bank holding company's Tier 1 capital and one-half (50 percent) 
from its Tier 2 capital. However, the Federal Reserve may, on a case-by-
case basis, deduct a proportionately greater amount from Tier 1 if the 
risks associated with the subsidiary so warrant. If the amount 
deductible from Tier 2 capital exceeds actual Tier 2 capital, the excess 
would be deducted from Tier 1 capital. Bank holding companies' risk-
based capital ratios, net of these deductions, must exceed the minimum 
standards set forth in section IV.
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    Advances (that is, loans, extensions of credit, guarantees, 
commitments, or any other forms of credit exposure) to such subsidiaries 
that are not deemed to be capital will generally not be deducted from 
capital. Rather, such advances will normally be included in the parent 
banking organization's consolidated assets and assigned to the 100 
percent risk category, unless such obligations are backed by recognized 
collateral or guarantees, in which case they will be assigned to the 
risk category appropriate to such collateral or guarantees. These 
advances may, however, be deducted from the consolidated parent banking 
organization's

[[Page 160]]

capital if, in the judgment of the Federal Reserve, the risks stemming 
from such advances are comparable to the risks associated with capital 
investments or if such advances involve other risk factors that warrant 
such an adjustment to capital for supervisory purposes. These other 
factors could include, for example, the absence of collateral 
support.\19\
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    \19\ In assessing the overall capital adequacy of a banking 
organization, the Federal Reserve may also consider the organization's 
fully consolidated capital position.
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    In general, when investments in a consolidated subsidiary are 
deducted from a consolidated parent banking organization's capital, the 
subsidiary's assets will also be excluded from the consolidated assets 
of the parent banking organization in order to assess the latter's 
capital adequacy.\20\
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    \20\ If the subsidiary's assets are consolidated with the parent 
banking organization for financial reporting purposes, this adjustment 
will involve excluding the subsidiary's assets on a line-by-line basis 
from the consolidated parent organization's assets. The parent banking 
organization's capital ratio will then be calculated on a consolidated 
basis with the exception that the assets of the excluded subsidiary will 
not be consolidated with the remainder of the parent banking 
organization.
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    The Federal Reserve may also deduct from a banking organization's 
capital, on a case-by-case basis, investments in certain other 
subsidiaries in order to determine if the consolidated banking 
organization meets minimum supervisory capital requirements without 
reliance on the resources invested in such subsidiaries.
    The Federal Reserve will not automatically deduct investments in 
other unconsolidated subsidiaries or investments in joint ventures and 
associated companies.\21\ Nonetheless, the resources invested in these 
entities, like investments in unconsolidated banking and finance 
subsidiaries, support assets not consolidated with the rest of the 
banking organization's activities and, therefore, may not be generally 
available to support additional leverage or absorb losses elsewhere in 
the banking organization. Moreover, experience has shown that banking 
organizations stand behind the losses of affiliated institutions, such 
as joint ventures and associated companies, in order to protect the 
reputation of the organization as a whole. In some cases, this has led 
to losses that have exceeded the investments in such organizations.
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    \21\ The definition of such entities is contained in the 
instructions to the Consolidated Financial Statements for Bank Holding 
Companies. Under regulatory reporting procedures, associated companies 
and joint ventures generally are defined as companies in which the 
banking organization owns 20 to 50 percent of the voting stock.
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    For this reason, the Federal Reserve will monitor the level and 
nature of such investments for individual banking organizations and may, 
on a case-by-case basis, deduct such investments from total capital 
components, apply an appropriate risk-weighted capital charge against 
the organization's proportionate share of the assets of its associated 
companies, require a line-by-line consolidation of the entity (in the 
event that the parent's control over the entity makes it the functional 
equivalent of a subsidiary), or otherwise require the organization to 
operate with a risk-based capital ratio above the minimum.
    In considering the appropriateness of such adjustments or actions, 
the Federal Reserve will generally take into account whether:
    (1) The parent banking organization has significant influence over 
the financial or managerial policies or operations of the subsidiary, 
joint venture, or associated company;
    (2) The banking organization is the largest investor in the 
affiliated company; or
    (3) Other circumstances prevail that appear to closely tie the 
activities of the affiliated company to the parent banking organization.
    3. Reciprocal holdings of banking organizations' capital 
instruments. Reciprocal holdings of banking organizations' capital 
instruments (that is, instruments that qualify as Tier 1 or Tier 2 
capital) will be deducted from an organization's total capital 
components for the purpose of determining the numerator of the risk-
based capital ratio.
    Reciprocal holdings are cross-holdings resulting from formal or 
informal arrangements in which two or more banking organizations swap, 
exchange, or otherwise agree to hold each other's capital instruments. 
Generally, deductions will be limited to intentional cross-holdings. At 
present, the Board does not intend to require banking organizations to 
deduct non-reciprocal holdings of such capital instruments.\22\ 
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    \22\ Deductions of holdings of capital securities also would not be 
made in the case of interstate ``stake out'' investments that comply 
with the Board's Policy Statement on Nonvoting Equity Investments, 12 
CFR 225.143 (Federal Reserve Regulatory Service 4-172.1; 68 Federal 
Reserve Bulletin 413 (1982)). In addition, holdings of capital 
instruments issued by other banking organizations but taken in 
satisfaction of debts previously contracted would be exempt from any 
deduction from capital. The Board intends to monitor nonreciprocal 
holdings of other banking organizations' capital instruments and to 
provide information on such holdings to the Basle Supervisors' Committee 
as called for under the Basle capital framework.

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[[Page 161]]

    4. Deferred tax assets. The amount of deferred tax assets that is 
dependent upon future taxable income, net of the valuation allowance for 
deferred tax assets, that may be included in, that is, not deducted 
from, a banking organization's capital may not exceed the lesser of (i) 
the amount of these deferred tax assets that the banking organization is 
expected to realize within one year of the calendar quarter-end date, 
based on its projections of future taxable income for that 
year,23 or (ii) 10 percent of Tier 1 capital. The reported 
amount of deferred tax assets, net of any valuation allowance for 
deferred tax assets, in excess of the lesser of these two amounts is to 
be deducted from a banking organization's core capital elements in 
determining Tier 1 capital. For purposes of calculating the 10 percent 
limitation, Tier 1 capital is defined as the sum of core capital 
elements, net of goodwill, and net of all identifiable intangible assets 
other than mortgage servicing assets, nonmortgage servicing assets, and 
purchased credit card relationships, before any disallowed deferred tax 
assets are deducted. There generally is no limit in Tier 1 capital on 
the amount of deferred tax assets that can be realized from taxes paid 
in prior carryback years or from future reversals of existing taxable 
temporary differences.
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    \23\ To determine the amount of expected deferred tax assets 
realizable in the next 12 months, an institution should assume that all 
existing temporary differences fully reverse as of the report date. 
Projected future taxable income should not include net operating loss 
carryforwards to be used during that year or the amount of existing 
temporary differences a bank holding company expects to reverse within 
the year. Such projections should include the estimated effect of tax 
planning strategies that the organization expects to implement to 
realize net operating losses or tax credit carryforwards that would 
otherwise expire during the year. Institutions do not have to prepare a 
new 12 month projection each quarter. Rather, on interim report dates, 
institutions may use the future taxable income projections for their 
current fiscal year, adjusted for any significant changes that have 
occurred or are expected to occur.
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III. Procedures for Computing Weighted Risk Assets and Off-Balance Sheet 
                                  Items

                              A. Procedures

    Assets and credit equivalent amounts of off-balance sheet items of 
bank holding companies are assigned to one of several broad risk 
categories, according to the obligor, or, if relevant, the guarantor or 
the nature of the collateral. The aggregate dollar value of the amount 
in each category is then multiplied by the risk weight associated with 
that category. The resulting weighted values from each of the risk 
categories are added together, and this sum is the banking 
organization's total weighted risk assets that comprise the denominator 
of the risk-based capital ratio. Attachment I provides a sample 
calculation.
    Risk weights for all off-balance sheet items are determined by a 
two-step process. First, the ``credit equivalent amount'' of off-balance 
sheet items is determined, in most cases, by multiplying the off-balance 
sheet item by a credit conversion factor. Second, the credit equivalent 
amount is treated like any balance sheet asset and generally is assigned 
to the appropriate risk category according to the obligor, or, if 
relevant, the guarantor or the nature of the collateral.
    In general, if a particular item qualifies for placement in more 
than one risk category, it is assigned to the category that has the 
lowest risk weight. A holding of a U.S. municipal revenue bond that is 
fully guaranteed by a U.S. bank, for example, would be assigned the 20 
percent risk weight appropriate to claims guaranteed by U.S. banks, 
rather than the 50 percent risk weight appropriate to U.S. municipal 
revenue bonds.\24\
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    \24\ An investment in shares of a fund whose portfolio consists 
primarily of various securities or money market instruments that, if 
held separately, would be assigned to different risk categories, 
generally is assigned to the risk category appropriate to the highest 
risk-weighted asset that the fund is permitted to hold in accordance 
with the stated investment objectives set forth in the prospectus. An 
organization may, at its option, assign a fund investment on a pro rata 
basis to different risk categories according to the investment limits in 
the fund's prospectus. In no case will an investment in shares in any 
fund be assigned to a total risk weight of less than 20 percent. If an 
organization chooses to assign a fund investment on a pro rata basis, 
and the sum of the investment limits of assets in the fund's prospectus 
exceeds 100 percent, the organization must assign risk weights in 
descending order. If, in order to maintain a necessary degree of short-
term liquidity, a fund is permitted to hold an insignificant amount of 
its assets in short-term, highly liquid securities of superior credit 
quality that do not qualify for a preferential risk weight, such 
securities generally will be disregarded when determining the risk 
category into which the organization's holding in the overall fund 
should be assigned. The prudent use of hedging instruments by a fund to 
reduce the risk of its assets will not increase the risk weighting of 
the fund investment. For example, the use of hedging instruments by a 
fund to reduce the interest rate risk of its government bond portfolio 
will not increase the risk weight of that fund above the 20 percent 
category. Nonetheless, if a fund engages in any activities that appear 
speculative in nature or has any other characteristics that are 
inconsistent with the preferential risk weighting assigned to the fund's 
assets, holdings in the fund will be assigned to the 100 percent risk 
category.

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[[Page 162]]

           B. Collateral, Guarantees, and Other Considerations

    1. Collateral. The only forms of collateral that are formally 
recognized by the risk-based capital framework are: Cash on deposit in a 
subsidiary lending institution; securities issued or guaranteed by the 
central governments of the OECD-based group of countries,\25\ U.S. 
Government agencies, or U.S. Government-sponsored agencies; and 
securities issued by multilateral lending institutions or regional 
development banks. Claims fully secured by such collateral generally are 
assigned to the 20 percent risk-weight category. Collateralized 
transactions meeting all the conditions described in section III.C.1. 
may be assigned a zero percent risk weight.
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    \25\ The OECD-based group of countries comprises all full members of 
the Organization for Economic Cooperation and Development (OECD) 
regardless of entry date, as well as countries that have concluded 
special lending arrangements with the International Monetary Fund (IMF) 
associated with the IMF's General Arrangements to Borrow, but excludes 
any country that has rescheduled its external sovereign debt within the 
previous five years. As of November 1995, the OECD included the 
following countries: Australia, Austria, Belgium, Canada, Denmark, 
Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, 
Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Portugal, 
Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United 
States; and Saudi Arabia had concluded special lending arrangements with 
the IMF associated with the IMF's General Arrangements to Borrow. A 
rescheduling of external sovereign debt generally would include any 
renegotiation of terms arising from a country's inability or 
unwillingness to meet its external debt service obligations, but 
generally would not include renegotiations of debt in the normal course 
of business, such as a renegotiation to allow the borrower to take 
advantage of a decline in interest rates or other change in market 
conditions.
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    With regard to collateralized claims that may be assigned to the 20 
percent risk-weight category, the extent to which qualifying securities 
are recognized as collateral is determined by their current market 
value. If such a claim is only partially secured, that is, the market 
value of the pledged securities is less than the face amount of a 
balance-sheet asset or an off-balance-sheet item, the portion that is 
covered by the market value of the qualifying collateral is assigned to 
the 20 percent risk category, and the portion of the claim that is not 
covered by collateral in the form of cash or a qualifying security is 
assigned to the risk category appropriate to the obligor or, if 
relevant, the guarantor. For example, to the extent that a claim on a 
private sector obligor is collateralized by the current market value of 
U.S. Government securities, it would be placed in the 20 percent risk 
category and the balance would be assigned to the 100 percent risk 
category.
    2. Guarantees. Guarantees of the OECD and non-OECD central 
governments, U.S. Government agencies, U.S. Government-sponsored 
agencies, state and local governments of the OECD-based group of 
countries, multilateral lending institutions and regional development 
banks, U.S. depository institutions, and foreign banks are also 
recognized. If a claim is partially guaranteed, that is, coverage of the 
guarantee is less than the face amount of a balance sheet asset or an 
off-balance sheet item, the portion that is not fully covered by the 
guarantee is assigned to the risk category appropriate to the obligor 
or, if relevant, to any collateral. The face amount of a claim covered 
by two types of guarantees that have different risk weights, such as a 
U.S. Government guarantee and a state guarantee, is to be apportioned 
between the two risk categories appropriate to the guarantors.
    The existence of other forms of collateral or guarantees that the 
risk-based capital framework does not formally recognize may be taken 
into consideration in evaluating the risks inherent in an organization's 
loan portfolio--which, in turn, would affect the overall supervisory 
assessment of the organization's capital adequacy.
    3. Mortgage-backed securities. Mortgage-backed securities, including 
pass-throughs and collateralized mortgage obligations (but not stripped 
mortgage-backed securities), that are issued or guaranteed by a U.S. 
Government agency or U.S. Government-sponsored agency are assigned to 
the risk weight category appropriate to the issuer or guarantor. 
Generally, a privately-issued mortgage-backed security meeting certain 
criteria set forth in the accompanying footnote \26\ is treated as 
essentially an indirect

[[Page 163]]

holding of the underlying assets, and is assigned to the same risk 
category as the underlying assets, but in no case to the zero percent 
risk category. Privately-issued mortgage-backed securities whose 
structures do not qualify them to be regarded as indirect holdings of 
the underlying assets are assigned to the 100 percent risk category. 
During the inspection process, privately-issued mortgage-backed 
securities that are assigned to a lower risk weight category will be 
subject to criteria.
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    \26\ A privately-issued mortgage-backed security may be treated as 
an indirect holding of the underlying assets provided that: (1) The 
underlying assets are held by an independent trustee and the trustee has 
a first priority, perfected security interest in the underlying assets 
on behalf of the holders of the security; (2) either the holder of the 
security has an undivided pro rata ownership interest in the underlying 
mortgage assets or the trust or single purpose entity (or conduit) that 
issues the security has no liabilities unrelated to the issued 
securities; (3) the security is structured such that the cash flow from 
the underlying assets in all cases fully meets the cash flow 
requirements of the security without undue reliance on any reinvestment 
income; and (4) there is no material reinvestment risk associated with 
any funds awaiting distribution to the holders of the security. In 
addition, if the underlying assets of a mortgage-backed security are 
composed of more than one type of asset, for example, U.S. Government-
sponsored agency securities and privately-issued pass-through securities 
that qualify for the 50 percent risk weight category, the entire 
mortgage-backed security is generally assigned to the category 
appropriate to the highest risk-weighted asset underlying the issue, but 
in no case to the zero percent risk category. Thus, in this example, the 
security would receive the 50 percent risk weight appropriate to the 
privately-issued pass-through securities.
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    While the risk category to which mortgage-backed securities is 
assigned will generally be based upon the issuer or guarantor or, in the 
case of privately-issued mortgage-backed securities, the assets 
underlying the security, any class of a mortgage-backed security that 
can absorb more than its pro rata share of loss without the whole issue 
being in default (for example, a so-called subordinated class or 
residual interest), is assigned to the 100 percent risk category. 
Furthermore, all stripped mortgage-backed securities, including 
interest-only strips (IOs), principal-only strips (POs), and similar 
instruments, are also assigned to the 100 percent risk weight category, 
regardless of the issuer or guarantor.
    4. Maturity. Maturity is generally not a factor in assigning items 
to risk categories with the exception of claims on non-OECD banks, 
commitments, and interest rate and foreign exchange rate contracts. 
Except for commitments, short-term is defined as one year or less 
remaining maturity and long-term is defined as over one year remaining 
maturity. In the case of commitments, short-term is defined as one year 
or less original maturity and long-term is defined as over one year 
original maturity.\27\
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    \27\ Through year-end 1992, remaining, rather than original, 
maturity may be used for determining the maturity of commitments.
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    5. Small Business Loans and Leases on Personal Property Transferred 
with Recourse. a. Notwithstanding other provisions of this appendix A, a 
qualifying banking organization that has transferred small business 
loans and leases on personal property (small business obligations) with 
recourse shall include in weighted-risk assets only the amount of 
retained recourse, provided two conditions are met. First, the 
transaction must be treated as a sale under GAAP and, second, the 
banking organization must establish pursuant to GAAP a non-capital 
reserve sufficient to meet the organization's reasonably estimated 
liability under the recourse arrangement. Only loans and leases to 
businesses that meet the criteria for a small business concern 
established by the Small Business Administration under section 3(a) of 
the Small Business Act are eligible for this capital treatment.
    b. For purposes of this appendix A, a banking organization is 
qualifying if it meets the criteria for well capitalized or, by order of 
the Board, adequately capitalized, as those criteria are set forth in 
the Board's prompt corrective action regulation for state member banks 
(12 CFR 208.40). For purposes of determining whether an organization 
meets these criteria, its capital ratios must be calculated without 
regard to the capital treatment for transfers of small business 
obligations with recourse specified in section III.B.5.a. of this 
appendix A. The total outstanding amount of recourse retained by a 
qualifying banking organization on transfers of small business 
obligations receiving the preferential capital treatment cannot exceed 
15 percent of the organization's total risk-based capital. By order, the 
Board may approve a higher limit.
    c. If a bank holding company ceases to be qualifying or exceeds the 
15 percent capital limitation, the preferential capital treatment will 
continue to apply to any transfers of small business obligations with 
recourse that were consummated during the time that the organization was 
qualifying and did not exceed the capital limit.

                             C. Risk Weights

    Attachment III contains a listing of the risk categories, a summary 
of the types of assets assigned to each category and the risk

[[Page 164]]

weight associated with each category, that is, 0 percent, 20 percent, 50 
percent, and 100 percent. A brief explanation of the components of each 
category follows.
    1. Category 1: zero percent. This category includes cash (domestic 
and foreign) owned and held in all offices of subsidiary depository 
institutions or in transit and gold bullion held in either a subsidiary 
depository institution's own vaults or in another's vaults on an 
allocated basis, to the extent it is offset by gold bullion 
liabilities.\28\ The category also includes all direct claims (including 
securities, loans, and leases) on, and the portions of claims that are 
directly and unconditionally guaranteed by, the central governments \29\ 
of the OECD countries and U.S. Government agencies,\30\ as well as all 
direct local currency claims on, and the portions of local currency 
claims that are directly and unconditionally guaranteed by, the central 
governments of non-OECD countries, to the extent that subsidiary 
depository institutions have liabilities booked in that currency. A 
claim is not considered to be unconditionally guaranteed by a central 
government if the validity of the guarantee is dependent upon some 
affirmative action by the holder or a third party. Generally, securities 
guaranteed by the U.S. Government or its agencies that are actively 
traded in financial markets, such as GNMA securities, are considered to 
be unconditionally guaranteed.
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    \28\ All other holdings of bullion are assigned to the 100 percent 
risk category.
    \29\ A central government is defined to include departments and 
ministries, including the central bank, of the central government. The 
U.S. central bank includes the 12 Federal Reserve Banks, and stock held 
in these banks as a condition of membership is assigned to the zero 
percent risk category. The definition of central government does not 
include state, provincial, or local governments; or commercial 
enterprises owned by the central government. In addition, it does not 
include local government entities or commercial enterprises whose 
obligations are guaranteed by the central government, although any 
claims on such entities guaranteed by central governments are placed in 
the same general risk category as other claims guaranteed by central 
governments. OECD central governments are defined as central governments 
of the OECD-based group of countries; non-OECD central governments are 
defined as central governments of countries that do not belong to the 
OECD-based group of countries.
    \30\ A U.S. Governmnt agency is defined as an instrumentality of the 
U.S. Government whose obligations are fully and explicitly guaranteed as 
to the timely payment of principal and interest by the full faith and 
credit of the U.S. Government. Such agencies include the Government 
National Mortgage Association (GNMA), the Veterans Administration (VA), 
the Federal Housing Administration (FHA), the Export-Import Bank (Exim 
Bank), the Overseas Private Investment Corporation (OPIC), the Commodity 
Credit Corporation (CCC), and the Small Business Administration (SBA).
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    This category also includes claims collateralized by cash on deposit 
in the subsidiary lending institution or by securities issued or 
guaranteed by OECD central governments or U.S. government agencies for 
which a positive margin of collateral is maintained on a daily basis, 
fully taking into account any change in the banking organization's 
exposure to the obligor or counterparty under a claim in relation to the 
market value of the collateral held in support of that claim.
    2. Category 2: 20 percent. This category includes cash items in the 
process of collection, both foreign and domestic; short-term claims 
(including demand deposits) on, and the portions of short-term claims 
that are guaranteed by,\31\ U.S. depository institutions \32\ and 
foreign banks \33\; and long-term

[[Page 165]]

claims on, and the portions of long-term claims that are guaranteed by, 
U.S. depository institutions and OECD banks.\34\
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    \31\ Claims guaranteed by U.S. depository institutions and foreign 
banks include risk participations in both bankers acceptances and 
standby letters of credit, as well as participations in commitments, 
that are conveyed to U.S. depository institutions or foreign banks.
    \32\ U.S. depository institutions are defined to include branches 
(foreign and domestic) of federally-insured banks and depository 
institutions chartered and headquartered in the 50 states of the United 
States, the District of Columbia, Puerto Rico, and U.S. territories and 
possessions. The definition encompasses banks, mutual or stock savings 
banks, savings or building and loan associations, cooperative banks, 
credit unions, and international banking facilities or domestic banks. 
U.S.-chartered depository institutions owned by foreigners are also 
included in the definition. However, branches and agencies of foreign 
banks located in the U.S., as well as all bank holding companies, are 
excluded.
    \33\ Foreign banks are distinguished as either OECD banks or non-
OECD banks. OECD banks include banks and their branches (foreign and 
domestic) organized under the laws of countries (other than the U.S.) 
that belong to the OECD-based group of countries. Non-OECD banks include 
banks and their branches (foreign and domestic) organized under the laws 
of countries that do not belong to the OECD-based group of countries. 
For this purpose, a bank is defined as an institution that engages in 
the business of banking; is recognized as a bank by the bank supervisory 
or monetary authorities of the country of its organization or principal 
banking operations; receives deposits to a substantial extent in the 
regular course of business; and has the power to accept demand deposits.
    \34\ Long-term claims on, or guaranteed by, non-OECD banks and all 
claims on bank holding companies are assigned to the 100 percent risk 
category, as are holdings of bank-issued securities that qualify as 
capital of the issuing banks.
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    This category also includes the portions of claims that are 
conditionally guaranteed by OECD central governments and U.S. Government 
agencies, as well as the portions of local currency claims that are 
conditionally guaranteed by non-OECD central governments, to the extent 
that subsidiary depository institutions have liabilities booked in that 
currency. In addition, this category also includes claims on, and the 
portions of claims that are guaranteed by, U.S. government-sponsored\35\ 
agencies and claims on, and the portions of claims guaranteed by, the 
International Bank for Reconstruction and Development (World Bank), the 
International Finance Corporation, the Interamerican Development Bank, 
the Asian Development Bank, the African Development Bank, the European 
Investment Bank, the European Bank for Reconstruction and Development, 
the Nordic Investment Bank, and other multilateral lending institutions 
or regional development banks in which the U.S. government is a 
shareholder or contributing member. General obligation claims on, or 
portions of claims guaranteed by the full faith and credit of, states or 
other political subdivisions of the U.S. or other countries of the 
OECD--based group are also assigned to this category.\36\
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    \35\ For this purpose, U.S. government-sponsored agencies are 
defined as agencies originally established or chartered by the Federal 
government to serve public purposes specified by the U.S. Congress but 
whose obligations are not explicitly guaranteed by the full faith and 
credit of the U.S. government. These agencies include the Federal Home 
Loan Mortgage Corporation (FHLMC), the Federal National Mortgage 
Association (FNMA), the Farm Credit System, the Federal Home Loan Bank 
System, and the Student Loan Marketing Association (SLMA). Claims on 
U.S. government-sponsored agencies include capital stock in a Federal 
Home Loan Bank that is held as a condition of membership in that Bank.
    \36\ Claims on, or guaranteed by, states or other political 
subdivisions of countries that do not belong to the OECD-based group of 
countries are placed in the 100 percent risk category.
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    This category also includes the portions of claims (including 
repurchase transactions) collateralized by cash on deposit in the 
subsidiary lending institution or by securities issued or guaranteed by 
OECD central governments or U.S. government agencies that do not qualify 
for the zero percent risk-weight category; collateralized by securities 
issued or guaranteed by U.S. government-sponsored agencies; or 
collateralized by securities issued by multilateral lending institutions 
or regional development banks in which the U.S. government is a 
shareholder or contributing member.
    3. Category 3: 50 percent. This category includes loans fully 
secured by first liens \37\ on 1- to 4-family residential properties, 
either owner-occupied or rented, or on multifamily residential 
properties,\38\ that meet certain criteria.\39\ Loans included in this 
category must have been made in accordance with prudent underwriting 
standards;\40\ be performing in accordance with their original

[[Page 166]]

terms; and not be 90 days or more past due or carried in nonaccrual 
status. The following additional criteria must also be applied to a loan 
secured by a multifamily residential property that is included in this 
category: all principal and interest payments on the loan must have been 
made on time for at least the year preceding placement in this category, 
or in the case where the existing property owner is refinancing a loan 
on that property, all principal and interest payments on the loan being 
refinanced must have been made on time for at least the year preceding 
placement in this category; amortization of the principal and interest 
must occur over a period of not more than 30 years and the minimum 
original maturity for repayment of principal must not be less than 7 
years; and the annual net operating income (before debt service) 
generated by the property during its most recent fiscal year must not be 
less than 120 percent of the loan's current annual debt service (115 
percent if the loan is based on a floating interest rate) or, in the 
case of a cooperative or other not-for-profit housing project, the 
property must generate sufficient cash flow to provide comparable 
protection to the institution. Also included in this category are 
privately-issued mortgage-backed securities provided that:
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    \37\ If a banking organization holds the first and junior lien(s) on 
a residential property and no other party holds an intervening lien, the 
transaction is treated as a single loan secured by a first lien for the 
purposes of determining the loan-to-value ratio and assigning a risk 
weight.
    \38\ Loans that qualify as loans secured by 1- to 4-family 
residential properties or multifamily residential properties are listed 
in the instructions to the FR Y-9C Report. In addition, for risk-based 
capital purposes, loans secured by 1- to 4-family residential properties 
include loans to builders with substantial project equity for the 
construction of 1-to 4-family residences that have been presold under 
firm contracts to purchasers who have obtained firm commitments for 
permanent qualifying mortgage loans and have made substantial earnest 
money deposits. Such loans to builders will be considered prudently 
underwritten only if the bank holding company has obtained sufficient 
documentation that the buyer of the home intends to purchase the home 
(i.e., has a legally binding written sales contract) and has the ability 
to obtain a mortgage loan sufficient to purchase the home (i.e., has a 
firm written commitment for permanent financing of the home upon 
completion).
    \39\ Residential property loans that do not meet all the specified 
criteria or that are made for the purpose of speculative property 
development are placed in the 100 percent risk category.
    \40\ Prudent underwriting standards include a conservative ratio of 
the current loan balance to the value of the property. In the case of a 
loan secured by multifamily residential property, the loan-to-value 
ratio is not conservative if it exceeds 80 percent (75 percent if the 
loan is based on a floating interest rate). Prudent underwriting 
standards also dictate that a loan-to-value ratio used in the case of 
originating a loan to acquire a property would not be deemed 
conservative unless the value is based on the lower of the acquisition 
cost of the property or appraised (or if appropriate, evaluated) value. 
Otherwise, the loan-to-value ratio generally would be based upon the 
value of the property as determined by the most current appraisal, or if 
appropriate, the most current evaluation. All appraisals must be made in 
a manner consistent with the Federal banking agencies' real estate 
appraisal regulations and guidelines and with the banking organization's 
own appraisal guidelines.
---------------------------------------------------------------------------

    (1) The structure of the security meets the criteria described in 
section III(B)(3) above;
    (2) if the security is backed by a pool of conventional mortgages, 
on 1- to 4-family residential or multifamily residential properties, 
each underlying mortgage meets the criteria described above in this 
section for eligibility for the 50 percent risk category at the time the 
pool is originated;
    (3) If the security is backed by privately-issued mortgage-backed 
securities, each underlying security qualifies for the 50 percent risk 
category; and
    (4) If the security is backed by a pool of multifamily residential 
mortgages, principal and interest payments on the security are not 30 
days or more past due. Privately-issued mortgage-backed securities that 
do not meet these criteria or that do not qualify for a lower risk 
weight are generally assigned to the 100 percent risk category.
    Also assigned to this category are revenue (non-general obligation) 
bonds or similar obligations, including loans and leases, that are 
obligations of states or other political subdivisions of the U.S. (for 
example, municipal revenue bonds) or other countries of the OECD-based 
group, but for which the government entity is committed to repay the 
debt with revenues from the specific projects financed, rather than from 
general tax funds.
    Credit equivalent amounts of derivative contracts involving standard 
risk obligors (that is, obligors whose loans or debt securities would be 
assigned to the 100 percent risk category) are included in the 50 
percent category, unless they are backed by collateral or guarantees 
that allow them to be placed in a lower risk category.
    4. Category 4: 100 percent. All assets not included in the 
categories above are assigned to this category, which comprises standard 
risk assets. The bulk of the assets typically found in a loan portfolio 
would be assigned to the 100 percent category.
    This category includes long-term claims on, and the portions of 
long-term claims that are guaranteed by, non-OECD banks, and all claims 
on non-OECD central governments that entail some degree of transfer 
risk.\41\ This category also includes all claims on foreign and domestic 
private sector obligors not included in the categories above (including 
loans to nondepository financial institutions and bank holding 
companies); claims on commercial firms owned by the public sector; 
customer liabilities to the bank on acceptances outstanding involving 
standard risk claims;\42\ investments in fixed assets,

[[Page 167]]

premises, and other real estate owned; common and preferred stock of 
corporations, including stock acquired for debts previously contracted; 
commercial and consumer loans (except those assigned to lower risk 
categories due to recognized guarantees or collateral and loans for 
residential property that qualify for a lower risk weight); mortgage-
backed securities that do not meet criteria for assignment to a lower 
risk weight (including any classes of mortgage-backed securities that 
can absorb more than their pro rata share of loss without the whole 
issue being in default); and all stripped mortgage-backed and similar 
securities.
---------------------------------------------------------------------------

    \41\ Such assets include all non-local currency claims on, and the 
portions of claims that are guaranteed by, non-OECD central governments 
and those portions of local currency claims on, or guaranteed by, non-
OECD central governments that exceed the local currency liabilities held 
by subsidiary depository institutions.
    \42\ Customer liabilities on acceptances outstanding involving non-
standard risk claims, such as claims on U.S. depository institutions, 
are assigned to the risk category appropriate to the identity of the 
obligor or, if relevant, the nature of the collateral or guarantees 
backing the claims. Portions of acceptances conveyed as risk 
participations to U.S. depository institutions or foreign banks are 
assigned to the 20 percent risk category appropriate to short-term 
claims guaranteed by U.S. depository institutions and foreign banks.
---------------------------------------------------------------------------

    Also included in this category are industrial development bonds and 
similar obligations issued under the auspices of states or political 
subdivisions of the OECD-based group of countries for the benefit of a 
private party or enterprise where that party or enterprise, not the 
government entity, is obligated to pay the principal and interest, and 
all obligations of states or political subdivisions of countries that do 
not belong to the OECD-based group.
    The following assets also are assigned a risk weight of 100 percent 
if they have not been deducted from capital: Investments in 
unconsolidated companies, joint ventures, or associated companies; 
instruments that qualify as capital issued by other banking 
organizations; and any intangibles, including those that may have been 
grandfathered into capital.

                       D. Off-Balance Sheet Items

    The face amount of an off-balance sheet item is incorporated into 
the risk-based capital ratio by multiplying it by a credit conversion 
factor. The resultant credit equivalent amount is assigned to the 
appropriate risk category according to the obligor, or, if relevant, the 
guarantor or the nature of the collateral.\43\ Attachment IV sets forth 
the conversion factors for various types of off-balance sheet items.
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    \43\ The sufficiency of collateral and guarantees for off-balance-
sheet items is determined by the market value of the collateral or the 
amount of the guarantee in relation to the face amount of the item, 
except for derivative contracts, for which this determination is 
generally made in relation to the credit equivalent amount. Collateral 
and guarantees are subject to the same provisions noted under section 
III.B. of this appendix A.
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    1. Items with a 100 percent conversion factor.
    a. A 100 percent conversion factor applies to direct credit 
substitutes, which include guarantees, or equivalent instruments, 
backing financial claims, such as outstanding securities, loans, and 
other financial liabilities, or that back off-balance sheet items that 
require capital under the risk-based capital framework. Direct credit 
substitutes include, for example, financial standby letters of credit, 
or other equivalent irrevocable undertakings or surety arrangements, 
that guarantee repayment of financial obligations such as: commercial 
paper, tax-exempt securities, commercial or individual loans or debt 
obligations, or standby or commercial letters of credit. Direct credit 
substitutes also include the acquisition of risk participations in 
bankers acceptances and standby letters of credit, since both of these 
transactions, in effect, constitute a guarantee by the acquiring banking 
organization that the underlying account party (obligor) will repay its 
obligation to the originating, or issuing, institution.44 
(Standby letters of credit that are performance-related are discussed 
below and have a credit conversion factor of 50 percent.)
---------------------------------------------------------------------------

    \44\ Credit equivalent amounts of acquisitions of risk 
participations are assigned to the risk category appropriate to the 
account party obligor, or, if relevant, the nature of the collateral or 
guarantees.
---------------------------------------------------------------------------

    b. The full amount of a direct credit substitute is converted at 100 
percent and the resulting credit equivalent amount is assigned to the 
risk category appropriate to the obligor or, if relevant, the guarantor 
or the nature of the collateral. In the case of a direct credit 
substitute in which a risk participation 45 has been 
conveyed, the full amount is still converted at 100 percent. However, 
the credit equivalent amount that has been conveyed is assigned to 
whichever risk category is lower: the risk category appropriate to the 
obligor, after giving effect to any relevant guarantees or collateral, 
or the risk category appropriate to the institution acquiring the 
participation. Any remainder is assigned to the risk category 
appropriate to the obligor, guarantor, or collateral. For example, the 
portion of a direct credit substitute conveyed as a risk participation 
to a U.S. domestic depository institution or foreign bank is assigned to 
the risk category appropriate to claims guaranteed by those 
institutions, that is, the 20 percent risk category.46 This 
approach recognizes that such conveyances replace the originating 
banking organization's exposure to

[[Page 168]]

the obligor with an exposure to the institutions acquiring the risk 
participations.47
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    \45\ That is, a participation in which the originating banking 
organization remains liable to the beneficiary for the full amount of 
the direct credit substitute if the party that has acquired the 
participation fails to pay when the instrument is drawn.
    \46\ Risk participations with a remaining maturity of over one year 
that are conveyed to non-OECD banks are to be assigned to the 100 
percent risk category, unless a lower risk category is appropriate to 
the obligor, guarantor, or collateral.
    \47\ A risk participation in bankers acceptances conveyed to other 
institutions is also assigned to the risk category appropriate to the 
institution acquiring the participation or, if relevant, the guarantor 
or nature of the collateral.
---------------------------------------------------------------------------

    c. In the case of direct credit substitutes that take the form of a 
syndication, that is, where each banking organization if obligated only 
for its pro rata share of the risk and there is no recourse to the 
originating banking organization, each banking organization will only 
include its pro rata share of the direct credit substitute in its risk-
based capital calculation.
    d. Financial standby letters of credit are distinguished from loan 
commitments (discussed below) in that standbys are irrevocable 
obligations of the banking organization to pay a third-party beneficiary 
when a customer (account party) fails to repay an outstanding loan or 
debt instrument (direct credit substitute). Performance standby letters 
of credit (performance bonds) are irrevocable obligations of the banking 
organization to pay a third-party beneficiary when a customer (account 
party) fails to perform some other contractual non-financial obligation.
    e. The distinguishing characteristic of a standby letter of credit 
for risk-based capital purposes is the combination of irrevocability 
with the fact that funding is triggered by some failure to repay or 
perform an obligation. Thus, any commitment (by whatever name) that 
involves an irrevocable obligation to make a payment to the customer or 
to a third party in the event the customer fails to repay an outstanding 
debt obligation or fails to perform a contractual obligation is treated, 
for risk-based capital purposes, as respectively, a financial guarantee 
standby letter of credit or a performance standby.
    f. A loan commitment, on the other hand, involves an obligation 
(with or without a material adverse change or similar clause) of the 
banking organization to fund its customer in the normal course of 
business should the customer seek to draw down the commitment.
    g. Sale and repurchase agreements and asset sales with recourse (to 
the extent not included on the balance sheet) and forward agreements 
also are converted at 100 percent.48 So-called ``loan 
strips'' (that is, short-term advances sold under long-term commitments 
without direct recourse) are treated for risk-based capital purposes as 
assets sold with recourse and, accordingly, are also converted at 100 
percent.
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    \48\ In regulatory reports and under GAAP, bank holding companies 
are permitted to treat some asset sales with recourse as ``true'' sales. 
For risk-based capital purposes, however, such assets sold with recourse 
and reported as ``true'' sales by bank holding companies are converted 
at 100 percent and assigned to the risk category appropriate to the 
underlying obligor or, if relevant, the guarantor or nature of the 
collateral, provided that the transactions meet the definition of assets 
sold with recourse (including assets sold subject to pro rata and other 
loss sharing arrangements), that is contained in the instructions to the 
commercial bank Consolidated Reports of Condition and Income (Call 
Report). This treatment applies to any assets, including the sale of 1- 
to 4-family and multifamily residential mortgages, sold with recourse. 
Accordingly, the entire amount of any assets transferred with recourse 
that are not already included on the balance sheet, including pools of 
1- to 4-family residential mortgages, are to be converted at 100 percent 
and assigned to the risk category appropriate to the obligor, or if 
relevant, the nature of any collateral or guarantees. The terms of a 
transfer of assets with recourse may contractually limit the amount of 
the institution's liability to an amount less than the effective risk-
based capital requirement for the assets being transferred with 
recourse. If such a transaction is recognized as a sale under GAAP, the 
amount of total capital required is equal to the maximum amount of loss 
possible under the recourse provision, less any amount held in an 
associated non-capital liability account established pursuant to GAAP to 
cover estimated probable losses under the recourse provision.
---------------------------------------------------------------------------

    h. Forward agreements are legally binding contractual obligations to 
purchase assets with certain drawdown at a specified future date. Such 
obligations include forward purchases, forward forward deposits 
placed,49 and partly-paid shares and securities; they do not 
include commitments to make residential mortgage loans or forward 
foreign exchange contracts.
---------------------------------------------------------------------------

    \49\ Forward forward deposits accepted are treated as interest rate 
contracts.
---------------------------------------------------------------------------

    i. Securities lent by a banking organization are treated in one of 
two ways, depending upon whether the lender is at risk of loss. If a 
banking organization, as agent for a customer, lends the customer's 
securities and does not indemnify the customer against loss, then the 
transaction is excluded from the risk-based capital calculation. If, 
alternatively, a banking organization lends its own securities or, 
acting as agent for a customer, lends the customer's securities and 
indemnifies the customer against loss, the transaction is converted at 
100 percent and assigned to the risk weight category appropriate to the 
obligor, to any collateral delivered to the lending banking 
organization, or,

[[Page 169]]

if applicable, to the independent custodian acting on the lender's 
behalf. Where a banking organization is acting as agent for a customer 
in a transaction involving the lending or sale of securities that is 
collateralized by cash delivered to the banking organization, the 
transaction is deemed to be collateralized by cash on deposit in a 
subsidiary lending institution for purposes of determining the 
appropriate risk-weight category, provided that any indemnification is 
limited to no more than the difference between the market value of the 
securities and the cash collateral received and any reinvestment risk 
associated with that cash collateral is borne by the customer.
    2. Items with a 50 percent conversion factor. Transaction-related 
contingencies are converted at 50 percent. Such contingencies include 
bid bonds, performance bonds, warranties, standby letters of credit 
related to particular transactions, and performance standby letters of 
credit, as well as acquisitions of risk participation in performance 
standby letters of credit. Peformance standby letters of credit 
represent obligations backing the performance of nonfinancial or 
commercial contracts or undertakings. To the extent permitted by law or 
regulation, performance standby letters of credit include arrangements 
backing, among other things, subcontractors' and suppliers' performance, 
labor and materials contracts, and construction bids.
    The unused portion of commitments with an original maturity 
exceeding one year,\50\ including underwriting commitments, and 
commercial and consumer credit commitments also are converted at 50 
percent. Original maturity is defined as the length of time between the 
date the commitment is issued and the earliest date on which: (1) The 
banking organization can, at its option, unconditionally (without cause) 
cancel the commitment;\51\ and (2) the banking organization is scheduled 
to (and as a normal practice actually does) review the facility to 
determine whether or not it should be extended. Such reviews must 
continue to be conducted at least annually for such a facility to 
qualify as a short-term commitment.
---------------------------------------------------------------------------

    \50\ Through year-end 1992, remaining maturity may be used for 
determining the maturity of off-balance sheet loan commitments; 
thereafter, original maturity must be used.
    \51\ In the case of consumer home equity or mortgage lines of credit 
secured by liens on 1-4 family residential properties, the bank is 
deemed able to unconditionally cancel the commitment for the purpose of 
this criterion if, at its option, it can prohibit additional extensions 
of credit, reduce the credit line, and terminate the commitment to the 
full extent permitted by relevant Federal law.
---------------------------------------------------------------------------

    Commitments are defined as any legally binding arrangements that 
obligate a banking organization to extend credit in the form of loans or 
leases; to purchase loans, securities, or other assets; or to 
participate in loans and leases. They also include overdraft facilities, 
revolving credit, home equity and mortgage lines of credit, and similar 
transactions. Normally, commitments involve a written contract or 
agreement and a commitment fee, or some other form of consideration. 
Commitments are included in weighted risk assets regardless of whether 
they contain ``material adverse change'' clauses or other provisions 
that are intended to relieve the issuer of its funding obligation under 
certain conditions. In the case of commitments structured as 
syndications, where the banking organization is obligated solely for its 
pro rata share, only the banking organization's proportional share of 
the syndicated commitment is taken into account in calculating the risk-
based capital ratio.
    Facilities that are unconditionally cancellable (without cause) at 
any time by the banking organization are not deemed to be commitments, 
provided the banking organization makes a separate credit decision 
before each drawing under the facility. Commitments with an original 
maturity of one year or less are deemed to involve low risk and, 
therefore, are not assessed a capital charge. Such short-term 
commitments are defined to include the unused portion of lines of credit 
on retail credit cards and related plans (as defined in the instructions 
to the FR Y-9C Report) if the banking organization has the unconditional 
right to cancel the line of credit at any time, in accordance with 
applicable law.
    Once a commitment has been converted at 50 percent, any portion that 
has been conveyed to U.S. depository institutions or OECD banks as 
participations in which the originating banking organization retains the 
full obligation to the borrower if the participating bank fails to pay 
when the instrument is drawn, is assigned to the 20 percent risk 
category. This treatment is analogous to that accorded to conveyances of 
risk participations in standby letters of credit. The acquisition of a 
participation in a commitment by a banking organization is converted at 
50 percent and assigned to the risk category appropriate to the account 
party obligor or, if relevant, the nature of the collateral or 
guarantees.
    Revolving underwriting facilities (RUFs), note issuance facilities 
(NIFs), and other similar arrangements also are converted at 50 percent 
regardless of maturity. These are facilities under which a borrower can 
issue on a revolving basis short-term paper in its own name, but for 
which the underwriting organizations have a legally binding commitment 
either to purchase any notes the

[[Page 170]]

borrower is unable to sell by the roll-over date or to advance funds to 
the borrower.
    3. Items with a 20 percent conversion factor. Short-term, self-
liquidating trade-related contingencies which arise from the movement of 
goods are converted at 20 percent. Such contingencies generally include 
commercial letters of credit and other documentary letters of credit 
collateralized by the underlying shipments.
    4. Items with a zero percent conversion factor. These include unused 
portions of commitments with an original maturity of one year or 
less,\52\ or which are unconditionally cancellable at any time, provided 
a separate credit decision is made before each drawing under the 
facility. Unused portions of lines of credit on retail credit cards and 
related plans are deemed to be short-term commitments if the banking 
organization has the unconditional right to cancel the line of credit at 
any time, in accordance with applicable law.
---------------------------------------------------------------------------

    \52\ Through year-end 1992, remaining maturity may be used for 
determining term to maturity for off-balance sheet loan commitments; 
thereafter, original maturity must be used.
---------------------------------------------------------------------------

    E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity- 
(including precious metals) and Equity-Linked Contracts)
    1. Scope. Credit equivalent amounts are computed for each of the 
following off-balance-sheet derivative contracts:
    a. Interest Rate Contracts. These include single currency interest 
rate swaps, basis swaps, forward rate agreements, interest rate options 
purchased (including caps, collars, and floors purchased), and any other 
instrument linked to interest rates that gives rise to similar credit 
risks (including when-issued securities and forward forward deposits 
accepted).
    b. Exchange Rate Contracts. These include cross-currency interest 
rate swaps, forward foreign exchange contracts, currency options 
purchased, and any other instrument linked to exchange rates that gives 
rise to similar credit risks.
    c. Equity Derivative Contracts. These include equity-linked swaps, 
equity-linked options purchased, forward equity-linked contracts, and 
any other instrument linked to equities that gives rise to similar 
credit risks.
    d. Commodity (including precious metal) Derivative Contracts. These 
include commodity-linked swaps, commodity-linked options purchased, 
forward commodity-linked contracts, and any other instrument linked to 
commodities that gives rise to similar credit risks.
    e. Exceptions. Exchange rate contracts with an original maturity of 
fourteen or fewer calendar days and derivative contracts traded on 
exchanges that require daily receipt and payment of cash variation 
margin may be excluded from the risk-based ratio calculation. Gold 
contracts are accorded the same treatment as exchange rate contracts 
except that gold contracts with an original maturity of fourteen or 
fewer calendar days are included in the risk-based ratio calculation. 
Over-the-counter options purchased are included and treated in the same 
way as other derivative contracts.
    2. Calculation of credit equivalent amounts. a. The credit 
equivalent amount of a derivative contract that is not subject to a 
qualifying bilateral netting contract in accordance with section 
III.E.3. of this appendix A is equal to the sum of (i) the current 
exposure (sometimes referred to as the replacement cost) of the 
contract; and (ii) an estimate of the potential future credit exposure 
of the contract.
    b. The current exposure is determined by the mark-to-market value of 
the contract. If the mark-to-market value is positive, then the current 
exposure is equal to that mark-to-market value. If the mark-to-market 
value is zero or negative, then the current exposure is zero. Mark-to-
market values are measured in dollars, regardless of the currency or 
currencies specified in the contract and should reflect changes in 
underlying rates, prices, and indices, as well as counterparty credit 
quality.
    c. The potential future credit exposure of a contract, including a 
contract with a negative mark-to-market value, is estimated by 
multiplying the notional principal amount of the contract by a credit 
conversion factor. Banking organizations should use, subject to examiner 
review, the effective rather than the apparent or stated notional amount 
in this calculation. The credit conversion factors are:

                                               Conversion Factors
                                                  [In percent]
----------------------------------------------------------------------------------------------------------------
                                                                                         Commodity,
                                                   Interest     Exchange                 excluding     Precious
               Remaining maturity                    rate       rate and      Equity      precious     metals,
                                                                  gold                     metals    except gold
----------------------------------------------------------------------------------------------------------------
One year or less...............................          0.0          1.0          6.0         10.0          7.0
Over one to five years.........................          0.5          5.0          8.0         12.0          7.0

[[Page 171]]

 
Over five years................................          1.5          7.5         10.0         15.0          8.0
----------------------------------------------------------------------------------------------------------------

    d. For a contract that is structured such that on specified dates 
any outstanding exposure is settled and the terms are reset so that the 
market value of the contract is zero, the remaining maturity is equal to 
the time until the next reset date. For an interest rate contract with a 
remaining maturity of more than one year that meets these criteria, the 
minimum conversion factor is 0.5 percent.
    e. For a contract with multiple exchanges of principal, the 
conversion factor is multiplied by the number of remaining payments in 
the contract. A derivative contract not included in the definitions of 
interest rate, exchange rate, equity, or commodity contracts as set 
forth in section III.E.1. of this appendix A is subject to the same 
conversion factors as a commodity, excluding precious metals.
    f. No potential future exposure is calculated for a single currency 
interest rate swap in which payments are made based upon two floating 
rate indices (a so called floating/floating or basis swap); the credit 
exposure on such a contract is evaluated solely on the basis of the 
mark-to-market value.
    g. The Board notes that the conversion factors set forth above, 
which are based on observed volatilities of the particular types of 
instruments, are subject to review and modification in light of changing 
volatilities or market conditions.
    3. Netting. a. For purposes of this appendix A, netting refers to 
the offsetting of positive and negative mark-to-market values when 
determining a current exposure to be used in the calculation of a credit 
equivalent amount. Any legally enforceable form of bilateral netting 
(that is, netting with a single counterparty) of derivative contracts is 
recognized for purposes of calculating the credit equivalent amount 
provided that:
    i. The netting is accomplished under a written netting contract that 
creates a single legal obligation, covering all included individual 
contracts, with the effect that the banking organization would have a 
claim to receive, or obligation to pay, only the net amount of the sum 
of the positive and negative mark-to-market values on included 
individual contracts in the event that a counterparty, or a counterparty 
to whom the contract has been validly assigned, fails to perform due to 
any of the following events: default, insolvency, liquidation, or 
similar circumstances.
    ii. The banking organization obtains a written and reasoned legal 
opinion(s) representing that in the event of a legal challenge--
including one resulting from default, insolvency, liquidation, or 
similar circumstances--the relevant court and administrative authorities 
would find the banking organization's exposure to be the net amount 
under:
    1. The law of the jurisdiction in which the counterparty is 
chartered or the equivalent location in the case of noncorporate 
entities, and if a branch of the counterparty is involved, then also 
under the law of the jurisdiction in which the branch is located;
    2. The law that governs the individual contracts covered by the 
netting contract; and
    3. The law that governs the netting contract.
    iii. The banking organization establishes and maintains procedures 
to ensure that the legal characteristics of netting contracts are kept 
under review in the light of possible changes in relevant law.
    iv. The banking organization maintains in its files documentation 
adequate to support the netting of derivative contracts, including a 
copy of the bilateral netting contract and necessary legal opinions.
    b. A contract containing a walkaway clause is not eligible for 
netting for purposes of calculating the credit equivalent 
amount.53
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    \53\ A walkaway clause is a provision in a netting contract that 
permits a non-defaulting counterparty to make lower payments than it 
would make otherwise under the contract, or no payment at all, to a 
defaulter or to the estate of a defaulter, even if the defaulter or the 
estate of the defaulter is a net creditor under the contract.
---------------------------------------------------------------------------

    c. A banking organization netting individual contracts for the 
purpose of calculating credit equivalent amounts of derivative contracts 
represents that it has met the requirements of this appendix A and all 
the appropriate documents are in the banking

[[Page 172]]

organization's files and available for inspection by the Federal 
Reserve. The Federal Reserve may determine that a banking organization's 
files are inadequate or that a netting contract, or any of its 
underlying individual contracts, may not be legally enforceable under 
any one of the bodies of law described in section III.E.3.a.ii. of this 
appendix A. If such a determination is made, the netting contract may be 
disqualified from recognition for risk-based capital purposes or 
underlying individual contracts may be treated as though they are not 
subject to the netting contract.
    d. The credit equivalent amount of contracts that are subject to a 
qualifying bilateral netting contract is calculated by adding (i) the 
current exposure of the netting contract (net current exposure) and (ii) 
the sum of the estimates of potential future credit exposures on all 
individual contracts subject to the netting contract (gross potential 
future exposure) adjusted to reflect the effects of the netting 
contract.54
---------------------------------------------------------------------------

    \54\ For purposes of calculating potential future credit exposure to 
a netting counterparty for foreign exchange contracts and other similar 
contracts in which notional principal is equivalent to cash flows, total 
notional principal is defined as the net receipts falling due on each 
value date in each currency.
---------------------------------------------------------------------------

    e. The net current exposure is the sum of all positive and negative 
mark-to-market values of the individual contracts included in the 
netting contract. If the net sum of the mark-to-market values is 
positive, then the net current exposure is equal to that sum. If the net 
sum of the mark-to-market values is zero or negative, then the net 
current exposure is zero. The Federal Reserve may determine that a 
netting contract qualifies for risk-based capital netting treatment even 
though certain individual contracts included under the netting contract 
may not qualify. In such instances, the nonqualifying contracts should 
be treated as individual contracts that are not subject to the netting 
contract.
    f. Gross potential future exposure, or Agross is 
calculated by summing the estimates of potential future exposure 
(determined in accordance with section III.E.2 of this appendix A) for 
each individual contract subject to the qualifying bilateral netting 
contract.
    g. The effects of the bilateral netting contract on the gross 
potential future exposure are recognized through the application of a 
formula that results in an adjusted add-on amount (Anet). The 
formula, which employs the ratio of net current exposure to gross 
current exposure (NGR), is expressed as:

Anet=(0.4 x Agross)+0.6(NGR x Agross)

    h. The NGR may be calculated in accordance with either the 
counterparty-by-counterparty approach or the aggregate approach.
    i. Under the counterparty-by-counterparty approach, the NGR is the 
ratio of the net current exposure for a netting contract to the gross 
current exposure of the netting contract. The gross current exposure is 
the sum of the current exposures of all individual contracts subject to 
the netting contract calculated in accordance with section III.E.2. of 
this appendix A. Net negative mark-to-market values for individual 
netting contracts with the same counterparty may not be used to offset 
net positive mark-to-market values for other netting contracts with the 
same counterparty.
    ii. Under the aggregate approach, the NGR is the ratio of the sum of 
all of the net current exposures for qualifying bilateral netting 
contracts to the sum of all of the gross current exposures for those 
netting contracts (each gross current exposure is calculated in the same 
manner as in section III.E.3.h.i. of this appendix A). Net negative 
mark-to-market values for individual counterparties may not be used to 
offset net positive current exposures for other counterparties.
    iii. A banking organization must use consistently either the 
counterparty-by-counterparty approach or the aggregate approach to 
calculate the NGR. Regardless of the approach used, the NGR should be 
applied individually to each qualifying bilateral netting contract to 
determine the adjusted add-on for that netting contract.
    i. In the event a netting contract covers contracts that are 
normally excluded from the risk-based ratio calculation--for example, 
exchange rate contracts with an original maturity of fourteen or fewer 
calendar days or instruments traded on exchanges that require daily 
payment and receipt of cash variation margin--an institution may elect 
to either include or exclude all mark-to-market values of such contracts 
when determining net current exposure, provided the method chosen is 
applied consistently.
    4. Risk Weights. Once the credit equivalent amount for a derivative 
contract, or a group of derivative contracts subject to a qualifying 
bilateral netting contract, has been determined, that amount is assigned 
to the risk category appropriate to the counterparty, or, if relevant, 
the guarantor or the nature of any collateral.55 However, the 
maximum risk weight applicable to the

[[Page 173]]

credit equivalent amount of such contracts is 50 percent.
---------------------------------------------------------------------------

    \55\ For derivative contracts, sufficiency of collateral or 
guarantees is generally determined by the market value of the collateral 
or the amount of the guarantee in relation to the credit equivalent 
amount. Collateral and guarantees are subject to the same provisions 
noted under section III.B. of this appendix A.
---------------------------------------------------------------------------

    5. Avoidance of double counting. a. In certain cases, credit 
exposures arising from the derivative contracts covered by section 
III.E. of this appendix A may already be reflected, in part, on the 
balance sheet. To avoid double counting such exposures in the assessment 
of capital adequacy and, perhaps, assigning inappropriate risk weights, 
counterparty credit exposures arising from the derivative instruments 
covered by these guidelines may need to be excluded from balance sheet 
assets in calculating a banking organization's risk-based capital 
ratios.
    b. Examples of the calculation of credit equivalent amounts for 
contracts covered under this section III.E. are contained in Attachment 
V of this appendix A.

              IV. Minimum Supervisory Ratios and Standards

    The interim and final supervisory standards set forth below specify 
minimum supervisory ratios based primarily on broad credit risk 
considerations. As noted above, the risk-based ratio does not take 
explicit account of the quality of individual asset portfolios or the 
range of other types of risks to which banking organizations may be 
exposed, such as interest rate, liquidity, market or operational risks. 
For this reason, banking organizations are generally expected to operate 
with capital positions well above the minimum ratios.
    Institutions with high or inordinate levels of risk are expected to 
operate well above minimum capital standards. Banking organizations 
experiencing or anticipating significant growth are also expected to 
maintain capital, including tangible capital positions, well above the 
minimum levels. For example, most such organizations generally have 
operated at capital levels ranging from 100 to 200 basis points above 
the stated minimums. Higher capital ratios could be required if 
warranted by the particular circumstances or risk profiles of individual 
banking organizations. In all cases, organizations should hold capital 
commensurate with the level and nature of all of the risks, including 
the volume and severity of problem loans, to which they are exposed.
    Upon adoption of the risk-based framework, any organization that 
does not meet the interim or final supervisory ratios, or whose capital 
is otherwise considered inadequate, is expected to develop and implement 
a plan acceptable to the Federal Reserve for achieving an adequate level 
of capital consistent with the provisions of these guidelines or with 
the special circumstances affecting the individual organization. In 
addition, such organizations should avoid any actions, including 
increased risk-taking or unwarranted expansion, that would lower or 
further erode their capital positions.

           A. Minimum Risk-Based Ratio After Transition Period

    As reflected in Attachment VI, by year-end 1992, all bank holding 
companies \56\ should meet a minimum ratio of qualifying total capital 
to weighted risk assets of 8 percent, of which at least 4.0 percentage 
points should be in the form of Tier 1 capital. For purposes of section 
IV.A., Tier 1 capital is defined as the sum of core capital elements 
less goodwill and other intangible assets required to be deducted in 
accordance with section II.B.1.b. of this appendix. The maximum amount 
of supplementary capital elements that qualifies as Tier 2 capital is 
limited to 100 percent of Tier 1 capital. In addition, the combined 
maximum amount of subordinated debt and intermediate-term preferred 
stock that qualifies as Tier 2 capital is limited to 50 percent of Tier 
1 capital. The maximum amount of the allowance for loan and lease losses 
that qualifies as Tier 2 capital is limited to 1.25 percent of gross 
weighted risk assets. Allowances for loan and lease losses in excess of 
this limit may, of course, be maintained, but would not be included in 
an organization's total capital. The Federal Reserve will continue to 
require bank holding companies to maintain reserves at levels fully 
sufficient to cover losses inherent in their loan portfolios.
---------------------------------------------------------------------------

    \56\ As noted in section I above, bank holding companies with less 
than $150 million in consolidated assets would generally be exempt from 
the calculation and analysis of risk-based ratios on a consolidated 
holding company basis, subject to certain terms and conditions.
---------------------------------------------------------------------------

    Qualifying total capital is calculated by adding Tier 1 capital and 
Tier 2 capital (limited to 100 percent of Tier 1 capital) and then 
deducting from this sum certain investments in banking or finance 
subsidiaries that are not consolidated for accounting or supervisory 
purposes, reciprocal holdings of banking organizations' capital 
securities, or other items at the direction of the Federal Reserve. The 
conditions under which these deductions are to be made and the 
procedures for making the deductions are discussed above in section 
II(B).

                       B. Transition Arrangements

    The transition period for implementing the risk-based capital 
standard ends on December 31, 1992.\57\ Initially, the risk-based 
capital

[[Page 174]]

guidelines do not establish a minimum level of capital. However, by 
year-end 1990, banking organizations are expected to meet a minimum 
interim target ratio for qualifying total capital to weighted risk 
assets of 7.25 percent, at least one-half of which should be in the form 
of Tier 1 capital. For purposes of meeting the 1990 interim target, the 
amount of loan loss reserves that may be included in capital is limited 
to 1.5 percent of weighted risk assets and up to 10 percent of an 
organization's Tier 1 capital may consist of supplementary capital 
elements. Thus, the 7.25 percent interim target ratio implies a minimum 
ratio of Tier 1 capital to weighted risk assets of 3.6 percent (one-half 
of 7.25) and a minimum ratio of core capital elements to weighted risk 
assets ratio of 3.25 percent (nine-tenths of the Tier 1 capital ratio).
---------------------------------------------------------------------------

    \57\ The Basle capital framework does not establish an initial 
minimum standard for the risk-based capital ratio before the end of 
1990. However, for the purpose of calculating a risk-based capital ratio 
prior to year-end 1990, no sublimit is placed on the amount of the 
allowance for loan and lease losses includable in Tier 2. In addition, 
this framework permits, under temporary transition arrangements, a 
certain percentage of an organization's Tier 1 capital to be made up of 
supplementary capital elements. In particular, supplementary elements 
may constitute 25 percent of an organization's Tier 1 capital (before 
the deduction of goodwill) up to the end of 1990; from year-end 1990 up 
to the end of 1992, this allowable percentage of supplementary elements 
in Tier 1 declines to 10 percent of Tier 1 (before the deduction of 
goodwill). Beginning on December 31, 1992, supplementary elements may 
not be included in Tier 1. The amount of subordinated debt and 
intermediate-term preferred stock temporarily included in Tier 1 under 
these arrangements will not be subject to the sublimit on the amount of 
such instruments includable in Tier 2 capital. While the transitional 
arrangements allow an organization to include supplementary elements in 
Tier 1 on a temporary basis, the amount of perpetual preferred stock 
that may be included in a bank holding company's Tier 1--both during and 
after the transition period--is, as described in section II(A), based 
solely upon a specified percentage of the organization's permanent core 
capital elements (that is, common equity, perpetual preferred stock, and 
minority interest in the equity of consolidated subsidiaries), not upon 
total Tier 1 elements that temporarily include Tier 2 items. Once the 
amount of supplementary items that may temporarily qualify as Tier 1 
elements is determined, goodwill must be deducted from the sum of this 
amount and the amount of the organization's permanent core capital 
elements for the purpose of calculating Tier 1 (net of goodwill), Tier 
2, and total capital.
---------------------------------------------------------------------------

    Through year-end 1990, banking organizations have the option of 
complying with the minimum 7.25 percent year-end 1990 risk-based capital 
standard, in lieu of the minimum 5.5 percent primary and 6 percent total 
capital to total assets ratios set forth in appendix B of this part. In 
addition, as more fully set forth in appendix D to this part, banking 
organizations are expected to maintain a minimum ratio of Tier 1 capital 
to total assets during this transition period.

  Attachment I--Sample Calculation of Risk-Based Capital Ratio for Bank
                            Holding Companies
Example of a banking organization with $6,000 in total capital and the
 following assets and off-balance sheet items:
Balance Sheet Assets:
    Cash...................................................       $5,000
    U.S. Treasuries........................................       20,000
    Balances at domestic banks.............................        5,000
    Loans secured by first liens on 1-4 family residential         5,000
     properties............................................
    Loans to private corporations..........................       65,000
                                                            ------------
      Total Balance Sheet Assets...........................     $100,000
                                                            ============
Off-Balance Sheet Items:
    Standby letters of credit (``SLCs'') backing general         $10,000
     obligation debt issues of U.S. municipalities
     (``GOs'').............................................
    Long-term legally binding commitments to private              20,000
     corporations..........................................
                                                            ------------
      Total Off/Balance Sheet Items........................      $30,000
This bank holding company's total capital to total assets (leverage)
 ratio would be: ($6,000/$100,000)=6.00%.
To compute the bank holding company's weighted risk assets:
1. Compute the credit equivalent amount of each off-balance sheet
 (``OBS'') item.


 
                                                                                                        Credit
                             OBS item                                Face value      Conversion       equivalent
                                                                                       factor           amount
----------------------------------------------------------------------------------------------------------------
SLCS backing municipal GOs........................................      $10,000            1.00   =      $10,000
                                                                                 x
Long-term commitments to private corporations.....................      $20,000            0.50   =      $10,000
                                                                                 x
2. Multiply each balance sheet asset and the credit equivalent amount of each
 OBS item by the appropriate risk weight.
0% Category:
    Cash..........................................................        5,000
    U.S. Treasuries...............................................       20,000
                                                                   -------------
                                                                         25,000               0   =            0
                                                                                 x
                                                                   =============

[[Page 175]]

 
20% Category:
    Balances at domestic banks....................................        5,000
    Credit equivalent amounts of SLCs backing GOs of U.S.                10,000
     municipalities...............................................
                                                                   --------------
                                                                         15,000             .20   =       $3,000
                                                                                 x
                                                                   =============
50% Category:
    Loans secured by first liens on 1-4 family residential                5,000             .50   =       $2,500
     properties...................................................               x
                                                                   =============
100% Category:
    Loans to private corporations.................................       65,000
    Credit equivalent amounts of long-term commitments to private        10,000
     corporations.................................................
                                                                   -------------
                                                                        $75,000            1.00   =       75,000
                                                                                 x
                                                                                                    ------------
      Total Risk-weighted Assets..................................                                        80,500
This bank holding company's ratio of total capital to weighted risk assets (risk-based capital ratio) would be:
 ($6,000/$80,500)=7.45%


Attachment II--Summary Definition of Qualifying Capital for Bank Holding
             Companies* (Using the Year-End 1992 Standards)
------------------------------------------------------------------------
                                            Minimum requirements after
               Components                       transition period
------------------------------------------------------------------------
Core Capital (Tier 1)..................  Must equal or exceed 4% of
                                          weighted risk assets.
Common stockholders' equity............  No limit.
Qualifying noncumulative perpetual       No limit.
 preferred stock.
Qualifying cumulative perpetual          Limited to 25% of the sum of
 preferred stock.                         common stock, qualifying
                                          perpetual preferred stock, and
                                          minority interests.
Minority interest in equity accounts of  Organizations should avoid
 consolidated subsidiaries.               using minority interests to
                                          introduce elements not
                                          otherwise qualifying for Tier
                                          1 capital.
Less: Goodwill and other intangible
 assets required to be deducted from
 capital.\1\.
Supplementary Capital (Tier 2).........  Total of Tier 2 is limited to
                                          100% of Tier 1.\2\
Allowance for loan and lease losses....  Limited to 1.25% of weighted
                                          risk assets.\2\
Perpetual preferred stock..............  No limit within Tier 2.
Hybrid capital instruments, perpetual    No limit within Tier 2.
 debt, and mandatory convertible
 securities.
Subordinated debt and intermediate-term  Subordinated debt and
 preferred stock (original weighted       intermediate-term preferred
 average maturity of 5 years or more)     stock are limited to 50% of
                                          Tier 1;\3\ amortized for
                                          capital purposes as they
                                          approach maturity.
Revaluation reserves (equity and         Not included; organizations
 building).                               encouraged to disclose; may be
                                          evaluated on a case-by-case
                                          basis for international
                                          comparisons; and taken into
                                          account in making an overall
                                          assessment of capital.
Deductions (from sum of Tier 1 and Tier
 2):
    Investments in unconsolidated        As a general rule, one-half of
     subsidiaries.                        the aggregate investments will
                                          be deducted from Tier 1
                                          capital and one-half from Tier
                                          2 capital.\4\
    Reciprocal holdings of banking
     organizations' capital securities
    Other deductions (such as other      On a case-by-case basis or as a
     subsidiaries or joint ventures) as   matter of policy after formal
     determined by supervisory            rulemaking.
     authority
Total Capital (Tier 1+Tier 2-            Must equal or exceed 8% of
 Deductions).                             weighted risk assets.
------------------------------------------------------------------------
* See discussion in section II of the guidelines for a complete
  description of the requirements for, and the limitations on, the
  components of qualifying capital.
 
\1\ Requirements for the deduction of other intangible assets are set
  forth in section II.B.1.b. of this appendix.
\2\ Amounts in excess of limitations are permitted but do not qualify as
  capital.
\3\ Amounts in excess of limitations are permitted but do not qualify as
  capital.
\4\ A proportionately greater amount may be deducted from Tier 1 capital
  if the risks associated with the subsidiary so warrant.


[[Page 176]]

  Attachment III--Summary of Risk Weights and Risk Categories for Bank 
                            Holding Companies

                        Category 1: Zero Percent

    1. Cash (domestic and foreign) held in subsidiary depository 
institutions or in transit.
    2. Balances due from Federal Reserve Banks (including Federal 
Reserve Bank stock) and central banks in other OECD countries.
    3. Direct claims on, and the portions of claims that are 
unconditionally guaranteed by, the U.S. Treasury and U.S. Government 
agencies \1\ and the central governments of other OECD countries, and 
local currency claims on, and the portions of local currency claims that 
are unconditionally guaranteed by, the central governments of non-OECD 
countries (including the central banks of non-OECD countries), to the 
extent that subsidiary depository institutions have liabilities booked 
in that currency.
---------------------------------------------------------------------------

    \1\ For the purpose of calculating the risk-based capital ratio, a 
U.S. Government agency is defined as an instrumentality of the U.S. 
Government whose obligations are fully and explicitly guaranteed as to 
the timely payment of principal and interest by the full faith and 
credit of the U.S. Government.
---------------------------------------------------------------------------

    4. Gold bullion held in the vaults of a subsidiary depository 
institution or in another's vaults on an allocated basis, to the extent 
offset by gold bullion liabilities.
    5. Claims collateralized by cash on deposit in the subsidiary 
lending institution or by securities issued or guaranteed by OECD 
central governments or U.S. government agencies for which a positive 
margin of collateral is maintained on a daily basis, fully taking into 
account any change in the bank's exposure to the obligor or counterparty 
under a claim in relation to the market value of the collateral held in 
support of that claim.

                         Category 2: 20 Percent

    1. Cash items in the process of collection.
    2. All claims (long- or short-term) on, and the portions of claims 
(long- or short-term) that are guaranteed by, U.S. depository 
institutions and OECD banks.
    3. Short-term claims (remaining maturity of one year or less) on, 
and the portions of short-term claims that are guaranteed by, non-OECD 
banks.
    4. The portions of claims that are conditionally guaranteed by the 
central governments of OECD countries and U.S. Government agencies, and 
the portions of local currency claims that are conditionally guaranteed 
by the central governments of non-OECD countries, to the extent that 
subsidiary depository institutions have liabilities booked in that 
currency.
    5. Claims on, and the portions of claims that are guaranteed by, 
U.S. Government-sponsored agencies.\2\
---------------------------------------------------------------------------

    \2\ For the purpose of calculating the risk-based capital ratio, a 
U.S. Government-sponsored agency is defined as an agency originally 
established or chartered to serve public purposes specified by the U.S. 
Congress but whose obligations are not explicitly guaranteed by the full 
faith and credit of the U.S. Government.
---------------------------------------------------------------------------

    6. General obligation claims on, and the portions of claims that are 
guaranteed by the full faith and credit of, local governments and 
political subdivisions of the U.S. and other OECD local governments.
    7. Claims on, and the portions of claims that are guaranteed by, 
official multilateral lending institutions or regional development 
banks.
    8. The portions of claims that are collateralized \3\ by cash on 
deposit in the subsidiary lending institution or by securities issued or 
guaranteed by the U.S. Treasury, the central governments of other OECD 
countries, and U.S. government agencies that do not qualify for the zero 
percent risk-weight category, or that are collateralized by securities 
issued or guaranteed by U.S. government-sponsored agencies.
    9. The portions of claims that are collateralized \3\ by securities 
issued by official multilateral lending institutions or regional 
development banks.
---------------------------------------------------------------------------

    \3\ The extent of collateralization is determined by current market 
value.
---------------------------------------------------------------------------

    10. Certain privately-issued securities representing indirect 
ownership of mortgage-backed U.S. Government agency or U.S. Government-
sponsored agency securities.
    11. Investments in shares of a fund whose portfolio is permitted to 
hold only securities that would qualify for the zero or 20 percent risk 
categories.

                         Category 3: 50 Percent

    1. Loans fully secured by first liens on 1- to 4-family residential 
properties or on multifamily residential properties that have been made 
in accordance with prudent underwriting standards, that are performing 
in accordance with their original terms, that are not past due or in 
nonaccrual status, and that meet other qualifying criteria, and certain 
privately-issued mortgage-backed securities representing indirect 
ownership of such loans. (Loans made for speculative purposes are 
excluded.)
    2. Revenue bonds or similar claims that are obligations of U.S. 
state or local governments, or other OECD local governments,

[[Page 177]]

but for which the government entity is committed to repay the debt only 
out of revenues from the facilities financed.
    3. Credit equivalent amounts of interest rate and foreign exchange 
rate related contracts, except for those assigned to a lower risk 
category.

                         Category 4: 100 Percent

    1. All other claims on private obligors.
    2. Claims on, or guaranteed by, non-OECD foreign banks with a 
remaining maturity exceeding one year.
    3. Claims on, or guaranteed by, non-OECD central governments that 
are not included in item 3 of Category 1 of item 4 of Category 2; all 
claims on non-OECD state or local governments.
    4. Obligations issued by U.S. state of local governments, or other 
OECD local governments (including industrial development authorities and 
similar entities), repayable solely by a private party or enterprise.
    5. Premises, plant, and equipment; other fixed assets; and other 
real estate owned.
    6. Investments in any unconsolidated subsidiaries, joint ventures, 
or associated companies--if not deducted from capital.
    7. Instruments issued by other banking organizations that qualify as 
capital--if not deducted from capital.
    8. Claims on commercial firms owned by a government.
    9. All other assets, including any intangible assets that are not 
deducted from capital.

Attachment IV--Credit Conversion Factors for Off-Balance-Sheet Items for 
                         Bank Holding Companies

                      100 Percent Conversion Factor

    1. Direct credit substitutes. (These include general guarantees of 
indebtedness and all guarantee-type instruments, including standby 
letters of credit backing the financial obligations of other parties.)
    2. Risk participations in bankers acceptances and direct credit 
substitutes, such as standby letters of credit.
    3. Sale and repurchase agreements and assets sold with recourse that 
are not included on the balance sheet.
    4. Forward agreements to purchase assets, including financing 
facilities, on which drawdown is certain.
    5. Securities lent for which the banking organization is at risk.

                      50 Percent Conversion Factor

    1. Transaction-related contingencies. (These include bid-bonds, 
performance bonds, warranties, and standby letters of credit backing the 
nonfinancial performance of other parties.)
    2. Unused portions of commitments with an original maturity 
exceeding one year, including underwriting commitments and commercial 
credit lines.
    3. Revolving underwriting facilities (RUFs), note issuance 
facilities (NIFs), and similar arrangements.

                      20 Percent Conversion Factor

    Short-term, self-liquidating trade-related contingencies, including 
commercial letters of credit.

                     Zero Percent Conversion Factor

    Unused portions of commitments with an original maturity of one year 
or less, or which are unconditionally cancellable at any time, provided 
a separate credit decision is made before each drawing.

               Credit Conversion for Derivative Contracts

    1. The credit equivalent amount of a derivative contract is the sum 
of the current credit exposure of the contract and an estimate of 
potential future increases in credit exposure. The current exposure is 
the positive mark-to-market value of the contract (or zero if the mark-
to-market value is zero or negative). For derivative contracts that are 
subject to a qualifying bilateral netting contract, the current exposure 
is, generally, the net sum of the positive and negative mark-to-market 
values of the contracts included in the netting contract (or zero if the 
net sum of the mark-to-market values is zero or negative). The potential 
future exposure is calculated by multiplying the effective notional 
amount of a contract by one of the following credit conversion factors, 
as appropriate:
      

                                               Conversion Factors
                                                  [In percent]
----------------------------------------------------------------------------------------------------------------
                                                                                         Commodity,
                                                   Interest     Exchange                 excluding     Precious
               Remaining maturity                    rate       rate and      Equity      precious     metals,
                                                                  gold                     metals    except gold
----------------------------------------------------------------------------------------------------------------
One year or less...............................          0.0          1.0          6.0         10.0          7.0
Over one to five years.........................          0.5          5.0          8.0         12.0          7.0
Over five years................................          1.5          7.5         10.0         15.0          8.0
----------------------------------------------------------------------------------------------------------------


[[Page 178]]

    For contracts subject to a qualifying bilateral netting contract, 
the potential future exposure is, generally, the sum of the individual 
potential future exposures for each contract included under the netting 
contract adjusted by the application of the following formula:

Anet=(0.4 x Agross)+0.6(NGR x Agross)

    NGR is the ratio of net current exposure to gross current exposure.
    2. No potential future exposure is calculated for single currency 
interest rate swaps in which payments are made based upon two floating 
indices, that is, so called floating/floating or basis swaps. The credit 
exposure on these contracts is evaluated solely on the basis of their 
mark-to-market value. Exchange rate contracts with an original maturity 
of fourteen or fewer days are excluded. Instruments traded on exchanges 
that require daily receipt and payment of cash variation margin are also 
excluded.
      

                  Attachment V--Calculating Credit Equivalent Amounts for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
                                      Notional                 Potential                  Current       Credit
         Type of Contract            principal    Conversion    exposure     Mark-to-     exposure    equivalent
                                       amount       factor     (dollars)      market     (dollars)      amount
----------------------------------------------------------------------------------------------------------------
(1) 120-day forward foreign           5,000,000          .01       50,000      100,000      100,000      150,000
 exchange.........................
(2) 4-year forward foreign            6,000,000          .05      300,000     -120,000            0      300,000
 exchange.........................
(3) 3-year single-currency fixed &   10,000,000         .005       50,000      200,000      200,000      250,000
 floating interest rate swap......
(4) 6-month oil swap..............   10,000,000          .10    1,000,000     -250,000            0    1,000,000
(5) 7-year cross-currency floating   20,000,000         .075    1,500,000   -1,500,000            0    1,500,000
 & floating interest rate swap....
      Total.......................  ...........  ...........    2,900,000            +      300,000   3,200,000
----------------------------------------------------------------------------------------------------------------
a. If contracts (1) through (5) above are subject to a qualifying bilateral netting contract, then the following
  applies:


------------------------------------------------------------------------
                                    Potential                   Credit
             Contract                 future    Net current   equivalent
                                     exposure     exposure      amount
------------------------------------------------------------------------
(1)..............................       50,000  ...........  ...........
(2)..............................      300,000  ...........  ...........
(3)..............................       50,000  ...........  ...........
(4)..............................    1,000,000  ...........  ...........
(5)..............................    1,500,000  ...........  ...........
      Total......................    2,900,000           +0    2,900,000
------------------------------------------------------------------------
Note: The total of the mark-to-market values from the first table is-
  $1,370,000. Since this is a negative amount the net current exposure
  is zero.

    b. To recognize the effects of bilateral netting on potential future 
exposure the following formula applies:

Anet=(0.4 x Agross)+0.6(NGR x Agross)
    c. In the above example, where the net current exposure is zero, the 
credit equivalent amount would be calculated as follows:

NGR=0=(0/300,000)
Anet=(0.4 x $2,900,000)+.6(0 x $2,900,000)
Anet=$1,160,000
    The credit equivalent amount is $1,160,000+0=$1,160,000.
    d. If the net current exposure was a positive number, for example 
$200,000, the credit equivalent would be calculated as follows:

NGR=.67=($200,000/$300,000)
Anet=(0.4 x $2,900,000)+0.6(.67 x $2,900,000)
Anet=$2,325,800
    The credit equivalent amount would be 
$2,325,800+$200,000=$2,525,800.
      

                                             Attachment VI--Summary
----------------------------------------------------------------------------------------------------------------
                                        Transitional arrangements for bank holding
                                                         companies                     Final arrangement--Year-
                                     ------------------------------------------------          end 1992
                                              Initial              Year-end 1990
---------------------------------------------------------------------------------------------------------------
1. Minimum standard of total capital  None..................  7.25%.................  8.0%.
 to weighted risk assets.
2. Definition of Tier 1 capital.....  Common equity,          Common equity,          Common equity, qualifying
                                       qualifying cum. and     qualifying cum. and     noncumulative and
                                       noncum. perpetual       noncum. perpetual       cumulative perpetual
                                       preferred stock,\1\     preferred stock,\1\     preferred stock,\1\ and
                                       and minority            and minority            minority interests less
                                       interests, plus         interests, plus         goodwill and other
                                       supplementary           supplementary           intangible assets
                                       elements,\2\ less       elements,\4\ less       required to be deducted
                                       goodwill.\3\.           goodwill.\3\.           from capital.\3\

[[Page 179]]

 
3. Minimum standard of Tier 1         None..................  3.625%................  4.0%.
 capital to weighted risk assets.
4. Minimum standard of stockholders'  None..................  3.25%.................  4.0%.
 equity to weighted risk assets.
5. Limitations on supplementary
 capital elements:
    a. Allowance for loan and lease   No limit within Tier 2  1.5% of weighted risk   1.25% of weighted risk
     losses.                                                   assets.                 assets.
    b. Perpetual preferred stock....  No limit within Tier 2  No limit within Tier 2  No limit within Tier 2.
    c. Hybrid capital instruments,    No limit within Tier 2  No limit within Tier 2  No limit within Tier 2.
     perpetual debt, and mandatory
     convertibles.
    d. Subordinated debt and          Combined maximum of     Combined maximum of     Combined maximum of 50%
     intermediate term preferred       50% of Tier 1.          50% of Tier 1.          of Tier 1.
     stock.
    c. Total qualifying Tier 2        May not exceed Tier 1   May not exceed Tier 1   May not exceed Tier 1
     capital.                          capital.                capital.                capital.
6. Definition of total capital......  Tier 1 plus Tier 2      Tier 1 plus Tier 2      Tier 1 plus Tier 2 less:
                                       less:                   less:
                                        --reciprocal            --reciprocal            --reciprocal holdings
                                         holdings of banking     holdings of banking     of banking
                                         organizations'          organizations'          organizations' capital
                                         capital instruments.    capital instruments.    instruments
                                        --investments in        --investments in        --investments in
                                         unconsolidated          unconsolidated          unconsolidated
                                         subsidiaries.\5\.       subsidiaries.\5\.       subsidiaries.\5\
----------------------------------------------------------------------------------------------------------------
\1\ Cumulative perpetual preferred stock is limited within tier 1 to 25% of the sum of common stockholders'
  equity, qualifying perpetual preferred stock, and minority interests.
\2\ Supplementary elements may be included in the Tier 1 up to 25% of the sum of Tier 1 plus goodwill.
\3\ Requirements for the deduction of other intangible assets are set forth in section II.B.1.b. of this
  appendix.
\4\ Supplementary elements may be included in Tier 1 up to 10% of the sum of Tier 1 plus goodwill.
\5\ As a general rule, one-half (50%) of the aggregate amount of investments will be deducted from Tier 1
  capital and one-half (50%) from Tier 2 capital. A proportionally greater amount may be deducted from Tier 1
  capital if the risks associated with the subsidiary so warrant.

[Reg. Y, 54 FR 4209, Jan. 27, 1989; 54 FR 12531, Mar. 27, 1989, as 
amended at 55 FR 32832, Aug. 10, 1990; 56 FR 51156, Oct. 10, 1991; 57 FR 
2012, Jan. 17, 1992; 57 FR 60720, Dec. 22, 1992; 57 FR 62180, 62182, 
Dec. 30, 1992; 58 FR 7980, 7981, Feb. 11, 1993; 58 FR 68739, Dec. 29, 
1993; 59 FR 62993, Dec. 7, 1994; 59 FR 63244, Dec. 8, 1994; 59 FR 65926, 
Dec. 22, 1994; 60 FR 8182, Feb. 13, 1995; 60 FR 45616, Aug. 31, 1995; 60 
FR 46179, 46181, Sept. 5, 1995; 60 FR 39230, 39231, Aug. 1, 1995; 60 FR 
66045, Dec. 20, 1995; 61 FR 47372, Sept. 6, 1996; 63 FR 42676, Aug. 10, 
1998; 63 FR 46522, Sept. 1, 1998; 63 FR 58621, Nov. 2, 1998; 64 FR 
10203, Mar. 2, 1999]

  Appendix B to Part 225--Capital Adequacy Guidelines for Bank Holding 
           Companies and State Member Banks: Leverage Measure

    The Board of Governors of the Federal Reserve System has adopted 
minimum capital ratios and guidelines to provide a framework for 
assessing the adequacy of the capital of bank holding companies and 
state member banks (collectively ``banking organizations''). The 
guidelines generally apply to all state member banks and bank holding 
companies regardless of size and are to be used in the examination and 
supervisory process as well as in the analysis of applications acted 
upon by the Federal Reserve. The Board of Governors will review the 
guidelines from time to time for possible adjustment commensurate with 
changes in the economy, financial markets, and banking practices. In 
this regard, the Board has determined that during the transition period 
through year-end 1990 for implementation of the risk-based capital 
guidelines contained in appendix A to this part and in appendix A to 
part 208, a banking organization may choose to fulfill the requirements 
of the guidelines relating capital to total assets contained in this 
Appendix in one of two manners. Until year-end 1990, a banking 
organization may choose to conform to either the 5.5 percent and 6 
percent minimum primary and total capital standards set forth in this 
appendix, or the 7.25 percent year-end 1990 minimum risk-based capital 
standard set forth in appendix A to this part and appendix A to part 
208. Those organizations that choose to conform during this period to 
the 7.25 percent year-end 1990 risk-based capital standard will be 
deemed to be in compliance with the capital

[[Page 180]]

adequacy guidelines set forth in this appendix.
    Two principal measurements of capital are used--the primary capital 
ratio and the total capital ratio. The definitions of primary and total 
capital for banks and bank holding companies and formulas for 
calculating the capital ratios are set forth below in the definitional 
sections of these guidelines.

                           Capital Guidelines

    The Board has established a minimum level of primary capital to 
total assets of 5.5 percent and a minimum level of total capital to 
total assets of 6.0 percent. Generally, banking organizations are 
expected to operate above the minimum primary and total capital levels. 
Those organizations whose operations involve or are exposed to high or 
inordinate degrees of risk will be expected to hold additional capital 
to compensate for these risks.
    In addition, the Board has established the following three zones for 
total capital for banking organizations of all sizes:


                           Total Capital Ratio
                              [In percent]
Zone 1....................................  Above 7.0.
Zone 2....................................  6.0 to 7.0.
Zone 3....................................  Below 6.0.
 

    The capital guidelines assume adequate liquidity and a moderate 
amount of risk in the loan and investment portfolios and in off-balance 
sheet activities. The Board is concerned that some banking organizations 
may attempt to comply with the guidelines in ways that reduce their 
liquidity or increase risk. Banking organizations should avoid the 
practice of attempting to meet the guidelines by decreasing the level of 
liquid assets in relation to total assets. In assessing compliance with 
the guidelines, the Federal Reserve will take into account liquidity and 
the overall degree of risk associated with an organization's operations, 
including the volume of assets exposed to risk.
    The Federal Reserve will also take into account the sale of loans or 
other assets with recourse and the volume and nature of all off-balance 
sheet risk. Particularly close attention will be directed to risks 
associated with standby letters of credit and participation in joint 
venture activities. The Federal Reserve will review the relationship of 
all on- and off-balance sheet risks to capital and will require those 
institutions with high or inordinate levels of risk to hold additional 
primary capital. In addition, the Federal Reserve will continue to 
review the need for more explicit procedures for factoring on- and off-
balance sheet risks into the assessment of capital adequacy.
    The capital guidelines apply to both banks and bank holding 
companies on a consolidated basis.\1\ Some banking organizations are 
engaged in significant nonbanking activities that typically require 
capital ratios higher than those of commercial banks alone. The Board 
believes that, as a matter of both safety and soundness and competitive 
equity, the degree of leverage common in banking should not 
automatically extend to nonbanking activities. Consequently, in 
evaluating the consolidated capital positions of banking organizations, 
the Board is placing greater weight on the building-block approach for 
assessing capital requirements. This approach generally provides that 
nonbank subsidiaries of a banking organization should maintain levels of 
capital consistent with the levels that have been established by 
industry norms or standards, by Federal or State regulatory agencies for 
similar firms that are not affiliated with banking organizations, or 
that may be established by the Board after taking into account risk 
factors of a particular industry. The assessment of an organization's 
consolidated capital adequacy must take into account the amount and 
nature of all nonbank activities, and an institution's consolidated 
capital position should at least equal the sum of the capital 
requirements of the organization's bank and nonbank subsidiaries as well 
as those of the parent company.
---------------------------------------------------------------------------

    \1\ The guidelines will apply to bank holding companies with less 
than $150 million in consolidated assets on a bank-only basis unless:
    (1) The holding company or any nonbank subsidiary is engaged 
directly or indirectly in any nonbank activity involving significant 
leverage or
    (2) The holding company or any nonbank subsidiary has outstanding 
significant debt held by the general public. Debt held by the general 
public is defined to mean debt held by parties other than financial 
institutions, officers, directors, and controlling shareholders of the 
banking organization or their related interests.
---------------------------------------------------------------------------

                           Supervisory Action

    The nature and intensity of supervisory action will be determined by 
an organization's compliance with the required minimum primary capital 
ratio as well as by the zone in which the company's total capital ratio 
falls. Banks and bank holding companies with primary capital ratios 
below the 5.5 percent minimum will be considered undercapitalized unless 
they can demonstrate clear extenuating circumstances. Such banking 
organizations will be required to submit an acceptable plan for 
achieving compliance with the capital guidelines and will be subject to 
denial of applications and appropriate supervisory enforcement actions.
    The zone in which an organization's total capital ratio falls will 
normally trigger the

[[Page 181]]

following supervisory responses, subject to qualitative analysis:
    For institutions operating in Zone 1, the Federal Reserve will:

--Consider that capital is generally adequate if the primary capital 
ratio is acceptable to the Federal Reserve and is above the 5.5 percent 
minimum.

    For institutions operating in Zone 2, the Federal Reserve will:

--Pay particular attention to financial factors, such as asset quality, 
liquidity, off-balance sheet risk, and interest rate risk, as they 
relate to the adequacy of capital. If these areas are deficient and the 
Federal Reserve concludes capital is not fully adequate, the Federal 
Reserve will intensify its monitoring and take appropriate supervisory 
action.

    For institutions operating in Zone 3, the Federal Reserve will:

--Consider that the institution is undercapitalized, absent clear 
extenuating circumstances;
--Require the institution to submit a comprehensive capital plan, 
acceptable to the Federal Reserve, that includes a program for achieving 
compliance with the required minimum ratios within a reasonable time 
period; and
--Institute appropriate supervisory and/or administrative enforcement 
action, which may include the issuance of a capital directive or denial 
of applications, unless a capital plan acceptable to the Federal Reserve 
has been adopted by the institution.

Treatment of Intangible Assets for the Purpose of Assessing the Capital 
        Adequacy of Bank Holding Companies and State Member Banks

    In considering the treatment of intangible assets for the purpose of 
assessing capital adequacy, the Federal Reserve recognizes that the 
determination of the future benefits and useful lives of certain 
intangible assets may involve a degree of uncertainty that is not 
normally associated with other banking assets. Supervisory concern over 
intangible assets derives from this uncertainty and from the possibility 
that, in the event an organization experiences financial difficulties, 
such assets may not provide the degree of support generally associated 
with other assets. For this reason, the Federal Reserve will carefully 
review the level and specific character of intangible assets in 
evaluating the capital adequacy of state member banks and bank holding 
companies.
    The Federal Reserve recognizes that intangible assets may differ 
with respect to predictability of any income stream directly associated 
with a particular asset, the existence of a market for the asset, the 
ability to sell the asset, or the reliability of any estimate of the 
asset's useful life. Certain intangible assets have predictable income 
streams and objectively verifiable values and may contribute to an 
organization's profitability and overall financial strength. The value 
of other intangibles, such as goodwill, may involve a number of 
assumptions and may be more subject to changes in general economic 
circumstances or to changes in an individual institution's future 
prospects. Consequently, the value of such intangible assets may be 
difficult to ascertain. Consistent with prudent banking practices and 
the principle of the diversification of risks, banking organizations 
should avoid excessive balance sheet concentration in any category or 
related categories of intangible assets.

                         Bank Holding Companies

    While the Federal Reserve will consider the amount and nature of all 
intangible assets, those holding companies with aggregate intangible 
assets in excess of 25 percent of tangible primary capital (i.e., stated 
primary capital less all intangible assets) or those institutions with 
lesser, although still significant, amounts of goodwill will be subject 
to close scrutiny. For the purpose of assessing capital adequacy, the 
Federal Reserve may, on a case-by-case basis, make adjustments to an 
organization's capital ratios based upon the amount of intangible assets 
in excess of the 25 percent threshold level or upon the specific 
character of the organization's intangible assets in relation to its 
overall financial condition. Such adjustments may require some 
organizations to raise additional capital.
    The Board expects banking organizations (including state member 
banks) contemplating expansion proposals to ensure that pro forma 
capital ratios exceed the minimum capital levels without significant 
reliance on intangibles, particularly goodwill. Consequently, in 
reviewing acquisition proposals, the Board will take into consideration 
both the stated primary capital ratio (that is, the ratio without any 
adjustment for intangible assets) and the primary capital ratio after 
deducting intangibles. In acting on applications, the Board will take 
into account the nature and amount of intangible assets and will, as 
appropriate, adjust capital ratios to include certain intangible assets 
on a case-by-case basis.

                           State Member Banks

    State member banks with intangible assets in excess of 25 percent of 
intangible primary capital will be subject to close scrutiny. In 
addition, for the purpose of calculating capital ratios of state member 
banks, the Federal Reserve will deduct goodwill from primary capital and 
total capital. The Federal Reserve may, on a case-by-case basis, make

[[Page 182]]

further adjustments to a bank's capital ratios based on the amount of 
intangible assets (aside from goodwill) in excess of the 25 percent 
threshold level or on the specific character of the bank's intangible 
assets in relation to its overall financial condition. Such adjustments 
may require some banks to raise additional capital.
    In addition, state member banks and bank holding companies are 
expected to review periodically the value at which intangible assets are 
carried on their balance sheets to determine whether there has been any 
impairment of value or whether changing circumstances warrant a 
shortening of amortization periods. Institutions should make appropriate 
reductions in carrying values and amortization periods in light of this 
review, and examiners will evaluate the treatment of intangible assets 
during on-site examinations.

Definition of Capital To Be Used in Determining Capital Adequacy of Bank 
                Holding Companies and State Member Banks

                       Primary Capital Components

    The components of primary capital are:
--Common stock,
--Perpetual preferred stock (preferred stock that does not have a stated 
maturity date and that may not be redeemed at the option of the holder),
--Surplus (excluding surplus relating to limited-life preferred stock),
--Undivided profits,
--Contingency and other capital reserves,
--Mandatory convertible instruments,\2\
---------------------------------------------------------------------------

    \2\ See the definitional section below that lists the criteria for 
mandatory convertible instruments to qualify as primary capital.
---------------------------------------------------------------------------

--Allowance for possible loan and lease losses (exclusive of allocated 
transfer risk reserves),
--Minority interest in equity accounts of consolidated subsidiaries,
--Perpetual debt instruments (for bank holding companies but not for 
state member banks).

               Limits on Certain Forms of Primary Capital

    Bank Holding Companies. The maximum composite amount of mandatory 
convertible securities, perpetual debt, and perpetual preferred stock 
that may be counted as primary capital for bank holding companies is 
limited to 33.3 percent of all primary capital, including these 
instruments. Perpetual preferred stock issued prior to November 20, 1985 
(or determined by the Federal Reserve to be in the process of being 
issued prior to that date), shall continue to be included as primary 
capital.
    The maximum composite amount of mandatory convertible securities and 
perpetual debt that may be counted as primary capital for bank holding 
companies is limited to 20 percent of all primary capital, including 
these instruments. The maximum amount of equity commitment notes (a form 
of mandatory convertible securities) that may be counted as primary 
capital for a bank holding company is limited to 10 percent of all 
primary capital, including mandatory convertible securities. Amounts 
outstanding in excess of these limitations may be counted as secondary 
capital provided they meet the requirements of secondary capital 
instruments.
    State Member Banks. The composite limitations on the amount of 
mandatory convertible securities and perpetual preferred stock 
(perpetual debt is not primary capital for state member banks) that may 
serve as primary capital for bank holding companies shall not be applied 
formally to state member banks, although the Board shall determine 
appropriate limits for these forms of primary capital on a case-by-case 
basis.
    The maximum amount of mandatory convertible securities that may be 
counted as primary capital for state member banks is limited to 16\2/3\ 
percent of all primary capital, including mandatory convertible 
securities. Equity commitment notes, one form of mandatory convertible 
securities, shall not be included as primary capital for state member 
banks, except that notes issued by state member banks prior to May 15, 
1985, will continue to be included in primary capital. Amounts of 
mandatory convertible securities in excess of these limitations may be 
counted as secondary capital if they meet the requirements of secondary 
capital instruments.

                      Secondary Capital Components

    The components of secondary capital are:

--Limited-life preferred stock (including related surplus) and
--Bank subordinated notes and debentures and unsecured long-term debt of 
the parent company and its nonbank subsidiaries.

               Restrictions Relating to Capital Components

    To qualify as primary or secondary capital, a capital instrument 
should not contain or be covered by any convenants, terms, or 
restrictions that are inconsistent with safe and sound banking 
practices. Examples of such terms are those regarded as unduly 
interfering with the ability of the bank or holding company to conduct 
normal banking operations or those resulting in significantly higher 
dividends or interest payments in the event of a deterioration in the 
financial condition of the issuer.
    The secondary components must meet the following conditions to 
qualify as capital:


[[Page 183]]


--The instrument must have an original weighted-average maturity of at 
least seven years.
--The instrument must be unsecured.
--The instrument must clearly state on its face that it is not a deposit 
and is not insured by a Federal agency.
--Bank debt instruments must be subordinated to claims of depositors.
--For banks only, the aggregate amount of limited-life preferred stock 
and subordinate debt qualifying as capital may not exceed 50 percent of 
the amount of the bank's primary capital.
    As secondary capital components approach maturity, the banking 
organization must plan to redeem or replace the instruments while 
maintaining an adequate overall capital position. Thus, the remaining 
maturity of secondary capital components will be an important 
consideration in assessing the adequacy of total capital.

                             Capital Ratios

    The primary and total capital ratios for bank holding companies are 
computed as follows:
    Primary capital ratio:

Primary capital components/Total assets + Allowance for loan and lease 
          losses (exclusive of allocated transfer risk reserves)
    Total capital ratio:

Primary capital components + Secondary capital components/Total assets + 
          Allowance for loan and lease losses (exclusive of allocated 
          transfer risk reserves)
    The primary and total capital ratios for state member banks are 
computed as follows:

    Primary capital ratio:

Primary capital components--Goodwill/Average total assets + Allowance 
          for loan and lease losses (exclusive of allocated transfer 
          risk reserves)--Goodwill
    Total capital ratio:

Primary capital components + Secondary capital components--Goodwill/
          Average total assets + Allowance for loan and lease losses 
          (exclusive of allocated transfer risk reserves)--Goodwill
    Generally, period-end amounts will be used to calculate bank holding 
company ratios. However, the Federal Reserve will discourage temporary 
balance sheet adjustments or any other ``window dressing'' practices 
designed to achieve transitory compliance with the guidelines. Banking 
organizations are expected to maintain adequate capital positions at all 
times. Thus, the Federal Reserve will, on a case-by-case basis, use 
average total assets in the calculation of bank holding company capital 
ratios whenever this approach provides a more meaningful indication of 
an individual holding company's capital position.
    For the calculation of bank capital ratios, ``average total assets'' 
will generally be defined as the quarterly average total assets figure 
reported on the bank's Report of Condition. If warranted, however, the 
Federal Reserve may calculate bank capital ratios based upon total 
assets as of period-end. All other components of the bank's capital 
ratios will be based upon period-end balances.

    Criteria for Determining the Primary Capital Status of Mandatory 
 Convertible Securities of Bank Holding Companies and State Member Banks

    Mandatory convertible securities are subordinated debt instruments 
that are eventually transformed into common or perpetual preferred stock 
within a specified period of time, not to exceed 12 years. To be counted 
as primary capital, mandatory convertible securities must meet the 
criteria set forth below. These criteria cover the two basic types of 
mandatory convertible securities: ``equity contract notes''--securities 
that obligate the holder to take common or perpetual preferred stock of 
the issuer in lieu of cash for repayment of principal, and ``equity 
commitment notes''--securities that are redeemable only with the 
proceeds from the sale of common or perpetual preferred stock. Both 
equity commitment notes and equity contract notes qualify as primary 
capital for bank holding companies, but only equity contract notes 
qualify as primary capital for banks.

  Criteria Applicable to Both Types of Mandatory Convertible Securities

    a. The securities must mature in 12 years or less.
    b. The issuer may redeem securities prior to maturity only with the 
proceeds from the sale of common or perpetual preferred stock of the 
bank or bank holding company. Any exception to this rule must be 
approved by the Federal Reserve. The securities may not be redeemed with 
the proceeds of another issue of mandatory convertible securities. Nor 
may the issuer repurchase or acquire its own mandatory convertible 
securities for resale or reissuance.
    c. Holders of the securities may not accelerate the payment of 
principal except in the event of bankruptcy, insolvency, or 
reorganization.
    d. The securities must be subordinate in right of payment to all 
senior indebtedness of the issuer. In the event that the proceeds of the 
securities are reloaned to an affiliate, the loan must be subordinated 
to the same degree as the original issue.
    e. An issuer that intends to dedicate the proceeds of an issue of 
common or perpetual

[[Page 184]]

preferred stock to satisfy the funding requirements of an issue of 
mandatory convertible securities (i.e. the requirement to retire or 
redeem the notes with the proceeds from the issuance of common or 
perpetual preferred stock) generally must make such a dedication during 
the quarter in which the new common or preferred stock is issued.\3\ As 
a general rule, if the dedication is not made within the prescribed 
period, then the securities issued may not at a later date be dedicated 
to the retirement or redemption of the mandatory convertible 
securities.\4\
---------------------------------------------------------------------------

    \3\ Common or perpetual preferred stock issued under dividend 
reinvestment plans or issued to finance acquisitions, including 
acquisitions of business entities, may be dedicated to the retirement or 
redemption of the mandatory convertible securities. Documentation 
certified by an authorized agent of the issuer showing the amount of 
common stock or perpetual preferred stock issued, the dates of issue, 
and amounts of such issues dedicated to the retirement or redemption of 
mandatory convertible securities will satisfy the dedication 
requirement.
    \4\ The dedication procedure is necessary to ensure that the primary 
capital of the issuer is not overstated. For each dollar of common or 
perpetual preferred proceeds dedicated to the retirement or redemption 
of the notes, there is a corresponding reduction in the amount of 
outstanding mandatory securities that may qualify as primary capital. De 
minimis amounts (in relation to primary capital) of common or perpetual 
preferred stock issued under arrangements in which the amount of stock 
issued is not predictable, such as dividend reinvestment plans and 
employee stock option plans (but excluding public stock offerings and 
stock issued in connection with acquisitions), should be dedicated by no 
later than the company's fiscal year end.
---------------------------------------------------------------------------

         Additional Criteria Applicable to Equity Contract Notes

    a. The note must contain a contractual provision (or must be issued 
with a mandatory stock purchase contract) that requires the holder of 
the instrument to take the common or perpetual stock of the issuer in 
lieu of cash in satisfaction of the claim for principal repayment. The 
obligation of the holder to take the common or perpetual preferred stock 
of the issuer may be waived if, and to the extent that, prior to the 
maturity date of the obligation, the issuer sells new common or 
perpetual preferred stock and dedicates the proceeds to the retirement 
or redemption of the notes. The dedication generally must be made during 
the quarter in which the new common or preferred stock is issued.
    b. A stock purchase contract may be separated from a security only 
if: (1) The holder of the contract provides sufficient collateral \5\ to 
the issuer, or to an independent trustee for the benefit of the issuer, 
to assure performance under the contract and (2) the stock purchase 
contract requires the purchase of common or perpetual preferred stock.
---------------------------------------------------------------------------

    \5\ Collateral is defined as: (1) Cash or certificates of deposit; 
(2) U.S. government securities that will mature prior to or simultaneous 
with the maturity of the equity contract and that have a par or maturity 
value at least equal to the amount of the holder's obligation under the 
stock purchase contract; (3) standby letters of credit issued by an 
insured U.S. bank that is not an affiliate of the issuer; or (4) other 
collateral as may be designated from time to time by the Federal 
Reserve.
---------------------------------------------------------------------------

        Additional Criteria Applicable to Equity Commitment Notes

    a. The indenture or note agreement must contain the following two 
provisions:
    1. The proceeds of the sale of common or perpetual preferred stock 
will be the sole source of repayment for the notes, and the issuer must 
dedicate the proceeds for the purpose of repaying the notes. 
(Documentation certified by an authorized agent of the issued showing 
the amount of common or perpetual preferred stock issued, the dates of 
issue, and amounts of such issues dedicated to the retirement or 
redemption of mandatory convertible securities will satisfy the 
dedication requirement.)
    2. By the time that one-third of the life of the securities has run, 
the issuer must have raised and dedicated an amount equal to one-third 
of the original principal of the securities. By the time that two-thirds 
of the life of the securities has run, the issuer must have raised and 
dedicated an amount equal to two-thirds of the original principal of the 
securities. At least 60 days prior to the maturity of the securities, 
the issuer must have raised and dedicated an amount equal to the entire 
original principal of the securities. Proceeds dedicated to redemption 
or retirement of the notes must come only from the sale of common or 
perpetual preferred stock.\6\
---------------------------------------------------------------------------

    \6\ The funded portions of the securities will be deducted from 
primary capital to avoid double counting.
---------------------------------------------------------------------------

    b. If the issuer fails to meet any of these periodic funding 
requirements, the Federal Reserve immediately will cease to treat the 
unfunded securities as primary capital and will take appropriate 
supervisory action. In addition, failure to meet the funding 
requirements will be viewed as a breach of a regulatory commitment and 
will be taken into

[[Page 185]]

consideration by the Board in acting on statutory applications.
    c. If a security is issued by a subsidiary of a bank or bank holding 
company, any guarantee of the principal by that subsidiary's parent bank 
or bank holding company must be subordinate to the same degree as the 
security issued by the subsidiary and limited to repayment of the 
principal amount of the security at its final maturity.

 Criteria for Determining the Primary Capital Status of Perpetual Debt 
                  Instruments of Bank Holding Companies

    1. The instrument must be unsecured and, if issued by a bank, must 
be subordinated to the claims of depositors.
    2. The instrument may not provide the noteholder with the right to 
demand repayment of principal except in the event of bankruptcy, 
insolvency, or reorganization. The instrument must provide that 
nonpayment of interest shall not trigger repayment of the principal of 
the perpetual debt note or any other obligation of the issuer, nor shall 
it constitute prima facie evidence of insolvency or bankruptcy.
    3. The issuer shall not voluntarily redeem the debt issue without 
prior approval of the Federal Reserve, except when the debt is converted 
to, exchanged for, or simultaneously replaced in like amount by an issue 
of common or perpetual preferred stock of the issuer or the issuer's 
parent company.
    4. If issued by a bank holding company, a bank subsidiary, or a 
subsidiary with substantial operations, the instrument must contain a 
provision that allows the issuer to defer interest payments on the 
perpetual debt in the event of, and at the same time as the elimination 
of dividends on all outstanding common or preferred stock of the issuer 
(or in the case of a guarantee by a parent company at the same time as 
the elimination of the dividends of the parent company's common and 
preferred stock). In the case of a nonoperating subsidiary (a funding 
subsidiary or one formed to issue securities), the deferral of interest 
payments must be triggered by elimination of dividends by the parent 
company.
    5. If issued by a bank holding company or a subsidiary with 
substantial operations, the instrument must convert automatically to 
common or perpetual preferred stock of the issuer when the issuer's 
retained earnings and surplus accounts become negative. If an operating 
subsidiary's perpetual debt is guaranteed by its parent, the debt may 
convert to the shares of the issuer or guarantor and such conversion may 
be triggered when the issuer's or parent's retained earnings and surplus 
accounts become negative. If issued by a nonoperating subsidiary of a 
bank holding company or bank, the instrument must convert automatically 
to common or preferred stock of the issuer's parent when the retained 
earnings and surplus accounts of the issuer's parent become negative.

[Reg. Y, 50 FR 16066, Apr. 24, 1985, as amended at 51 FR 40969, Nov. 12, 
1986. Redesignated and amended at 54 FR 4209, Jan. 27, 1989; 55 FR 
32832, Aug. 10, 1990; 58 FR 474, Jan. 6, 1993]

   Appendix C to Part 225--Small Bank Holding Company Policy Statement

   Policy Statement on Assessment of Financial and Managerial Factors

    In acting on applications filed under the Bank Holding Company Act, 
the Board has adopted, and continues to follow, the principle that bank 
holding companies should serve as a source of strength for their 
subsidiary banks. When bank holding companies incur debt and rely upon 
the earnings of their subsidiary banks as the means of repaying such 
debt, a question arises as to the probable effect upon the financial 
condition of the holding company and its subsidiary bank or banks.
    The Board believes that a high level of debt at the parent holding 
company impairs the ability of a bank holding company to provide 
financial assistance to its subsidiary bank(s) and, in some cases, the 
servicing requirements on such debt may be a significant drain on the 
resources of the bank(s). For these reasons, the Board has not favored 
the use of acquisition debt in the formation of bank holding companies 
or in the acquisition of additional banks. Nevertheless, the Board has 
recognized that the transfer of ownership of small banks often requires 
the use of acquisition debt. The Board, therefore, has permitted the 
formation and expansion of small bank holding companies with debt levels 
higher than would be permitted for larger holding companies. Approval of 
these applications has been given on the condition that small bank 
holding companies demonstrate the ability to service acquisition debt 
without straining the capital of their subsidiary banks and, further, 
that such companies restore their ability to serve as a source of 
strength for their subsidiary banks within a relatively short period of 
time.
    In the interest of continuing its policy of facilitating the 
transfer of ownership in banks without compromising bank safety and 
soundness, the Board has, as described below, adopted the following 
procedures and standards for the formation and expansion of small bank 
holding companies subject to this policy statement.

                  1. Applicability of Policy Statement

    This policy statement applies only to bank holding companies with 
pro forma consolidated assets of less than $150 million that: (i) are 
not engaged in any nonbanking activities

[[Page 186]]

involving significant leverage 1 and (ii) do not have a 
significant amount of outstanding debt that is held by the general 
public.
---------------------------------------------------------------------------

    \1\ A parent company that is engaged in significant off-balance 
sheet activities would generally be deemed to be engaged in activities 
that involve significant leverage.
---------------------------------------------------------------------------

    While this policy statement primarily applies to the formation of 
small bank holding companies, it also applies to existing small bank 
holding companies that wish to acquire an additional bank or company and 
to transactions involving changes in control, stock redemptions, or 
other shareholder transactions. 2
---------------------------------------------------------------------------

    \2\ The appropriate Reserve Bank should be contacted to determine 
the manner in which a specific situation may qualify for treatment under 
this policy statement.
---------------------------------------------------------------------------

                         2. Ongoing Requirements

    The following guidelines must be followed on an ongoing basis for 
all organizations operating under this policy statement.
    A. Reduction in parent company leverage: Small bank holding 
companies are to reduce their parent company debt consistent with the 
requirement that all debt be retired within 25 years of being incurred. 
The Board also expects that these bank holding companies reach a debt to 
equity ratio of .30:1 or less within 12 years of the incurrence of the 
debt. 3 The bank holding company must also comply with debt 
servicing and other requirements imposed by its creditors.
---------------------------------------------------------------------------

    \3\ The term debt, as used in the ratio of debt to equity, means any 
borrowed funds (exclusive of short-term borrowings that arise out of 
current transactions, the proceeds of which are used for current 
transactions), and any securities issued by, or obligations of, the 
holding company that are the functional equivalent of borrowed funds.
    The term equity, as used in the ratio of debt to equity, means the 
total stockholders' equity of the bank holding company as defined in 
accordance with generally accepted accounting principles. In determining 
the total amount of stockholders' equity, the bank holding company 
should account for its investments in the common stock of subsidiaries 
by the equity method of accounting.
    Ordinarily the Board does not view redeemable preferred stock as a 
substitute for common stock in a small bank holding company. 
Nevertheless, to a limited degree and under certain circumstances, the 
Board will consider redeemable preferred stock as equity in the capital 
accounts of the holding company if the following conditions are met: (1) 
The preferred stock is redeemable only at the option of the issuer and 
(2) the debt to equity ratio of the holding company would be at or 
remain below .30:1 following the redemption or retirement of any 
preferred stock. Preferred stock that is convertible into common stock 
of the holding company may be treated as equity.
---------------------------------------------------------------------------

    B. Capital adequacy: Each insured depository subsidiary of a small 
bank holding company is expected to be well-capitalized. Any institution 
that is not well-capitalized is expected to become well-capitalized 
within a brief period of time.
    C. Dividend restrictions: A small bank holding company whose debt to 
equity ratio is greater than 1.0:1 is not expected to pay corporate 
dividends until such time as it reduces its debt to equity ratio to 
1.0:1 or less and otherwise meets the criteria set forth in 
Secs. 225.14(c)(1)(ii), 225.14(c)(2), and 225.14(c)(7) of Regulation Y. 
4
---------------------------------------------------------------------------

    \4\ Dividends may be paid by small bank holding companies with debt 
to equity at or below 1.0:1 and otherwise meeting the requirements of 
Sec. Sec. 225.14(c)(1)(ii), 225.14(c)(2), and 225.14(c)(7) if the 
dividends are reasonable in amount, do not adversely affect the ability 
of the bank holding company to service its debt in an orderly manner, 
and do not adversely affect the ability of the subsidiary banks to be 
well-capitalized. It is expected that dividends will be eliminated if 
the holding company is (1) not reducing its debt consistent with the 
requirement that the debt to equity ratio be reduced to .30:1 within 12 
years of consummation of the proposal or (2) not meeting the 
requirements of its loan agreement(s).
---------------------------------------------------------------------------

    Small bank holding companies formed before the effective date of 
this policy statement may switch to a plan that adheres to the intent of 
this statement provided they comply with the requirements set forth 
above.

                 3. Core Requirements for All Applicants

    In assessing applications or notices by organizations subject to 
this policy statement, the Board will continue to take into account a 
full range of financial and other information about the applicant, and 
its current and proposed subsidiaries, including the recent trend and 
stability of earnings, past and prospective growth, asset quality, the 
ability to meet debt servicing requirements without placing an undue 
strain on the resources of the bank(s), and the record and competency of 
management. In addition, the Board will require applicants to meet the 
following requirements:
    A. Minimum down payment: The amount of acquisition debt should not 
exceed 75 percent of the purchase price of the bank(s) or company to be 
acquired. When the owner(s) of the holding company incurs debt to 
finance the purchase of the bank(s) or company, such debt will be 
considered acquisition debt even though it does not represent

[[Page 187]]

an obligation of the bank holding company, unless the owner(s) can 
demonstrate that such debt can be serviced without reliance on the 
resources of the bank(s) or bank holding company.
    B. Ability to reduce parent company leverage: The bank holding 
company must clearly be able to reduce its debt to equity ratio and 
comply with its loan agreement(s) as set forth in paragraph 2A above.
    Failure to meet the criteria in this section would normally result 
in denial of an application.

 4. Additional Application Requirements for Expedited/Waived Processing

    A. Expedited notices under Secs. 225.14 and 225.23 of Regulation Y: 
A small bank holding company proposal will be eligible for the expedited 
processing procedures set forth in Secs. 225.14 and 225.23 of Regulation 
Y if the bank holding company is in compliance with the ongoing 
requirements of this policy statement, the bank holding company meets 
the core requirements for all applicants noted above, and the following 
requirements are met:
    i. The parent bank holding company has a pro forma debt to equity 
ratio of 1.0:1 or less.
    ii. The bank holding company meets all of the criteria for expedited 
action set forth in Secs. 225.14 or 225.23 of Regulation Y.
    B. Waiver of stock redemption filing: A small bank holding company 
will be eligible for the stock redemption filing exception for well-
capitalized bank holding companies contained in Sec. 225.4(b)(6) if the 
following requirements are met:
    i. The parent bank holding company has a pro forma debt to equity 
ratio of 1.0:1 or less.
    ii. The bank holding company is in compliance with the ongoing 
requirements of this policy statement and meets the requirements of 
Secs. 225.14(c)(1)(ii), 225.14(c)(2), and 225.14(c)(7) of Regulation Y.

[62 FR 9343, Feb. 28, 1997]

  Appendix D to Part 225--Capital Adequacy Guidelines for Bank Holding 
                   Companies: Tier 1 Leverage Measure

                               I. Overview

    a. The Board of Governors of the Federal Reserve System has adopted 
a minimum ratio of tier 1 capital to total assets to assist in the 
assessment of the capital adequacy of bank holding companies (banking 
organizations).\1\ The principal objectives of this measure is to place 
a constraint on the maximum degree to which a banking organization can 
leverage its equity capital base. It is intended to be used as a 
supplement to the risk-based capital measure.
---------------------------------------------------------------------------

    \1\ Supervisory ratios that related capital to total assets for 
state member banks are outlined in Appendix B of this part.
---------------------------------------------------------------------------

    b. The guidelines apply to consolidated basis to banking holding 
companies with consolidated assets of $150 million or more. For bank 
holding companies with less that $150 million in consolidated assets, 
the guidelines will be applied on a bank-only basis unless (i) the 
parent bank holding company is engaged in nonbank activity involving 
significant leverage \2\ or (ii) the parent company has a significant 
amount of outstanding debt that is held by the general public.
---------------------------------------------------------------------------

    \2\ A parent company that is engaged is significant off balance 
sheet activities would generally be deemed to be engaged in activities 
that involve significant leverage.
---------------------------------------------------------------------------

    c. The tier 1 leverage guidelines are to be used in the inspection 
and supervisory process as well as in the analysis of applications acted 
upon by the Federal Reserve. The Board will review the guidelines from 
time to time and will consider the need for possible adjustments in 
light of any significant changes in the economy, financial markets, and 
banking practices.

                      II. The Tier 1 Leverage Ratio

    a. The Board has established a minimum ratio of Tier 1 capital to 
total assets of 3.0 percent for strong bank holding companies (rated 
composite ``1'' under the BOPEC rating system of bank holding 
companies), and for bank holding companies that have implemented the 
Board's risk-based capital measure for market risk as set forth in 
appendices A and E of this part. For all other bank holding companies, 
the minimum ratio of Tier 1 capital to total assets is 4.0 percent. 
Banking organizations with supervisory, financial, operational, or 
managerial weaknesses, as well as organizations that are anticipating or 
experiencing significant growth, are expected to maintain capital ratios 
well above the minimum levels. Moreover, higher capital ratios may be 
required for any bank holding company if warranted by its particular 
circumstances or risk profile. In all cases, bank holding companies 
should hold capital commensurate with the level and nature of the risks, 
including the volume and severity of problem loans, to which they are 
exposed.
    b. A banking organization's Tier 1 leverage ratio is calculated by 
dividing its Tier 1 capital (the numerator of the ratio) by its average 
total consolidated assets (the denominator of the ratio). The ratio will 
also be calculated using period-end assets whenever necessary, on a 
case-by-case basis. For the purpose of this leverage ratio, the 
definition of Tier 1 capital as set forth in the risk-based capital 
guidelines contained in Appendix A

[[Page 188]]

of this part will be used.3 As a general matter, average 
total consolidated assets are defined as the quarterly average total 
assets (defined net of the allowance for loan and lease losses) reported 
on the organization's Consolidated Financial Statements (FR Y-9C 
Report), less goodwill; amounts of mortgage servicing assets, 
nonmortgage servicing assets, and purchased credit card relationships 
that, in the aggregate, are in excess of 100 percent of Tier 1 capital; 
amounts of nonmortgage servicing assets and purchased credit card 
relationships that, in the aggregate, are in excess of 25 percent of 
Tier 1 capital; all other identifiable intangible assets; any 
investments in subsidiaries or associated companies that the Federal 
Reserve determines should be deducted from Tier 1 capital; and deferred 
tax assets that are dependent upon future taxable income, net of their 
valuation allowance, in excess of the limitation set forth in section 
II.B.4 of Appendix A of this part.4
---------------------------------------------------------------------------

    \3\ Tier 1 capital for banking organizations includes common equity, 
minority interest in the equity accounts of consolidated subsidiaries, 
qualifying noncumulative perpetual preferred stock, and qualifying 
cumulative perpetual preferred stock. (Cumulative perpetual preferred 
stock is limited to 25 percent of Tier 1 capital.) In addition, as a 
general matter, Tier 1 capital excludes goodwill; amounts of mortgage 
servicing assets, nonmortgage servicing assets, and purchased credit 
card relationships that, in the aggregate, exceed 100 percent of Tier 1 
capital; nonmortgage servicing assets and purchased credit card 
relationships that, in the aggregate, exceed 25 percent of Tier 1 
capital; all other identifiable intangible assets; and deferred tax 
assets that are dependent upon future taxable income, net of their 
valuation allowance, in excess of certain limitations. The Federal 
Reserve may exclude certain investments in subsidiaries or associated 
companies as appropriate.
    \4\ Deductions from Tier 1 capital and other adjustments are 
discussed more fully in section II.B. in Appendix A of this part.
---------------------------------------------------------------------------

    c. Whenever appropriate, including when an organization is 
undertaking expansion, seeking to engage in new activities or otherwise 
facing unusual or abnormal risks, the Board will continue to consider 
the level of an individual organization's tangible tier 1 leverage ratio 
(after deducting all intangibles) in making an overall assessment of 
capital adequacy. This is consistent with the Federal Reserve's risk-
based capital guidelines an long-standing Board policy and practice with 
regard to leverage guidelines. Organizations experiencing growth, 
whether internally or by acquisition, are expected to maintain strong 
capital position substantially above minimum supervisory levels, without 
significant reliance on intangible assets.

[Reg. Y, 59 FR 65926, Dec. 22, 1994, as amended by Reg. Y, 60 FR 39231, 
Aug. 1, 1995; Reg. Y, 63 FR 30370, June 4, 1998; Reg. Y, 63 FR 42676, 
Aug. 10, 1998]

  Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding 
                     Companies: Market Risk Measure

      Section 1. Purpose, Applicability, Scope, and Effective Date

    (a) Purpose. The purpose of this appendix is to ensure that banks 
with significant exposure to market risk maintain adequate capital to 
support that exposure.1 This appendix supplements and adjusts 
the risk-based capital ratio calculations under appendix A of this part 
with respect to those banks.
---------------------------------------------------------------------------

    \1\ This appendix is based on a framework developed jointly by 
supervisory authorities from the countries represented on the Basle 
Committee on Banking Supervision and endorsed by the Group of Ten 
Central Bank Governors. The framework is described in a Basle Committee 
paper entitled ``Amendment to the Capital Accord to Incorporate Market 
Risks,'' January 1996. Also see modifications issued in September 1997.
---------------------------------------------------------------------------

    (b) Applicability. (1) This appendix applies to any insured state 
member bank whose trading activity 2 (on a worldwide 
consolidated basis) equals:
---------------------------------------------------------------------------

    \2\ Trading activity means the gross sum of trading assets and 
liabilities as reported in the bank's most recent quarterly Consolidated 
Report of Condition and Income (Call Report).
---------------------------------------------------------------------------

    (i) 10 percent or more of total assets; 3 or
---------------------------------------------------------------------------

    \3\ Total assets means quarter-end total assets as reported in the 
bank's most recent Call Report.
---------------------------------------------------------------------------

    (ii) $1 billion or more.
    (2) The Federal Reserve may additionally apply this appendix to any 
insured state member bank if the Federal Reserve deems it necessary or 
appropriate for safe and sound banking practices.
    (3) The Federal Reserve may exclude an insured state member bank 
otherwise meeting the criteria of paragraph (b)(1) of this section from 
coverage under this appendix if it determines the bank meets such 
criteria as a consequence of accounting, operational, or similar 
considerations, and the Federal Reserve deems it consistent with safe 
and sound banking practices.
    (c) Scope. The capital requirements of this appendix support market 
risk associated with a bank's covered positions.

[[Page 189]]

    (d) Effective date. This appendix is effective as of January 1, 
1997. Compliance is not mandatory until January 1, 1998. Subject to 
supervisory approval, a bank may opt to comply with this appendix as 
early as January 1, 1997.4
---------------------------------------------------------------------------

    \4\ A bank that voluntarily complies with the final rule prior to 
January 1, 1998, must comply with all of its provisions.
---------------------------------------------------------------------------

                         Section 2. Definitions

    For purposes of this appendix, the following definitions apply:
    (a) Covered positions means all positions in a bank's trading 
account, and all foreign exchange 5 and commodity positions, 
whether or not in the trading account.6 Positions include on-
balance-sheet assets and liabilities and off-balance-sheet items. 
Securities subject to repurchase and lending agreements are included as 
if they are still owned by the lender.
---------------------------------------------------------------------------

    \5\ Subject to supervisory review, a bank may exclude structural 
positions in foreign currencies from its covered positions.
    \6\ The term trading account is defined in the instructions to the 
Call Report.
---------------------------------------------------------------------------

    (b) Market risk means the risk of loss resulting from movements in 
market prices. Market risk consists of general market risk and specific 
risk components.
    (1) General market risk means changes in the market value of covered 
positions resulting from broad market movements, such as changes in the 
general level of interest rates, equity prices, foreign exchange rates, 
or commodity prices.
    (2) Specific risk means changes in the market value of specific 
positions due to factors other than broad market movements and includes 
event and default risk as well as idiosyncratic variations.
    (c) Tier 1 and Tier 2 capital are defined in appendix A of this 
part.
    (d) Tier 3 capital is subordinated debt that is unsecured; is fully 
paid up; has an original maturity of at least two years; is not 
redeemable before maturity without prior approval by the Federal 
Reserve; includes a lock-in clause precluding payment of either interest 
or principal (even at maturity) if the payment would cause the issuing 
bank's risk-based capital ratio to fall or remain below the minimum 
required under appendix A of this part; and does not contain and is not 
covered by any covenants, terms, or restrictions that are inconsistent 
with safe and sound banking practices.
    (e) Value-at-risk (VAR) means the estimate of the maximum amount 
that the value of covered positions could decline during a fixed holding 
period within a stated confidence level, measured in accordance with 
section 4 of this appendix.

   Section 3. Adjustments to the Risk-Based Capital Ratio Calculations

    (a) Risk-based capital ratio denominator. A bank subject to this 
appendix shall calculate its risk-based capital ratio denominator as 
follows:
    (1) Adjusted risk-weighted assets. Calculate adjusted risk-weighted 
assets, which equals risk-weighted assets (as determined in accordance 
with appendix A of this part), excluding the risk-weighted amounts of 
all covered positions (except foreign exchange positions outside the 
trading account and over-the-counter derivative positions).7
---------------------------------------------------------------------------

    \7\ Foreign exchange positions outside the trading account and all 
over-the-counter derivative positions, whether or not in the trading 
account, must be included in adjusted risk weighted assets as determined 
in appendix A of this part.
---------------------------------------------------------------------------

    (2) Measure for market risk. Calculate the measure for market risk, 
which equals the sum of the VAR-based capital charge, the specific risk 
add-on (if any), and the capital charge for de minimis exposures (if 
any).
    (i) VAR-based capital charge. The VAR-based capital charge equals 
the higher of:
    (A) The previous day's VAR measure; or
    (B) The average of the daily VAR measures for each of the preceding 
60 business days multiplied by three, except as provided in section 4(e) 
of this appendix;
    (ii) Specific risk add-on. The specific risk add-on is calculated in 
accordance with section 5 of this appendix; and
    (iii) Capital charge for de minimis exposure. The capital charge for 
de minimis exposure is calculated in accordance with section 4(a) of 
this appendix.
    (3) Market risk equivalent assets. Calculate market risk equivalent 
assets by multiplying the measure for market risk (as calculated in 
paragraph (a)(2) of this section) by 12.5.
    (4) Denominator calculation. Add market risk equivalent assets (as 
calculated in paragraph (a)(3) of this section) to adjusted risk-
weighted assets (as calculated in paragraph (a)(1) of this section). The 
resulting sum is the bank's risk-based capital ratio denominator.
    (b) Risk-based capital ratio numerator. A bank subject to this 
appendix shall calculate its risk-based capital ratio numerator by 
allocating capital as follows:
    (1) Credit risk allocation. Allocate Tier 1 and Tier 2 capital equal 
to 8.0 percent of adjusted risk-weighted assets (as calculated in 
paragraph (a)(1) of this section).8
---------------------------------------------------------------------------

    \8\ A bank may not allocate Tier 3 capital to support credit risk 
(as calculated under appendix A of this part).

---------------------------------------------------------------------------

[[Page 190]]

    (2) Market risk allocation. Allocate Tier 1, Tier 2, and Tier 3 
capital equal to the measure for market risk as calculated in paragraph 
(a)(2) of this section. The sum of Tier 2 and Tier 3 capital allocated 
for market risk must not exceed 250 percent of Tier 1 capital allocated 
for market risk. (This requirement means that Tier 1 capital allocated 
in this paragraph (b)(2) must equal at least 28.6 percent of the measure 
for market risk.)
    (3) Restrictions. (i) The sum of Tier 2 capital (both allocated and 
excess) and Tier 3 capital (allocated in paragraph (b)(2) of this 
section) may not exceed 100 percent of Tier 1 capital (both allocated 
and excess).9
---------------------------------------------------------------------------

    \9\ Excess Tier 1 capital means Tier 1 capital that has not been 
allocated in paragraphs (b)(1) and (b)(2) of this section. Excess Tier 2 
capital means Tier 2 capital that has not been allocated in paragraph 
(b)(1) and (b)(2) of this section, subject to the restrictions in 
paragraph (b)(3) of this section.
---------------------------------------------------------------------------

    (ii) Term subordinated debt (and intermediate-term preferred stock 
and related surplus) included in Tier 2 capital (both allocated and 
excess) may not exceed 50 percent of Tier 1 capital (both allocated and 
excess).
    (4) Numerator calculation. Add Tier 1 capital (both allocated and 
excess), Tier 2 capital (both allocated and excess), and Tier 3 capital 
(allocated under paragraph (b)(2) of this section). The resulting sum is 
the bank's risk-based capital ratio numerator.

                       Section 4. Internal Models

    (a) General. For risk-based capital purposes, a bank subject to this 
appendix must use its internal model to measure its daily VAR, in 
accordance with the requirements of this section.10 The 
Federal Reserve may permit a bank to use alternative techniques to 
measure the market risk of de minimis exposures so long as the 
techniques adequately measure associated market risk.
---------------------------------------------------------------------------

    \10\ A bank's internal model may use any generally accepted 
measurement techniques, such as variance-covariance models, historical 
simulations, or Monte Carlo simulations. However, the level of 
sophistication and accuracy of a bank's internal model must be 
commensurate with the nature and size of its covered positions. A bank 
that modifies its existing modeling procedures to comply with the 
requirements of this appendix for risk-based capital purposes should, 
nonetheless, continue to use the internal model it considers most 
appropriate in evaluating risks for other purposes.
---------------------------------------------------------------------------

    (b) Qualitative requirements. A bank subject to this appendix must 
have a risk management system that meets the following minimum 
qualitative requirements:
    (1) The bank must have a risk control unit that reports directly to 
senior management and is independent from business trading units.
    (2) The bank's internal risk measurement model must be integrated 
into the daily management process.
    (3) The bank's policies and procedures must identify, and the bank 
must conduct, appropriate stress tests and backtests.11 The 
bank's policies and procedures must identify the procedures to follow in 
response to the results of such tests.
---------------------------------------------------------------------------

    \11\ Stress tests provide information about the impact of adverse 
market events on a bank's covered positions. Backtests provide 
information about the accuracy of an internal model by comparing a 
bank's daily VAR measures to its corresponding daily trading profits and 
losses.
---------------------------------------------------------------------------

    (4) The bank must conduct independent reviews of its risk 
measurement and risk management systems at least annually.
    (c) Market risk factors. The bank's internal model must use risk 
factors sufficient to measure the market risk inherent in all covered 
positions. The risk factors must address interest rate 
risk,12 equity price risk, foreign exchange rate risk, and 
commodity price risk.
---------------------------------------------------------------------------

    \12\ For material exposures in the major currencies and markets, 
modeling techniques must capture spread risk and must incorporate enough 
segments of the yield curve--at least six--to capture differences in 
volatility and less than perfect correlation of rates along the yield 
curve.
---------------------------------------------------------------------------

    (d) Quantitative requirements. For regulatory capital purposes, VAR 
measures must meet the following quantitative requirements:
    (1) The VAR measures must be calculated on a daily basis using a 99 
percent, one-tailed confidence level with a price shock equivalent to a 
ten-business day movement in rates and prices. In order to calculate VAR 
measures based on a ten-day price shock, the bank may either calculate 
ten-day figures directly or convert VAR figures based on holding periods 
other than ten days to the equivalent of a ten-day holding period (for 
instance, by multiplying a one-day VAR measure by the square root of 
ten).
    (2) The VAR measures must be based on an historical observation 
period (or effective observation period for a bank using a weighting 
scheme or other similar method) of at least one year. The bank must 
update data sets at least once every three months or more frequently as 
market conditions warrant.
    (3) The VAR measures must include the risks arising from the non-
linear price characteristics of options positions and the sensitivity of 
the market value of the positions to changes in the volatility of the 
underlying

[[Page 191]]

rates or prices. A bank with a large or complex options portfolio must 
measure the volatility of options positions by different maturities.
    (4) The VAR measures may incorporate empirical correlations within 
and across risk categories, provided that the bank's process for 
measuring correlations is sound. In the event that the VAR measures do 
not incorporate empirical correlations across risk categories, then the 
bank must add the separate VAR measures for the four major risk 
categories to determine its aggregate VAR measure.
    (e) Backtesting. (1) Beginning one year after a bank starts to 
comply with this appendix, a bank must conduct backtesting by comparing 
each of its most recent 250 business days' actual net trading profit or 
loss 13 with the corresponding daily VAR measures generated 
for internal risk measurement purposes and calibrated to a one-day 
holding period and a 99 percent, one-tailed confidence level.
---------------------------------------------------------------------------

    \13\ Actual net trading profits and losses typically include such 
things as realized and unrealized gains and losses on portfolio 
positions as well as fee income and commissions associated with trading 
activities.
---------------------------------------------------------------------------

    (2) Once each quarter, the bank must identify the number of 
exceptions, that is, the number of business days for which the magnitude 
of the actual daily net trading loss, if any, exceeds the corresponding 
daily VAR measure.
    (3) A bank must use the multiplication factor indicated in Table 1 
of this appendix in determining its capital charge for market risk under 
section 3(a)(2)(i)(B) of this appendix until it obtains the next 
quarter's backtesting results, unless the Federal Reserve determines 
that a different adjustment or other action is appropriate.


     Table 1.--Multiplication Factor Based on Results of Backtesting
------------------------------------------------------------------------
                                                          Multiplication
                  Number of exceptions                        factor
------------------------------------------------------------------------
4 or fewer..............................................          3.00
5.......................................................          3.40
6.......................................................          3.50
7.......................................................          3.65
8.......................................................          3.75
9.......................................................          3.85
10 or more..............................................          4.00
------------------------------------------------------------------------

                        Section 5. Specific Risk

    (a) Modeled specific risk. A bank holding company may use its 
internal model to measure specific risk. If the organization has 
demonstrated to the Federal Reserve that its internal model measures the 
specific risk, including event and default risk as well as idiosyncratic 
variation, of covered debt and equity positions and includes the 
specific risk measures in the VAR-based capital charge in section 
3(a)(2)(i) of this appendix, then the organization has no specific risk 
add-on for purposes of section 3(a)(2)(ii) of this appendix. The model 
should explain the historical price variation in the trading portfolio 
and capture concentration, both magnitude and changes in composition. 
The model should also be robust to an adverse environment and have been 
validated through backtesting which assesses whether specific risk is 
being accurately captured.
    (b) Partially modeled specific risk. (1) A bank holding company that 
incorporates specific risk in its internal model but fails to 
demonstrate to the Federal Reserve that its internal model adequately 
measures all aspects of specific risk for covered debt and equity 
positions, including event and default risk, as provided by section 5(a) 
of this appendix, must calculate its specific risk add-on in accordance 
with one of the following methods:
    (i) If the model is susceptible to valid separation of the VAR 
measure into a specific risk portion and a general market risk portion, 
then the specific risk add-on is equal to the previous day's specific 
risk portion.
    (ii) If the model does not separate the VAR measure into a specific 
risk portion and a general market risk portion, then the specific risk 
add-on is the sum of the previous day's VAR measures for subportfolios 
of covered debt and equity positions that contain specific risk.
    (2) If a bank holding company models the specific risk of covered 
debt positions but not covered equity positions (or vice versa), then 
the bank holding company may determine its specific risk charge for the 
included positions under section 5(a) or 5(b)(1) of this appendix, as 
appropriate. The specific risk charge for the positions not included 
equals the standard specific risk capital charge under paragraph (c) of 
this section.
    (c) Specific risk not modeled. If a bank holding company does not 
model specific risk in accordance with section 5(a) or 5(b) of this 
appendix, then the organization's specific risk capital charge shall 
equal the standard specific risk capital charge, calculated as follows:
    (1) Covered debt positions. (i) For purposes of this section 5, 
covered debt positions means fixed-rate or floating-rate debt 
instruments located in the trading account and instruments located in 
the trading account with values that react primarily to changes in 
interest rates, including certain non-convertible preferred stock, 
convertible bonds, and instruments subject to repurchase and lending 
agreements. Also included are derivatives (including written and 
purchased options) for which the underlying instrument is a covered debt 
instrument that is subject to a non-zero specific risk capital charge.

[[Page 192]]

    (A) For covered debt positions that are derivatives, a bank must 
risk-weight (as described in paragraph (c)(1)(iii) of this section) the 
market value of the effective notional amount of the underlying debt 
instrument or index portfolio. Swaps must be included as the notional 
position in the underlying debt instrument or index portfolio, with a 
receiving side treated as a long position and a paying side treated as a 
short position; and
    (B) For covered debt positions that are options, whether long or 
short, a bank must risk-weight (as described in paragraph (c)(1)(iii) of 
this section) the market value of the effective notional amount of the 
underlying debt instrument or index multiplied by the option's delta.
    (ii) A bank may net long and short covered debt positions (including 
derivatives) in identical debt issues or indices.
    (iii) A bank must multiply the absolute value of the current market 
value of each net long or short covered debt position by the appropriate 
specific risk weighting factor indicated in Table 2 of this appendix. 
The specific risk capital charge component for covered debt positions is 
the sum of the weighted values.


  Table 2.--Specific Risk Weighting Factors for Covered Debt Positions
------------------------------------------------------------------------
                                                               Weighting
                                         Remaining maturity      factor
              Category                     (contractual)          (in
                                                                percent)
------------------------------------------------------------------------
Government..........................  N/A....................       0.00
Qualifying..........................  6 months or less.......       0.25
                                      Over 6 months to 24           1.00
                                       months.
                                      Over 24 months.........       1.60
Other...............................  N/A....................       8.00
------------------------------------------------------------------------

    (A) The government category includes all debt instruments of central 
governments of OECD-based countries 14 including bonds, 
Treasury bills, and other short-term instruments, as well as local 
currency instruments of non-OECD central governments to the extent the 
bank has liabilities booked in that currency.
---------------------------------------------------------------------------

    \14\ Organization for Economic Cooperation and Development (OECD)-
based countries is defined in appendix A of this part.
---------------------------------------------------------------------------

    (B) The qualifying category includes debt instruments of U.S. 
government-sponsored agencies, general obligation debt instruments 
issued by states and other political subdivisions of OECD-based 
countries, multilateral development banks, and debt instruments issued 
by U.S. depository institutions or OECD-banks that do not qualify as 
capital of the issuing institution.15 This category also 
includes other debt instruments, including corporate debt and revenue 
instruments issued by states and other political subdivisions of OECD 
countries, that are:
---------------------------------------------------------------------------

    \15\ U.S. government-sponsored agencies, multilateral development 
banks, and OECD banks are defined in appendix A of this part.
---------------------------------------------------------------------------

    (1) Rated investment-grade by at least two nationally recognized 
credit rating services;
    (2) Rated investment-grade by one nationally recognized credit 
rating agency and not rated less than investment-grade by any other 
credit rating agency; or
    (3) Unrated, but deemed to be of comparable investment quality by 
the reporting bank and the issuer has instruments listed on a recognized 
stock exchange, subject to review by the Federal Reserve.
    (C) The other category includes debt instruments that are not 
included in the government or qualifying categories.
    (2) Covered equity positions. (i) For purposes of this section 5, 
covered equity positions means equity instruments located in the trading 
account and instruments located in the trading account with values that 
react primarily to changes in equity prices, including voting or non-
voting common stock, certain convertible bonds, and commitments to buy 
or sell equity instruments. Also included are derivatives (including 
written and purchased options) for which the underlying is a covered 
equity position.
    (A) For covered equity positions that are derivatives, a bank must 
risk weight (as described in paragraph (c)(2)(iii) of this section) the 
market value of the effective notional amount of the underlying equity 
instrument or equity portfolio. Swaps must be included as the notional 
position in the underlying equity instrument or index portfolio, with a 
receiving side treated as a long position and a paying side treated as a 
short position; and
    (B) For covered equity positions that are options, whether long or 
short, a bank must risk weight (as described in paragraph (c)(2)(iii) of 
this section) the market value of the effective notional amount of the 
underlying equity instrument or index multiplied by the option's delta.
    (ii) A bank may net long and short covered equity positions 
(including derivatives) in identical equity issues or equity indices in 
the same market.16
---------------------------------------------------------------------------

    \16\ A bank may also net positions in depository receipts against an 
opposite position in the underlying equity or identical equity in 
different markets, provided that the bank includes the costs of 
conversion.
---------------------------------------------------------------------------

    (iii)(A) A bank must multiply the absolute value of the current 
market value of each net long or short covered equity position by a risk 
weighting factor of 8.0 percent, or by 4.0 percent if the equity is held 
in a portfolio

[[Page 193]]

that is both liquid and well-diversified.17 For covered 
equity positions that are index contracts comprising a well-diversified 
portfolio of equity instruments, the net long or short position is 
multiplied by a risk weighting factor of 2.0 percent.
---------------------------------------------------------------------------

    \17\ A portfolio is liquid and well-diversified if: (1) It is 
characterized by a limited sensitivity to price changes of any single 
equity issue or closely related group of equity issues held in the 
portfolio; (2) the volatility of the portfolio's value is not dominated 
by the volatility of any individual equity issue or by equity issues 
from any single industry or economic sector; (3) it contains a large 
number of individual equity positions, with no single position 
representing a substantial portion of the portfolio's total market 
value; and (4) it consists mainly of issues traded on organized 
exchanges or in well-established over-the-counter markets.
---------------------------------------------------------------------------

    (B) For covered equity positions from the following futures-related 
arbitrage strategies, a bank may apply a 2.0 percent risk weighting 
factor to one side (long or short) of each position with the opposite 
side exempt from charge, subject to review by the Federal Reserve:
    (1) Long and short positions in exactly the same index at different 
dates or in different market centers; or
    (2) Long and short positions in index contracts at the same date in 
different but similar indices.
    (C) For futures contracts on broadly-based indices that are matched 
by offsetting positions in a basket of stocks comprising the index, a 
bank may apply a 2.0 percent risk weighting factor to the futures and 
stock basket positions (long and short), provided that such trades are 
deliberately entered into and separately controlled, and that the basket 
of stocks comprises at least 90 percent of the capitalization of the 
index.
    (iv) The specific risk capital charge component for covered equity 
positions is the sum of the weighted values.

[Reg. Y, 61 FR 47373, Sept. 6, 1996, as amended by Reg. Y, 62 FR 68068, 
Dec. 30, 1997; 64 FR 19038, Apr. 19, 1999]



PART 226--TRUTH IN LENDING (REGULATION Z)--Table of Contents




                           Subpart A--General

Sec.
226.1  Authority, purpose, coverage, organization, enforcement and 
          liability.
226.2  Definitions and rules of construction.
226.3  Exempt transactions.
226.4  Finance charge.

                       Subpart B--Open-End Credit

226.5  General disclosure requirements.
226.5a  Credit and charge card applications and solicitations.
226.5b  Requirements for home equity plans.
226.6  Initial disclosure statement.
226.7  Periodic statement.
226.8  Identification of transactions.
226.9  Subsequent disclosure requirements.
226.10  Prompt crediting of payments.
226.11  Treatment of credit balances.
226.12  Special credit card provisions.
226.13  Billing error resolution.
226.14  Determination of annual percentage rate.
226.15  Right of rescission.
226.16  Advertising.

                      Subpart C--Closed-End Credit

226.17  General disclosure requirements.
226.18  Content of disclosures.
226.19  Certain residential mortgage and variable-rate transactions.
226.20  Subsequent disclosure requirements.
226.21  Treatment of credit balances.
226.22  Determination of annual percentage rate.
226.23  Right of rescission.
226.24  Advertising.

                        Subpart D--Miscellaneous

226.25  Record retention.
226.26  Use of annual percentage rate in oral disclosures.
226.27  Spanish language disclosures.
226.28  Effect on State laws.
226.29  State exemptions.
226.30  Limitation on rates.

     Subpart E--Special Rules for Certain Home Mortgage Transactions

226.31  General rules.
226.32  Requirements for certain closed-end home mortgages.
226.33  Requirements for reverse mortgages.

Appendix A to Part 226--Effect on State Laws
Appendix B to Part 226--State Exemptions
Appendix C to Part 226--Issuance of Staff Interpretations
Appendix D to Part 226--Multiple Advance Construction Loans
Appendix E to Part 226--Rules For Card Issuers That Bill On a 
          Transaction-By-Transaction Basis
Appendix F to Part 226--Annual Percentage Rate Computations for Certain 
          Open-End Credit Plans
Appendix G to Part 226--Open-End Model Forms and Clauses
Appendix H to Part 226--Closed-End Model Forms and Clauses
Appendix I to Part 226--Federal Enforcement Agencies

[[Page 194]]

Appendix J to Part 226--Annual Percentage Rate Computations For Closed-
          End Credit Transactions
Appendix K to Part 226--Total Annual Loan Cost Rate Computations for 
          Reverse Mortgage Transactions
Appendix L to Part 226--Assumed Loan Periods for Computations of Total 
          Annual Loan Cost Rates
Supplement I to Part 226--Official Staff Interpretations

    Authority: 12 U.S.C. 3806; 15 U.S.C. 1604 and 1637(c)(5).

    Source: Reg. Z, 46 FR 20892, Apr. 7, 1981, unless otherwise noted.



                           Subpart A--General



Sec. 226.1  Authority, purpose, coverage, organization, enforcement and liability.

    (a) Authority. This regulation, known as Regulation Z, is issued by 
the Board of Governors of the Federal Reserve System to implement the 
Federal Truth in Lending Act, which is contained in title I of the 
Consumer Credit Protection Act, as amended (15 U.S.C. 1601 et seq.). 
This regulation also implements title XII, section 1204 of the 
Competitive Equality Banking Act of 1987 (Pub. L. 100-86, 101 Stat. 
552). Information-collection requirements contained in this regulation 
have been approved by the Office of Management and Budget under the 
provisions of 44 U.S.C. 3501 et seq. and have been assigned OMB number 
7100-0199.
    (b) The purpose of this regulation is to promote the informed use of 
consumer credit by requiring disclosures about its terms and cost. The 
regulation gives consumers the right to cancel certain credit 
transactions that involve a lien on a consumer's principal dwelling, 
regulates certain credit card practices, and provides a means for fair 
and timely resolution of credit billing disputes. The regulation does 
not govern charges for consumer credit. The regulation requires a 
maximum interest rate to be stated in variable-rate contracts secured by 
the consumer's dwelling. It also imposes limitations on home equity 
plans that are subject to the requirements of Sec. 226.5b and mortgages 
that are subject to the requirements of Sec. 226.32.
    (c) Coverage. (1) In general, this regulation applies to each 
individual or business that offers or extends credit when four 
conditions are met: (i) The credit is offered or extended to consumers; 
(ii) the offering or extension of credit is done regularly;1 
(iii) the credit is subject to a finance charge or is payable by a 
written agreement in more than 4 installments; and (iv) the credit is 
primarily for personal, family, or household purposes.
---------------------------------------------------------------------------

    \1\ The meaning of regularly is explained in the definition of 
creditor in Sec. 226.2(a).
---------------------------------------------------------------------------

    (2) If a credit card is involved, however, certain provisions apply 
even if the credit is not subject to a finance charge, or is not payable 
by a written agreement in more than 4 installments, or if the credit 
card is to be used for business purposes.
    (3) In addition, certain requirements of Sec. 226.5b apply to 
persons who are not creditors but who provide applications for home 
equity plans to consumers.
    (d) Organization. The regulation is divided into subparts and 
appendices as follows:
    (1) Subpart A contains general information. It sets forth: (i) The 
authority, purpose, coverage, and organization of the regulation; (ii) 
the definitions of basic terms; (iii) the transactions that are exempt 
from coverage; and (iv) the method of determining the finance charge.
    (2) Subpart B contains the rules for open-end credit. It requires 
that initial disclosures and periodic statements be provided, as well as 
additional disclosures for credit and charge card applications and 
solicitations and for home equity plans subject to the requirements of 
Secs. 226.5a and 226.5b, respectively.
    (3) Subpart C relates to closed-end credit. It contains rules on 
disclosures, treatment of credit balances, annual percentage rate 
calculations, rescission requirements, and advertising.
    (4) Subpart D contains rules on oral disclosures, Spanish language 
disclosure in Puerto Rico, record retention, effect on state laws, state 
exemptions, and rate limitations.
    (5) Subpart E relates to mortgage transactions covered by 
Sec. 226.32 and reverse mortgage transactions. It contains rules on 
disclosures, fees, and total annual loan cost rates.

[[Page 195]]

    (6) Several appendices contain information such as the procedures 
for determinations about state laws, state exemptions and issuance of 
staff interpretations, special rules for certain kinds of credit plans, 
a list of enforcement agencies, and the rules for computing annual 
percentage rates in closed-end credit transactions and total annual loan 
cost rates for reverse mortgage transactions.
    (e) Enforcement and liability. Section 108 of the act contains the 
administrative enforcement provisions. Sections 112, 113, 130, 131, and 
134 contain provisions relating to liability for failure to comply with 
the requirements of the act and the regulation. Section 1204(c) of title 
XII of the Competitive Equality Banking Act of 1987, Pub. L. 100-86, 101 
Stat. 552, incorporates by reference administrative enforcement and 
civil liability provisions of sections 108 and 130 of the act.

[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 52 FR 43181, Nov. 9, 
1987; 54 FR 13865, Apr. 6, 1989; 54 FR 24686, June 9, 1989; 60 FR 15471, 
Mar. 24, 1995]



Sec. 226.2  Definitions and rules of construction.

    (a) Definitions. For purposes of this regulation, the following 
definitions apply:
    (1) Act means the Truth in Lending Act (15 U.S.C. 1601 et seq.).
    (2) Advertisement means a commercial message in any medium that 
promotes, directly or indirectly, a credit transaction.
    (3) [Reserved] \2\
---------------------------------------------------------------------------

    \2\ [Reserved]
---------------------------------------------------------------------------

    (4) Billing cycle or cycle means the interval between the days or 
dates of regular periodic statements. These intervals shall be equal and 
no longer than a quarter of a year. An interval will be considered equal 
if the number of days in the cycle does not vary more than 4 days from 
the regular day or date of the periodic statement.
    (5) Board means the Board of Governors of the Federal Reserve 
System.
    (6) Business day means a day on which the creditor's offices are 
open to the public for carrying on substantially all of its business 
functions. However, for purposes of rescission under Secs. 226.15 and 
226.23, and for purposes of Sec. 226.31, the term means all calendar 
days except Sundays and the legal public holidays specified in 5 U.S.C. 
6103(a), such as New Year's Day, the Birthday of Martin Luther King, 
Jr., Washington's Birthday, Memorial Day, Independence Day, Labor Day, 
Columbus Day, Veterans Day, Thanksgiving Day, and Christmas Day.
    (7) Card issuer means a person that issues a credit card or that 
person's agent with respect to the card.
    (8) Cardholder means a natural person to whom a credit card is 
issued for consumer credit purposes, or a natural person who has agreed 
with the card issuer to pay consumer credit obligations arising from the 
issuance of a credit card to another natural person. For purposes of 
Sec. 226.12(a) and (b), the term includes any person to whom a credit 
card is issued for any purpose, including business, commercial, or 
agricultural use, or a person who has agreed with the card issuer to pay 
obligations arising from the issuance of such a credit card to another 
person.
    (9) Cash price means the price at which a creditor, in the ordinary 
course of business, offers to sell for cash the property or service that 
is the subject of the transaction. At the creditor's option, the term 
may include the price of accessories, services related to the sale, 
service contracts and taxes and fees for license, title, and 
registration. The term does not include any finance charge.
    (10) Closed-end credit means consumer credit other than open-end 
credit as defined in this section.
    (11) Consumer means a cardholder or a natural person to whom 
consumer credit is offered or extended. However, for purposes of 
rescission under Secs. 226.15 and 226.23, the term also includes a 
natural person in whose principal dwelling a security interest is or 
will be retained or acquired, if that person's ownership interest in the 
dwelling is or will be subject to the security interest.
    (12) Consumer credit means credit offered or extended to a consumer 
primarily for personal, family, or household purposes.
    (13) Consummation means the time that a consumer becomes 
contractually obligated on a credit transaction.

[[Page 196]]

    (14) Credit means the right to defer payment of debt or to incur 
debt and defer its payment.
    (15) Credit card means any card, plate, coupon book, or other single 
credit device that may be used from time to time to obtain credit. 
Charge card means a credit card on an account for which no periodic rate 
is used to compute a finance charge.
    (16) Credit sale means a sale in which the seller is a creditor. The 
term includes a bailment or lease (unless terminable without penalty at 
any time by the consumer) under which the consumer:
    (i) Agrees to pay as compensation for use a sum substantially 
equivalent to, or in excess of, the total value of the property and 
services involved; and
    (ii) Will become (or has the option to become), for no additional 
consideration or for nominal consideration, the owner of the property 
upon compliance with the agreement.
    (17) Creditor means: (i) A person (A) who regularly extends consumer 
credit 3 that is subject to a finance charge or is payable by 
written agreement in more than 4 installments (not including a 
downpayment), and (B) to whom the obligation is initially payable, 
either on the face of the note or contract, or by agreement when there 
is no note or contract.
---------------------------------------------------------------------------

    \3\ A person regularly extends consumer credit only if it extended 
credit (other than credit subject to the requirements of Sec. 226.32) 
more than 25 times (or more than 5 times for transactions secured by a 
dwelling) in the preceding calendar year. If a person did not meet these 
numerical standards in the preceding calendar year, the numerical 
standards shall be applied to the current calendar year. A person 
regularly extends consumer credit if, in any 12-month period, the person 
originates more than one credit extension that is subject to the 
requirements of Sec. 226.32 or one or more such credit extensions 
through a mortgage broker.
---------------------------------------------------------------------------

    (ii) For purposes of Secs. 226.4(c)(8) (discounts), 226.9(d) 
(Finance charge imposed at time of transaction), and 226.12(e) (Prompt 
notification of returns and crediting of refunds), a person that honors 
a credit card.
    (iii) For purposes of subpart B, any card issuer that extends either 
open-end credit or credit that is not subject to a finance charge and is 
not payable by written agreement in more than 4 installments.
    (iv) For purposes of subpart B (except for the credit and charge 
card disclosures contained in Secs. 226.5(a) and 226.9 (e) and (f), the 
finance charge disclosures contained in Secs. 226.6(a) and 226.7 (d) 
through (g) and the right of rescission set forth in Sec. 226.15) and 
subpart C, any card issuer that extends closed-end credit that is 
subject to a finance charge or is payable by written agreement in more 
than 4 installments.
    (18) Downpayment means an amount, including the value of any 
property used as a trade-in, paid to a seller to reduce the cash price 
of goods or services purchased in a credit sale transaction. A deferred 
portion of a downpayment may be treated as part of the downpayment if it 
is payable not later than the due date of the second otherwise regularly 
scheduled payment and is not subject to a finance charge.
    (19) Dwelling means a residential structure that contains 1 to 4 
units, whether or not that structure is attached to real property. The 
term includes an individual condominium unit, cooperative unit, mobile 
home, and trailer, if it is used as a residence.
    (20) Open-end credit means consumer credit extended by a creditor 
under a plan in which:
    (i) The creditor reasonably contemplates repeated transactions;
    (ii) The creditor may impose a finance charge from time to time on 
an outstanding unpaid balance; and
    (iii) The amount of credit that may be extended to the consumer 
during the term of the plan (up to any limit set by the creditor) is 
generally made available to the extent that any outstanding balance is 
repaid.
    (21) Periodic rate means a rate of finance charge that is or may be 
imposed by a creditor on a balance for a day, week, month, or other 
subdivision of a year.
    (22) Person means a natural person or an organization, including a 
corporation, partnership, proprietorship, association, cooperative, 
estate, trust, or government unit.
    (23) Prepaid finance charge means any finance charge paid separately 
in cash or by check before or at consummation

[[Page 197]]

of a transaction, or withheld from the proceeds of the credit at any 
time.
    (24) Residential mortgage transaction means a transaction in which a 
mortgage, deed of trust, purchase money security interest arising under 
an installment sales contract, or equivalent consensual security 
interest is created or retained in the consumer's principal dwelling to 
finance the acquisition or initial construction of that dwelling.
    (25) Security interest means an interest in property that secures 
performance of a consumer credit obligation and that is recognized by 
State or Federal law. It does not include incidental interests such as 
interests in proceeds, accessions, additions, fixtures, insurance 
proceeds (whether or not the creditor is a loss payee or beneficiary), 
premium rebates, or interests in after-acquired property. For purposes 
of disclosure under Secs. 226.6 and 226.18, the term does not include an 
interest that arises solely by operation of law. However, for purposes 
of the right of rescission under Secs. 226.15 and 226.23, the term does 
include interests that arise solely by operation of law.
    (26) State means any state, the District of Columbia, the 
Commonwealth of Puerto Rico, and any territory or possession of the 
United States.
    (b) Rules of construction. For purposes of this regulation, the 
following rules of construction apply:
    (1) Where appropriate, the singular form of a word includes the 
plural form and plural includes singular.
    (2) Where the words obligation and transaction are used in this 
regulation, they refer to a consumer credit obligation or transaction, 
depending upon the context. Where the word credit is used in this 
regulation, it means consumer credit unless the context clearly 
indicates otherwise.
    (3) Unless defined in this regulation, the words used have the 
meanings given to them by state law or contract.
    (4) Footnotes have the same legal effect as the text of the 
regulation.

[Reg. Z, 46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981, as 
amended at 47 FR 7392, Feb. 19, 1982; 48 FR 14886, Apr. 6, 1983; 54 FR 
13865, Apr. 6, 1989; 60 FR 15471, Mar. 24, 1995; 61 FR 49245, Sept. 19, 
1996]



Sec. 226.3  Exempt transactions.

    This regulation does not apply to the following:\4\
---------------------------------------------------------------------------

    \4\ The provisions in Sec. 226.12 (a) and (b) governing the issuance 
of credit cards and the liability for their unauthorized use apply to 
all credit cards, even if the credit cards are issued for use in 
connection with extensions of credit that otherwise are exempt under 
this section.
---------------------------------------------------------------------------

    (a) Business, commercial, agricultural, or organizational credit. 
(1) An extension of credit primarily for a business, commercial or 
agricultural purpose.
    (2) An extension of credit to other than a natural person, including 
credit to government agencies or instrumentalities.
    (b) Credit over $25,000 not secured by real property or a dwelling. 
An extension of credit not secured by real property, or by personal 
property used or expected to be used as the principal dwelling of the 
consumer, in which the amount financed exceeds $25,000 or in which there 
is an express written commitment to extend credit in excess of $25,000.
    (c) Public utility credit. An extension of credit that involves 
public utility services provided through pipe, wire, other connected 
facilities, or radio or similar transmission (including extensions of 
such facilities), if the charges for service, delayed payment, or any 
discounts for prompt payment are filed with or regulated by any 
government unit. The financing of durable goods or home improvements by 
a public utility is not exempt.
    (d) Securities or commodities accounts. Transactions in securities 
or commodities accounts in which credit is extended by a broker-dealer 
registered with the Securities and Exchange Commission or the Commodity 
Futures Trading Commission.
    (e) Home fuel budget plans. An installment agreement for the 
purchase of home fuels in which no finance charge is imposed.
    (f) Student loan programs. Loans made, insured, or guaranteed 
pursuant to a program authorized by title IV of

[[Page 198]]

the Higher Education Act of 1965 (20 U.S.C. 1070 et seq.).

[46 FR 20892, Apr. 7, 1981, as amended at 48 FR 14886, Apr. 6, 1983; 49 
FR 46991, Nov. 30, 1984]



Sec. 226.4  Finance charge.

    (a) Definition. The finance charge is the cost of consumer credit as 
a dollar amount. It includes any charge payable directly or indirectly 
by the consumer and imposed directly or indirectly by the creditor as an 
incident to or a condition of the extension of credit. It does not 
include any charge of a type payable in a comparable cash transaction.
    (1) Charges by third parties. The finance charge includes fees and 
amounts charged by someone other than the creditor, unless otherwise 
excluded under this section, if the creditor:
    (i) requires the use of a third party as a condition of or an 
incident to the extension of credit, even if the consumer can choose the 
third party; or
    (ii) retains a portion of the third-party charge, to the extent of 
the portion retained.
    (2) Special rule; closing agent charges. Fees charged by a third 
party that conducts the loan closing (such as a settlement agent, 
attorney, or escrow or title company) are finance charges only if the 
creditor:
    (i) Requires the particular services for which the consumer is 
charged;
    (ii) Requires the imposition of the charge; or
    (iii) Retains a portion of the third-party charge, to the extent of 
the portion retained.
    (3) Special rule; mortgage broker fees. Fees charged by a mortgage 
broker (including fees paid by the consumer directly to the broker or to 
the creditor for delivery to the broker) are finance charges even if the 
creditor does not require the consumer to use a mortgage broker and even 
if the creditor does not retain any portion of the charge.
    (b) Example of finance charge. The finance charge includes the 
following types of charges, except for charges specifically excluded by 
paragraphs (c) through (e) of this section:
    (1) Interest, time price differential, and any amount payable under 
an add-on or discount system of additional charges.
    (2) Service, transaction, activity, and carrying charges, including 
any charge imposed on a checking or other transaction account to the 
extent that the charge exceeds the charge for a similar account without 
a credit feature.
    (3) Points, loan fees, assumption fees, finder's fees, and similar 
charges.
    (4) Appraisal, investigation, and credit report fees.
    (5) Premiums or other charges for any guarantee or insurance 
protecting the creditor against the consumer's default or other credit 
loss.
    (6) Charges imposed on a creditor by another person for purchasing 
or accepting a consumer's obligation, if the consumer is required to pay 
the charges in cash, as an addition to the obligation, or as a deduction 
from the proceeds of the obligation.
    (7) Premiums or other charges for credit life, accident, health, or 
loss-of-income insurance, written in connection with a credit 
transaction.
    (8) Premiums or other charges for insurance against loss of or 
damage to property, or against liability arising out of the ownership or 
use of property, written in connection with a credit transaction.
    (9) Discounts for the purpose of inducing payment by a means other 
than the use of credit.
    (10) Debt cancellation fees. Charges or premiums paid for debt 
cancellation coverage written in connection with a credit transaction, 
whether or not the debt cancellation coverage is insurance under 
applicable law.
    (c) Charges excluded from the finance charge. The following charges 
are not finance charges:
    (1) Application fees charged to all applicants for credit, whether 
or not credit is actually extended.
    (2) Charges for actual unanticipated late payment, for exceeding a 
credit limit, or for delinquency, default, or a similar occurrence.
    (3) Charges imposed by a financial institution for paying items that 
overdraw an account, unless the payment of such items and the imposition 
of the

[[Page 199]]

charge were previously agreed upon in writing.
    (4) Fees charged for participation in a credit plan, whether 
assessed on an annual or other periodic basis.
    (5) Seller's points.
    (6) Interest forfeited as a result of an interest reduction required 
by law on a time deposit used as security for an extension of credit.
    (7) Real-estate related fees. The following fees in a transaction 
secured by real property or in a residential mortgage transaction, if 
the fees are bona fide and reasonable in amount:
    (i) Fees for title examination, abstract of title, title insurance, 
property survey, and similar purposes.
    (ii) Fees for preparing loan-related documents, such as deeds, 
mortgages, and reconveyance or settlement documents.
    (iii) Notary and credit report fees.
    (iv) Property appraisal fees or fees for inspections to assess the 
value or condition of the property if the service is performed prior to 
closing, including fees related to pest infestation or flood hazard 
determinations.
    (v) Amounts required to be paid into escrow or trustee accounts if 
the amounts would not otherwise be included in the finance charge.
    (8) Discounts offered to induce payment for a purchase by cash, 
check, or other means, as provided in section 167(b) of the Act.
    (d) Insurance and debt cancellation coverage--(1) Voluntary credit 
insurance premiums. Premiums for credit life, accident, health or loss-
of-income insurance may be excluded from the finance charge if the 
following conditions are met:
    (i) The insurance coverage is not required by the creditor, and this 
fact is disclosed in writing.
    (ii) The premium for the initial term of insurance coverage is 
disclosed. If the term of insurance is less than the term of the 
transaction, the term of insurance also shall be disclosed. The premium 
may be disclosed on a unit-cost basis only in open-end credit 
transactions, closed-end credit transactions by mail or telephone under 
Sec. 226.17(g), and certain closed-end credit transactions involving an 
insurance plan that limits the total amount of indebtedness subject to 
coverage.
    (iii) The consumer signs or initials an affirmative written request 
for the insurance after receiving the disclosures specified in this 
paragraph. Any consumer in the transaction may sign or initial the 
request.
    (2) Premiums for insurance against loss of or damage to property, or 
against liability arising out of the ownership or use of 
property,5 may be excluded from the finance charge if the 
following conditions are met:
---------------------------------------------------------------------------

    \5\ This includes single interest insurance if the insurer waives 
all right of subrogation against the consumer.
---------------------------------------------------------------------------

    (i) The insurance coverage may be obtained from a person of the 
consumer's choice,6 and this fact is disclosed.
---------------------------------------------------------------------------

    \6\ A creditor may reserve the right to refuse to accept, for 
reasonable cause, an insurer offered by the consumer.
---------------------------------------------------------------------------

    (ii) If the coverage is obtained from or through the creditor, the 
premium for the initial term of insurance coverage shall be disclosed. 
If the term of insurance is less than the term of the transaction, the 
term of insurance shall also be disclosed. The premium may be disclosed 
on a unit-cost basis only in open-end credit transactions, closed-end 
credit transactions by mail or telephone under Sec. 226.17(g), and 
certain closed-end credit transactions involving an insurance plan that 
limits the total amount of indebtedness subject to coverage.
    (3) Voluntary debt cancellation fees. (i) Charges or premiums paid 
for debt cancellation coverage of the type specified in paragraph 
(d)(3)(ii) of this section may be excluded from the finance charge, 
whether or not the coverage is insurance, if the following conditions 
are met:
    (A) The debt cancellation agreement or coverage is not required by 
the creditor, and this fact is disclosed in writing;
    (B) The fee or premium for the initial term of coverage is 
disclosed. If the term of coverage is less than the term of the credit 
transaction, the term of coverage also shall be disclosed. The fee or 
premium may be disclosed on a unit-cost basis only in open-end credit

[[Page 200]]

transactions, closed-end credit transactions by mail or telephone under 
Sec. 226.17(g), and certain closed-end credit transactions involving a 
debt cancellation agreement that limits the total amount of indebtedness 
subject to coverage;
    (C) The consumer signs or initials an affirmative written request 
for coverage after receiving the disclosures specified in this 
paragraph. Any consumer in the transaction may sign or initial the 
request.
    (ii) Paragraph (d)(3)(i) of this section applies to fees paid for 
debt cancellation coverage that provides for cancellation of all or part 
of the debtor's liability for amounts exceeding the value of the 
collateral securing the obligation, or in the event of the loss of life, 
health, or income or in case of accident.
    (e) Certain security interest charges. If itemized and disclosed, 
the following charges may be excluded from the finance charge:
    (1) Taxes and fees prescribed by law that actually are or will be 
paid to public officials for determining the existence of or for 
perfecting, releasing, or satisfying a security interest.
    (2) The premium for insurance in lieu of perfecting a security 
interest to the extent that the premium does not exceed the fees 
described in paragraph (e)(1) of this section that otherwise would be 
payable.
    (3) Taxes on security instruments. Any tax levied on security 
instruments or on documents evidencing indebtedness if the payment of 
such taxes is a requirement for recording the instrument securing the 
evidence of indebtedness.
    (f) Prohibited offsets. Interest, dividends, or other income 
received or to be received by the consumer on deposits or investments 
shall not be deducted in computing the finance charge.

[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 61 FR 49245, Sept. 19, 
1996]



                       Subpart B--Open-End Credit



Sec. 226.5  General disclosure requirements.

    (a) Form of disclosures. (1) The creditor shall make the disclosures 
required by this subpart clearly and conspicuously in 
writing,7 in a form that the consumer may keep.8
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    \7\ The disclosure required by Sec. 226.9(d) when a finance charge 
is imposed at the time of a transaction need not be written.
    \8\ The disclosures required under Sec. 226.5a for credit and charge 
card applications and solicitations, the home equity disclosures 
required under Sec. 226.5b(d), the alternative summary billing rights 
statement provided for in Sec. 226.9(a)(2), the credit and charge card 
renewal disclosures required under Sec. 226.9(e), and the disclosures 
made under Sec. 226.10(b) about payment requirements need not be in a 
form that the consumer can keep.
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    (2) The terms finance charge and annual percentage rate, when 
required to be disclosed with a corresponding amount or percentage rate, 
shall be more conspicuous than any other required 
disclosure.9
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    \9\ The terms need not be more conspicuous when used under 
Sec. 226.5a for credit and charge card applications and solicitations 
under Sec. 226.7(d) on periodic statements, under Sec. 226.9(e) in 
credit and charge card renewal disclosures, and under Sec. 226.16 in 
advertisements.
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    (3) Certain disclosures required under Sec. 226.5a for credit and 
charge card applications and solicitations must be provided in a tabular 
format or in a prominent location in accordance with the requirements of 
that section.
    (4) For rules governing the form of disclosures for home equity 
plans, see Sec. 226.5b(a).
    (b) Time of disclosures. (1) Initial disclosures. The creditor shall 
furnish the initial disclosure statement required by Sec. 226.6 before 
the first transaction is made under the plan.
    (2) Periodic statements. (i) The creditor shall mail or deliver a 
periodic statement as required by Sec. 226.7 for each billing cycle at 
the end of which an account has a debit or credit balance of more than 
$1 or on which a finance charge has been imposed. A periodic statement 
need not be sent for an account if the creditor deems it uncollectible, 
or if delinquency collection proceedings have been instituted, or if 
furnishing the statement would violate Federal law.
    (ii) The creditor shall mail or deliver the periodic statement at 
least 14 days prior to any date or the end of any time period required 
to be disclosed

[[Page 201]]

under Sec. 226.7(j) in order for the consumer to avoid an additional 
finance or other charge.10 A creditor that fails to meet this 
requirement shall not collect any finance or other charge imposed as a 
result of such failure.
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    \10\ This timing requirement does not apply if the creditor is 
unable to meet the requirement because of an act of God, war, civil 
disorder, natural disaster, or strike.
---------------------------------------------------------------------------

    (3) Credit and charge card application and solicitation disclosures. 
The card issuer shall furnish the disclosures for credit and charge card 
applications and solicitations in accordance with the timing 
requirements of Sec. 226.5a.
    (4) Home equity plans. Disclosures for home equity plans shall be 
made in accordance with the timing requirements of Sec. 226.5b(b).
    (c) Basis of disclosures and use of estimates. Disclosures shall 
reflect the terms of the legal obligation between the parties. If any 
information necessary for accurate disclosure is unknown to the 
creditor, it shall make the disclosure based on the best information 
reasonably available and shall state clearly that the disclosure is an 
estimate.
    (d) Multiple creditors; multiple consumers. If the credit plan 
involves more than one creditor, only one set of disclosures shall be 
given, and the creditors shall agree among themselves which creditor 
must comply with the requirements that this regulation imposes on any or 
all of them. If there is more than one consumer, the disclosures may be 
made to any consumer who is primarily liable on the account. If the 
right of rescission under Sec. 226.15 is applicable, however, the 
disclosures required by Secs. 226.6 and 226.15(b) shall be made to each 
consumer having the right to rescind.
    (e) Effect of subsequent events. If a disclosure becomes inaccurate 
because of an event that occurs after the creditor mails or delivers the 
disclosures, the resulting inaccuracy is not a violation of this 
regulation, although new disclosures may be required under 
Sec. 226.9(c).

[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 13865, Apr. 6, 
1989; 54 FR 24686, June 9, 1989]



Sec. 226.5a  Credit and charge card applications and solicitations.

    (a) General rules. The card issuer shall provide the disclosures 
required under this section on or with a solicitation or an application 
to open a credit or charge card account.
    (1) Definition of solicitation. For purposes of this section, the 
term solicitation means an offer by the card issuer to open a credit or 
charge card account that does not require the consumer to complete an 
application.
    (2) Form of disclosures. (i) The disclosures in paragraphs (b) (1) 
through (7) of this section shall be provided in a prominent location on 
or with an application or a solicitation, or other applicable document, 
and in the form of a table with headings, content, and format 
substantially similar to any of the applicable tables found in appendix 
G.
    (ii) The disclosures in paragraphs (b) (8) through (10) of this 
section shall be provided either in the table containing the disclosures 
in paragraphs (b) (1) through (7), or clearly and conspicuously 
elsewhere on or with the application or solicitation.
    (iii) The disclosure required under paragraph (b)(5) of this section 
shall contain the term grace period.
    (iv) The terminology in the disclosures under paragraph (b) of this 
section shall be consistent with that to be used in the disclosures 
under Secs. 226.6 and 226.7.
    (3) Exceptions. This section does not apply to home equity plans 
accessible by a credit or charge card that are subject to the 
requirements of Sec. 226.5b;
    (4) Fees based on a percentage. If the amount of any fee required to 
be disclosed under this section is determined on the basis of a 
percentage of another amount, the percentage used and the identification 
of the amount against which the percentage is applied may be disclosed 
instead of the amount of the fee.
    (5) Certain fees that vary by state. If the amount of any fee 
referred to in paragraphs (b) (8) through (10) of this section varies 
from state to state, the card issuer may disclose the range of the fees 
instead of the amount for each state, if the disclosure includes a 
statement that the amount of the fee varies from state to state.

[[Page 202]]

    (b) Required disclosures. The card issuer shall disclose the items 
in this paragraph on or with an application or a solicitation in 
accordance with the requirements of paragraphs (c), (d) or (e) of this 
section. A credit card issuer shall disclose all applicable items in 
this paragraph except for paragraph (b)(7) of this section. A charge 
card issuer shall disclose the applicable items in paragraphs (b) (2), 
(4), and (7) through (10) of this section.
    (1) Annual percentage rate. Each periodic rate that may be used to 
compute the finance charge on an outstanding balance for purchases, 
expressed as an annual percentage rate (as determined by 
Sec. 226.14(b)). When more than one rate applies, the range of balances 
to which each rate is applicable shall also be disclosed.
    (i) If the account has a variable rate, the card issuer shall also 
disclose the fact that the rate may vary and how the rate is determined.
    (ii) When variable rate disclosures are provided under paragraph (c) 
of this section, an annual percentage rate disclosure is accurate if the 
rate was in effect within 60 days before mailing the disclosures. When 
variable rate disclosures are provided under paragraph (e) of this 
section, an annual percentage rate disclosure is accurate if the rate 
was in effect within 30 days before printing the disclosures.
    (2) Fees for issuance or availability. Any annual or other periodic 
fee, expressed as an annualized amount, or any other fee that may be 
imposed for the issuance or availability of a credit or charge card, 
including any fee based on account activity or inactivity.
    (3) Minimum finance charge. Any minimum or fixed finance charge that 
could be imposed during a billing cycle.
    (4) Transaction charges. Any transaction charge imposed for the use 
of the card for purchases.
    (5) Grace period. The date by which or the period within which any 
credit extended for purchases may be repaid without incurring a finance 
charge. If no grace period is provided, that fact must be disclosed. If 
the length of the grace period varies, the card issuer may disclose the 
range of days, the minimum number of days, or the average number of days 
in the grace period, if the disclosure is identified as a range, 
minimum, or average.
    (6) Balance computation method. The name of the balance computation 
method listed in paragraph (g) of this section that is used to determine 
the balance for purchases on which the finance charge is computed, or an 
explanation of the method used if it is not listed. The explanation may 
appear outside the table if the table contains a reference to the 
explanation. In determining which balance computation method to 
disclose, the card issuer shall assume that credit extended for 
purchases will not be repaid within the grace period, if any.
    (7) Statement on charge card payments. A statement that charges 
incurred by use of the charge card are due when the periodic statement 
is received.
    (8) Cash advance fee. Any fee imposed for an extension of credit in 
the form of cash.
    (9) Late payment fee. Any fee imposed for a late payment.
    (10) Over-the-limit fee. Any fee imposed for exceeding a credit 
limit.
    (c) Direct mail applications and solicitations. The card issuer 
shall disclose the applicable items in paragraph (b) of this section on 
or with an application or solicitation that is mailed to consumers.
    (d) Telephone applications and solicitations--(1) Oral disclosure. 
The card issuer shall orally disclose the information in paragraphs (b) 
(1) through (7) of this section, to the extent applicable, in a 
telephone application or solicitation initiated by the card issuer.
    (2) Alternative disclosure. The oral disclosure under paragraph 
(d)(1) of this section need not be given if the card issuer either does 
not impose a fee described in paragraph (b)(2) of this section or does 
not impose such a fee unless the consumer uses the card, and the card 
issuer discloses in writing within 30 days after the consumer requests 
the card (but in no event later than the delivery of the card) the 
following:
    (i) The applicable information in paragraph (b) of this section; and
    (ii) The fact that the consumer need not accept the card or pay any 
fee disclosed unless the consumer uses the card.

[[Page 203]]

    (e) Applications and solicitations made available to general public. 
The card issuer shall provide disclosures, to the extent applicable, on 
or with an application or solicitation that is made available to the 
general public, including one contained in a catalog, magazine, or other 
generally available publication. The disclosures shall be provided in 
accordance with paragraph (e) (1), (2) or (3) of this section.
    (1) Disclosure of required credit information. The card issuer may 
disclose in a prominent location on the application or solicitation the 
following:
    (i) The applicable information in paragraph (b) of this section;
    (ii) The date the required information was printed, including a 
statement that the required information was accurate as of that date and 
is subject to change after that date; and
    (iii) A statement that the consumer should contact the card issuer 
for any change in the required information since it was printed, and a 
toll-free telephone number or a mailing address for that purpose.
    (2) Inclusion of certain initial disclosures. The card issuer may 
disclose on or with the application or solicitation the following:
    (i) The disclosures required under Sec. 226.6 (a) through (c); and
    (ii) A statement that the consumer should contact the card issuer 
for any change in the required information, and a toll-free telephone 
number or a mailing address for that purpose.
    (3) No disclosure of credit information. If none of the items in 
paragraph (b) of this section is provided on or with the application or 
solicitation, the card issuer may state in a prominent location on the 
application or solicitation the following:
    (i) There are costs associated with the use of the card; and
    (ii) The consumer may contact the card issuer to request specific 
information about the costs, along with a toll-free telephone number and 
a mailing address for that purpose.
    (4) Prompt response to requests for information. Upon receiving a 
request for any of the information referred to in this paragraph, the 
card issuer shall promptly and fully disclose the information requested.
    (f) Special charge card rule--card issuer and person extending 
credit not the same person. If a cardholder may by use of a charge card 
access an open-end credit plan that is not maintained by the charge card 
issuer, the card issuer need not provide the disclosures in paragraphs 
(c), (d) or (e) of this section for the open-end credit plan if the card 
issuer states on or with an application or a solicitation the following:
    (1) The card issuer will make an independent decision whether to 
issue the card;
    (2) The charge card may arrive before the decision is made about 
extending credit under the open-end credit plan; and
    (3) Approval for the charge card does not constitute approval for 
the open-end credit plan.
    (g) Balance computation methods defined. The following methods may 
be described by name. Methods that differ due to variations such as the 
allocation of payments, whether the finance charge begins to accrue on 
the transaction date or the date of posting the transaction, the 
existence or length of a grace period, and whether the balance is 
adjusted by charges such as late fees, annual fees and unpaid finance 
charges do not constitute separate balance computation methods.
    (1)(i) Average daily balance (including new purchases). This balance 
is figured by adding the outstanding balance (including new purchases 
and deducting payments and credits) for each day in the billing cycle, 
and then dividing by the number of days in the billing cycle.
    (ii) Average daily balance (excluding new purchases). This balance 
is figured by adding the outstanding balance (excluding new purchases 
and deducting payments and credits) for each day in the billing cycle, 
and then dividing by the number of days in the billing cycle.
    (2)(i) Two-cycle average daily balance (including new purchases). 
This balance is the sum of the average daily balances for two billing 
cycles. The first balance is for the current billing cycle, and is 
figured by adding the outstanding balance (including new purchases and 
deducting payments and credits) for each day in the billing cycle, and 
then dividing by the number of days in the billing cycle. The second

[[Page 204]]

balance is for the preceding billing cycle.
    (ii) Two-cycle average daily balance (excluding new purchases). This 
balance is the sum of the average daily balances for two billing cycles. 
The first balance is for the current billing cycle, and is figured by 
adding the outstanding balance (excluding new purchases and deducting 
payments and credits) for each day in the billing cycle, and then 
dividing by the number of days in the billing cycle. The second balance 
is for the preceding billing cycle.
    (3) Adjusted balance. This balance is figured by deducting payments 
and credits made during the billing cycle from the outstanding balance 
at the beginning of the billing cycle.
    (4) Previous balance. This balance is the outstanding balance at the 
beginning of the billing cycle.

[Reg. Z, 54 FR 13865, Apr. 6, 1989, as amended at 54 FR 24686, June 9, 
1989; 54 FR 32954, Aug. 11, 1989]



Sec. 226.5b  Requirements for home equity plans.

    The requirements of this section apply to open-end credit plans 
secured by the consumer's dwelling. For purposes of this section, an 
annual percentage rate is the annual percentage rate corresponding to 
the periodic rate as determined under Sec. 226.14(b).
    (a) Form of disclosures--(1) General. The disclosures required by 
paragraph (d) of this section shall be made clearly and conspicuously 
and shall be grouped together and segregated from all unrelated 
information. The disclosures may be provided on the application form or 
on a separate form. The disclosure described in paragraph (d)(4)(iii), 
the itemization of third-party fees described in paragraph (d)(8), and 
the variable-rate information described in paragraph (d)(12) of this 
section may be provided separately from the other required disclosures.
    (2) Precedence of certain disclosures. The disclosures described in 
paragraph (d)(1) through (4)(ii) of this section shall precede the other 
required disclosures.
    (b) Time of disclosures. The disclosures and brochure required by 
paragraphs (d) and (e) of this section shall be provided at the time an 
application is provided to the consumer.10 a
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    \10 a\ The disclosures and the brochure may be delivered or placed 
in the mail not later than three business days following receipt of a 
consumer's application in the case of applications contained in 
magazines or other publications, or when the application is received by 
telephone or through an intermediary agent or broker.
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    (c) Duties of third parties. Persons other than the creditor who 
provide applications to consumers for home equity plans must provide the 
brochure required under paragraph (e) of this section at the time an 
application is provided. If such persons have the disclosures required 
under paragraph (d) of this section for a creditor's home equity plan, 
they also shall provide the disclosures at such time.10 a
    (d) Content of disclosures. The creditor shall provide the following 
disclosures, as applicable:
    (1) Retention of information. A statement that the consumer should 
make or otherwise retain a copy of the disclosures.
    (2) Conditions for disclosed terms. (i) A statement of the time by 
which the consumer must submit an application to obtain specific terms 
disclosed and an identification of any disclosed term that is subject to 
change prior to opening the plan.
    (ii) A statement that, if a disclosed term changes (other than a 
change due to fluctuations in the index in a variable-rate plan) prior 
to opening the plan and the consumer therefore elects not to open the 
plan, the consumer may receive a refund of all fees paid in connection 
with the application.
    (3) Security interest and risk to home. A statement that the 
creditor will acquire a security interest in the consumer's dwelling and 
that loss of the dwelling may occur in the event of default.
    (4) Possible actions by creditor. (i) A statement that, under 
certain conditions, the creditor may terminate the plan and require 
payment of the outstanding balance in full in a single payment and 
impose fees upon termination; prohibit additional extensions of credit 
or reduce the credit limit;

[[Page 205]]

and, as specified in the initial agreement, implement certain changes in 
the plan.
    (ii) A statement that the consumer may receive, upon request, 
information about the conditions under which such actions may occur.
    (iii) In lieu of the disclosure required under paragraph (d)(4)(ii) 
of this section, a statement of such conditions.
    (5) Payment terms. The payment terms of the plan, including:
    (i) The length of the draw period and any repayment period.
    (ii) An explanation of how the minimum periodic payment will be 
determined and the timing of the payments. If paying only the minimum 
periodic payments may not repay any of the principal or may repay less 
than the outstanding balance, a statement of this fact, as well as a 
statement that a balloon payment may result.10 b
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    \10 b\ A balloon payment results if paying the minimum periodic 
payments does not fully amortize the outstanding balance by a specified 
date or time, and the consumer must repay the entire outstanding balance 
at such time.
---------------------------------------------------------------------------

    (iii) An example, based on a $10,000 outstanding balance and a 
recent annual percentage rate,10 c showing the minimum 
periodic payment, any balloon payment, and the time it would take to 
repay the $10,000 outstanding balance if the consumer made only those 
payments and obtained no additional extensions of credit.
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    \10 c\ For fixed-rate plans, a recent annual percentage rate is a 
rate that has been in effect under the plan within the twelve months 
preceding the date the disclosures are provided to the consumer. For 
variable-rate plans, a recent annual percentage rate is the most recent 
rate provided in the historical example described in paragraph 
(d)(12)(xi) of this section or a rate that has been in effect under the 
plan since the date of the most recent rate in the table.

If different payment terms may apply to the draw and any repayment 
period, or if different payment terms may apply within either period, 
the disclosures shall reflect the different payment terms.
    (6) Annual percentage rate. For fixed-rate plans, a recent annual 
percentage rate10 c imposed under the plan and a statement 
that the rate does not include costs other than interest.
    (7) Fees imposed by creditor. An itemization of any fees imposed by 
the creditor to open, use, or maintain the plan, stated as a dollar 
amount or percentage, and when such fees are payable.
    (8) Fees imposed by third parties to open a plan. A good faith 
estimate, stated as a single dollar amount or range, of any fees that 
may be imposed by persons other than the creditor to open the plan, as 
well as a statement that the consumer may receive, upon request, a good 
faith itemization of such fees. In lieu of the statement, the 
itemization of such fees may be provided.
    (9) Negative amortization. A statement that negative amortization 
may occur and that negative amortization increases the principal balance 
and reduces the consumer's equity in the dwelling.
    (10) Transaction requirements. Any limitations on the number of 
extensions of credit and the amount of credit that may be obtained 
during any time period, as well as any minimum outstanding balance and 
minimum draw requirements, stated as dollar amounts or percentages.
    (11) Tax implications. A statement that the consumer should consult 
a tax advisor regarding the deductibility of interest and charges under 
the plan.
    (12) Disclosures for variable-rate plans. For a plan in which the 
annual percentage rate is variable, the following disclosures, as 
applicable:
    (i) The fact that the annual percentage rate, payment, or term may 
change due to the variable-rate feature.
    (ii) A statement that the annual percentage rate does not include 
costs other than interest.
    (iii) The index used in making rate adjustments and a source of 
information about the index.
    (iv) An explanation of how the annual percentage rate will be 
determined, including an explanation of how the index is adjusted, such 
as by the addition of a margin.
    (v) A statement that the consumer should ask about the current index 
value, margin, discount or premium, and annual percentage rate.
    (vi) A statement that the initial annual percentage rate is not 
based on the index and margin used to make

[[Page 206]]

later rate adjustments, and the period of time such initial rate will be 
in effect.
    (vii) The frequency of changes in the annual percentage rate.
    (viii) Any rules relating to changes in the index value and the 
annual percentage rate and resulting changes in the payment amount, 
including, for example, an explanation of payment limitations and rate 
carryover.
    (ix) A statement of any annual or more frequent periodic limitations 
on changes in the annual percentage rate (or a statement that no annual 
limitation exists), as well as a statement of the maximum annual 
percentage rate that may be imposed under each payment option.
    (x) The minimum periodic payment required when the maximum annual 
percentage rate for each payment option is in effect for a $10,000 
outstanding balance, and a statement of the earliest date or time the 
maximum rate may be imposed.
    (xi) An historical example, based on a $10,000 extension of credit, 
illustrating how annual percentage rates and payments would have been 
affected by index value changes implemented according to the terms of 
the plan. The historical example shall be based on the most recent 15 
years of index values (selected for the same time period each year) and 
shall reflect all significant plan terms, such as negative amortization, 
rate carryover, rate discounts, and rate and payment limitations, that 
would have been affected by the index movement during the period.
    (xii) A statement that rate information will be provided on or with 
each periodic statement.
    (e) Brochure. The home equity brochure published by the Board or a 
suitable substitute shall be provided.
    (f) Limitations on home equity plans. No creditor may, by contract 
or otherwise:
    (1) Change the annual percentage rate unless:
    (i) Such change is based on an index that is not under the 
creditor's control; and
    (ii) Such index is available to the general public.
    (2) Terminate a plan and demand repayment of the entire outstanding 
balance in advance of the original term (except for reverse mortgage 
transactions that are subject to paragraph (f)(4) of this section) 
unless:
    (i) There is fraud or material misrepresentation by the consumer in 
connection with the plan;
    (ii) The consumer fails to meet the repayment terms of the agreement 
for any outstanding balance;
    (iii) Any action or inaction by the consumer adversely affects the 
creditor's security for the plan, or any right of the creditor in such 
security; or
    (iv) Federal law dealing with credit extended by a depository 
institution to its executive officers specifically requires that as a 
condition of the plan the credit shall become due and payable on demand, 
provided that the creditor includes such a provision in the initial 
agreement.
    (3) Change any term, except that a creditor may:
    (i) Provide in the initial agreement that it may prohibit additional 
extensions of credit or reduce the credit limit during any period in 
which the maximum annual percentage rate is reached. A creditor also may 
provide in the initial agreement that specified changes will occur if a 
specified event takes place (for example, that the annual percentage 
rate will increase a specified amount if the consumer leaves the 
creditor's employment).
    (ii) Change the index and margin used under the plan if the original 
index is no longer available, the new index has an historical movement 
substantially similar to that of the original index, and the new index 
and margin would have resulted in an annual percentage rate 
substantially similar to the rate in effect at the time the original 
index became unavailable.
    (iii) Make a specified change if the consumer specifically agrees to 
it in writing at that time.
    (iv) Make a change that will unequivocally benefit the consumer 
throughout the remainder of the plan.
    (v) Make an insignificant change to terms.
    (vi) Prohibit additional extensions of credit or reduce the credit 
limit applicable to an agreement during any period in which:

[[Page 207]]

    (A) The value of the dwelling that secures the plan declines 
significantly below the dwelling's appraised value for purposes of the 
plan;
    (B) The creditor reasonably believes that the consumer will be 
unable to fulfill the repayment obligations under the plan because of a 
material change in the consumer's financial circumstances;
    (C) The consumer is in default of any material obligation under the 
agreement;
    (D) The creditor is precluded by government action from imposing the 
annual percentage rate provided for in the agreement;
    (E) The priority of the creditor's security interest is adversely 
affected by government action to the extent that the value of the 
security interest is less than 120 percent of the credit line; or
    (F) The creditor is notified by its regulatory agency that continued 
advances constitute an unsafe and unsound practice.
    (4) For reverse mortgage transactions that are subject to 
Sec. 226.33, terminate a plan and demand repayment of the entire 
outstanding balance in advance of the original term except:
    (i) In the case of default;
    (ii) If the consumer transfers title to the property securing the 
note;
    (iii) If the consumer ceases using the property securing the note as 
the primary dwelling; or
    (iv) Upon the consumer's death.
    (g) Refund of fees. A creditor shall refund all fees paid by the 
consumer to anyone in connection with an application if any term 
required to be disclosed under paragraph (d) of this section changes 
(other than a change due to fluctuations in the index in a variable-rate 
plan) before the plan is opened and, as a result, the consumer elects 
not to open the plan.
    (h) Imposition of nonrefundable fees. Neither a creditor nor any 
other person may impose a nonrefundable fee in connection with an 
application until three business days after the consumer receives the 
disclosures and brochure required under this section.10 d
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    \10 d\ If the disclosures and brochure are mailed to the consumer, 
the consumer is considered to have received them three business days 
after they are mailed.

[Reg. Z, 54 FR 24686, June 9, 1989, as amended at 55 FR 38312, Sept. 18, 
1990; 55 FR 42148, Oct. 17, 1990; 57 FR 34681, Aug. 6, 1992; 60 FR 
15471, Mar. 24, 1995]



Sec. 226.6  Initial disclosure statement.

    The creditor shall disclose to the consumer, in terminology 
consistent with that to be used on the periodic statement, each of the 
following items, to the extent applicable:
    (a) Finance charge. The circumstances under which a finance charge 
will be imposed and an explanation of how it will be determined, as 
follows:
    (1) A statement of when finance charges begin to accrue, including 
an explanation of whether or not any time period exists within which any 
credit extended may be repaid without incurring a finance charge. If 
such a time period is provided, a creditor may, at its option and 
without disclosure, impose no finance charge when payment is received 
after the time period's expiration.
    (2) A disclosure of each periodic rate that may be used to compute 
the finance charge, the range of balances to which it is 
applicable,11 and the corresponding annual percentage 
rate.12 When different periodic rates apply to different 
types of transactions, the types of transactions to which the periodic 
rates apply shall also be disclosed.
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    \11\ A creditor is not required to adjust the range of balances 
disclosure to reflect the balance below which only a minimum charge 
applies.
    \12\ If a creditor is offering a variable rate plan, the creditor 
shall also disclose: (1) The circumstances under which the rate(s) may 
increase; (2) any limitations on the increase; and (3) the effect(s) of 
an increase.
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    (3) An explanation of the method used to determine the balance on 
which the finance charge may be computed.
    (4) An explanation of how the amount of any finance charge will be 
determined,13 including a description of how

[[Page 208]]

any finance charge other than the periodic rate will be determined.
---------------------------------------------------------------------------

    \13\ If no finance charge is imposed when the outstanding balance is 
less than a certain amount, no disclosure is required of that fact or of 
the balance below which no finance charge will be imposed.
---------------------------------------------------------------------------

    (b) Other charges. The amount of any charge other than a finance 
charge that may be imposed as part of the plan, or an explanation of how 
the charge will be determined.
    (c) Security interests. The fact that the creditor has or will 
acquire a security interest in the property purchased under the plan, or 
in other property identified by item or type.
    (d) Statement of billing rights. A statement that outlines the 
consumer's rights and the creditor's responsibilities under 
Secs. 226.12(c) and 226.13 and that is substantially similar to the 
statement found in appendix G.
    (e) Home equity plan information. The following disclosures 
described in Sec. 226.5b(d), as applicable:
    (1) A statement of the conditions under which the creditor may take 
certain action, as described in Sec. 226.5b(d)(4)(i), such as 
terminating the plan or changing the terms.
    (2) The payment information described in Sec. 226.5b(d)(5) (i) and 
(ii) for both the draw period and any repayment period.
    (3) A statement that negative amortization may occur as described in 
Sec. 226.5b(d)(9).
    (4) A statement of any transaction requirements as described in 
Sec. 226.5b(d)(10).
    (5) A statement regarding the tax implications as described in 
Sec. 226.5b(d)(11).
    (6) A statement that the annual percentage rate imposed under the 
plan does not include costs other than interest as described in 
Secs. 226.5b(d)(6) and (d)(12)(ii).
    (7) The variable-rate disclosures described in Sec. 226.5b(d)(12) 
(viii), (x), (xi), and (xii), as well as the disclosure described in 
Sec. 226.5b(d)(5)(iii), unless the disclosures provided with the 
application were in a form the consumer could keep and included a 
representative payment example for the category of payment option chosen 
by the consumer.

[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 24688, June 9, 
1989]



Sec. 226.7  Periodic statement.

    The creditor shall furnish the consumer with a periodic statement 
that discloses the following items, to the extent applicable:
    (a) Previous balance. The account balance outstanding at the 
beginning of the billing cycle.
    (b) Identification of transactions. An identification of each credit 
transaction in accordance with Sec. 226.8.
    (c) Credits. Any credit to the account during the billing cycle, 
including the amount and the date of crediting. The date need not be 
provided if a delay in crediting does not result in any finance or other 
charge.
    (d) Periodic rates. Each periodic rate that may be used to compute 
the finance charge, the range of balances to which it is 
applicable,14 and the corresponding annual percentage 
rate.15 If different periodic rates apply to different types 
of transactions, the types of transactions to which the periodic rates 
apply shall also be disclosed.
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    \14\ See footnotes 11 and 13.
    \15\ If a variable rate plan is involved, the creditor shall 
disclose the fact that the periodic rate(s) may vary.
---------------------------------------------------------------------------

    (e) Balance on which finance charge computed. The amount of the 
balance to which a periodic rate was applied and an explanation of how 
that balance was determined. When a balance is determined without first 
deducting all credits and payments made during the billing cycle, that 
fact and the amount of the credits and payments shall be disclosed.
    (f) Amount of finance charge. The amount of any finance charge 
debited or added to the account during the billing cycle, using the term 
finance charge. The components of the finance charge shall be 
individually itemized and identified to show the amount(s) due to the 
appliction of any periodic rates and the amount(s) of any other type of 
finance charge. If there periodic rate, the amount of the finance charge 
attributable to each rate need not be separately itemized and 
identified.
    (g) Annual percentage rate. When a finance charge is imposed during 
the billing cycle, the annual percentage rate(s) determined under 
Sec. 226.14, using the term annual percentage rate.

[[Page 209]]

    (h) Other charges. The amounts, itemized and identified by type, of 
any charges other than finance charges debited to the account during the 
billing cycle.
    (i) Closing date of billing cycle; new balance. The closing date of 
the billing cycle and the account balance outstanding on that date.
    (j) Free-ride period. The date by which or the time period within 
which the new balance or any portion of the new balance must be paid to 
avoid additional finance charges. If such a time period is provided, a 
creditor may, at its option and without disclosure, impose no finance 
charge when payment is received after the time period's expiration.
    (k) Address for notice of billing errors. The address to be used for 
notice of billing errors. Alternatively, the address may be provided on 
the billing rights statement permitted by Sec. 226.9(a)(2).

[46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981]



Sec. 226.8  Identification of transactions.

    The creditor shall identify credit transactions on or with the first 
periodic statement that reflects the transaction by furnishing the 
following information, as applicable.16
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    \16\ Failure to disclose the information required by this section 
shall not be deemed a failure to comply with the regulation if: (1) The 
creditor maintains procedures reasonably adapted to obtain and provide 
the information; and (2) the creditor treats an inquiry for 
clarification or documentation as a notice of a billing error, including 
correcting the account in accordance with Sec. 226.13(e). This applies 
to transactions that take place outside a state, as defined in 
Sec. 226.2(a), whether or not the creditor maintains procedures 
reasonably adapted to obtain the required information.
---------------------------------------------------------------------------

    (a) Sale credit. For each credit transaction involving the sale of 
property or services, the following rules shall apply:
    (1) Copy of credit document provided. When an actual copy of the 
receipt or other credit document is provided with the first periodic 
statement reflecting the transaction, the transaction is sufficiently 
identified if the amount of the transaction and either the date of the 
transaction or the date of debiting the transaction to the consumer's 
account are disclosed on the copy or on the periodic statement.
    (2) Copy of credit document not provided--creditor and seller same 
or related person(s). When the creditor and the seller are the same 
person or related persons, and an actual copy of the receipt or other 
credit document is not provided with the periodic statement, the 
creditor shall disclose the amount and date of the transaction, and a 
brief identification 17 of the property or services 
purchased.18
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    \17\ As an alternative to the brief identification, the creditor may 
disclose a number or symbol that also appears on the receipt or other 
credit document given to the consumer, if the number or symbol 
reasonably identifies that transaction with that creditor, and if the 
creditor treats an inquiry for clarification or documentation as a 
notice of a billing error, including correcting the account in 
accordance with Sec. 226.13(e).
    \18\ An identification of property or services may be replaced by 
the seller's name and location of the transaction when: (1) The creditor 
and the seller are the same person; (2) the creditor's open-end plan has 
fewer than 15,000 accounts; (3) the creditor provides the consumer with 
point-of-sale documentation for that transaction; and (4) the creditor 
treats an inquiry for clarification or documentation as a notice of a 
billing error, including correcting the account in accordance with 
Sec. 226.13(e).
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    (3) Copy of credit document not provided--creditor and seller not 
same or related person(s). When the creditor and seller are not the same 
person or related persons, and an actual copy of the receipt or other 
credit document is not provided with the periodic statement, the 
creditor shall disclose the amount and date of the transaction; the 
seller's name; and the city, and state or foreign country where the 
transaction took place.19
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    \19\ The creditor may omit the address or provide any suitable 
designation that helps the consumer to identify the transaction when the 
transaction (1) took place at a location that is not fixed; (2) took 
place in the consumer's home; or (3) was a mail or telephone order.
---------------------------------------------------------------------------

    (b) Nonsale credit. A nonsale credit transaction is sufficiently 
identified if the first periodic statement reflecting

[[Page 210]]

the transaction discloses a brief identification of the 
transaction;20 the amount of the transaction; and at least 
one of the following dates: the date of the transaction, the date of 
debiting the transaction to the consumer's account, or, if the consumer 
signed the credit document, the date appearing on the document. If an 
actual copy of the receipt or other credit document is provided and that 
copy shows the amount and at least one of the specified dates, the brief 
identification may be omitted.
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    \20\ See Footnote 17.

[46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981]



Sec. 226.9  Subsequent disclosure requirements.

    (a) Furnishing statement of billing rights--(1) Annual statement. 
The creditor shall mail or deliver the billing rights statement required 
by Sec. 226.6(d) at least once per calendar year, at intervals of not 
less than 6 months nor more than 18 months, either to all consumers or 
to each consumer entitled to receive a periodic statement under 
Sec. 226.5(b)(2) for any one billing cycle.
    (2) Alternative summary statement. As an alternative to paragraph 
(a)(1) of this section, the creditor may mail or deliver, on or with 
each periodic statement, a statement substantially similar to that in 
appendix G.
    (b) Disclosures for supplemental credit devices and additional 
features--(1) If a creditor, within 30 days after mailing or delivering 
the initial disclosures under Sec. 226.6(a), adds a credit feature to 
the consumer's account or mails or delivers to the consumer a credit 
device for which the finance charge terms are the same as those 
previously disclosed, no additional disclosures are necessary. After 30 
days, if the creditor adds a credit feature or furnishes a credit device 
(other than as a renewal, resupply, or the original issuance of a credit 
card) on the same finance charge terms, the creditor shall disclose, 
before the consumer uses the feature or device for the first time, that 
it is for use in obtaining credit under the terms previously disclosed.
    (2) Whenever a credit feature is added or a credit device is mailed 
or delivered, and the finance charge terms for the feature or device 
differ from disclosures previously given, the disclosures required by 
Sec. 226.6(a) that are applicable to the added feature or device shall 
be given before the consumer uses the feature or device for the first 
time.
    (c) Change in terms--(1) Written notice required. Whenever any term 
required to be disclosed under Sec. 226.6 is changed or the required 
minimum periodic payment is increased, the creditor shall mail or 
deliver written notice of the change to each consumer who may be 
affected. The notice shall be mailed or delivered at least 15 days prior 
to the effective date of the change. The 15-day timing requirement does 
not apply if the change has been agreed to by the consumer, or if a 
periodic rate or other finance charge is increased because of the 
consumer's delinquency or default; the notice shall be given, however, 
before the effective date of the change.
    (2) Notice not required. No notice under this section is required 
when the change involves late payment charges, charges for documentary 
evidence, or over-the-limit charges; a reduction of any component of a 
finance or other charge; suspension of future credit privileges or 
termination of an account or plan; or when the change results from an 
agreement involving a court proceeding, or from the consumer's default 
or delinquency (other than an increase in the periodic rate or other 
finance charge).
    (3) Notice for home equity plans. If a creditor prohibits additional 
extensions of credit or reduces the credit limit applicable to a home 
equity plan pursuant to Sec. 226.5b(f)(3)(i) or Sec. 226.5b(f)(3)(vi), 
the creditor shall mail or deliver written notice of the action to each 
consumer who will be affected. The notice must be provided not later 
than three business days after the action is taken and shall contain 
specific reasons for the action. If the creditor requires the consumer 
to request reinstatement of credit privileges, the notice also shall 
state that fact.
    (d) Finance charge imposed at time of transaction. (1) Any person, 
other than the card issuer, who imposes a finance charge at the time of 
honoring a consumer's credit card, shall disclose the

[[Page 211]]

amount of that finance charge prior to its imposition.
    (2) The card issuer, if other than the person honoring the 
consumer's credit card, shall have no responsibility for the disclosure 
required by paragraph (d)(1) of this section, and shall not consider any 
such charge for purposes of Secs. 226.5a, 226.6 and 226.7.
    (e) Disclosures upon renewal of credit or charge card-- (1) Notice 
prior to renewal. Except as provided in paragraph (e)(2) of this 
section, a card issuer that imposes any annual or other periodic fee to 
renew a credit or charge card account of the type subject to 
Sec. 226.5a, including any fee based on account activity or inactivity, 
shall mail or deliver written notice of the renewal to the cardholder. 
The notice shall be provided at least 30 days or one billing cycle, 
whichever is less, before the mailing or the delivery of the periodic 
statement on which the renewal fee is initially charged to the account. 
The notice shall contain the following information:
    (i) The disclosures contained in Sec. 226.5a(b) (1) through (7) that 
would apply if the account were renewed;20 a and
---------------------------------------------------------------------------

    \20 a\ These disclosures need not be provided in tabular format or 
in a prominent location.
---------------------------------------------------------------------------

    (ii) How and when the cardholder may terminate credit availability 
under the account to avoid paying the renewal fee.
    (2) Delayed notice. The disclosures required by paragraph (e)(1) of 
this section may be provided later than the time in paragraph (e)(1) of 
this section, but no later than the mailing or the delivery of the 
periodic statement on which the renewal fee is initially charged to the 
account, if the card issuer also discloses at that time that:
    (i) The cardholder has 30 days from the time the periodic statement 
is mailed or delivered to avoid paying the fee or to have the fee 
recredited if the cardholder terminates credit availability under the 
account; and
    (ii) The cardholder may use the card during the interim period 
without having to pay the fee.
    (3) Notification on periodic statements. The disclosures required by 
this paragraph may be made on or with a periodic statement. If any of 
the disclosures are provided on the back of a periodic statement, the 
card issuer shall include a reference to those disclosures on the front 
of the statement.
    (f) Change in credit card account insurance provided--(1) Notice 
prior to change. If a credit card issuer plans to change the provider of 
insurance for repayment of all or part of the outstanding balance of an 
open-end credit card account of the type subject to Sec. 226.5a, the 
card issuer shall mail or deliver the cardholder written notice of the 
change not less than 30 days before the change in providers occurs. The 
notice shall also include the following items, to the extent applicable:
    (i) Any increase in the rate that will result from the change;
    (ii) Any substantial decrease in coverage that will result from the 
change; and
    (iii) A statement that the cardholder may discontinue the insurance.
    (2) Notice when change in provider occurs. If a change described in 
paragraph (f)(1) of this section occurs, the card issuer shall provide 
the cardholder with a written notice no later than 30 days after the 
change, including the following items, to the extent applicable:
    (i) The name and address of the new insurance provider;
    (ii) A copy of the new policy or group certificate containing the 
basic terms of the insurance, including the rate to be charged; and
    (iii) A statement that the cardholder may discontinue the insurance.
    (3) Substantial decrease in coverage. For purposes of this 
paragraph, a substantial decrease in coverage is a decrease in a 
significant term of coverage that might reasonably be expected to affect 
the cardholder's decision to continue the insurance. Significant terms 
of coverage include, for example, the following:
    (i) Type of coverage provided;
    (ii) Age at which coverage terminates or becomes more restrictive;
    (iii) Maximum insurable loan balance, maximum periodic benefit 
payment, maximum number of payments, or other term affecting the dollar 
amount of coverage or benefits provided;

[[Page 212]]

    (iv) Eligibility requirements and number and identity of persons 
covered;
    (v) Definition of a key term of coverage such as disability;
    (vi) Exclusions from or limitations on coverage; and
    (vii) Waiting periods and whether coverage is retroactive.
    (4) Combined notification. The notices required by paragraph (f) (1) 
and (2) of this section may be combined provided the timing requirement 
of paragraph (f)(1) of this section is met. The notices may be provided 
on or with a periodic statement.

[Reg. Z, 46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981, as 
amended at 54 FR 13867, Apr. 6, 1989; 54 FR 24688, June 9, 1989; 54 FR 
32954, Aug. 11, 1989; 55 FR 38312, Sept. 18, 1990; 55 FR 42148, Oct. 17, 
1990]



Sec. 226.10  Prompt crediting of payments.

    (a) General rule. A creditor shall credit a payment to the 
consumer's account as of the date of receipt, except when a delay in 
crediting does not result in a finance or other charge or except as 
provided in paragraph (b) of this section.
    (b) Specific requirements for payments. If a creditor specifies, on 
or with the periodic statement, requirements for the consumer to follow 
in making payments, but accepts a payment that does not conform to the 
requirements, the creditor shall credit the payment within 5 days of 
receipt.
    (c) Adjustment of account. If a creditor fails to credit a payment, 
as required by paragraphs (a) and (b) of this section, in time to avoid 
the imposition of finance or other charges, the creditor shall adjust 
the consumer's account so that the charges imposed are credited to the 
consumer's account during the next billing cycle.



Sec. 226.11  Treatment of credit balances.

    When a credit balance in excess of $1 is created on a credit account 
(through transmittal of funds to a creditor in excess of the total 
balance due on an account, through rebates of unearned finance charges 
or insurance premiums, or through amounts otherwise owed to or held for 
the benefit of a consumer), the creditor shall:
    (a) Credit the amount of the credit balance to the consumer's 
account;
    (b) Refund any part of the remaining credit balance within 7 
business days from receipt of a written request from the consumer; and
    (c) Make a good faith effort to refund to the consumer by cash, 
check, or money order, or credit to a deposit account of the consumer, 
any part of the credit balance remaining in the account for more than 6 
months. No further action is required if the consumer's current location 
is not known to the creditor and cannot be traced through the consumer's 
last known address or telephone number.



Sec. 226.12  Special credit card provisions.

    (a) Issuance of credit cards. Regardless of the purpose for which a 
credit card is to be used, including business, commercial, or 
agricultural use, no credit card shall be issued to any person except:
    (1) In response to an oral or written request or application for the 
card; or
    (2) As a renewal of, or substitute for, an accepted credit 
card.21
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    \21\ For purposes of this section, accepted credit card means any 
credit card that a cardholder has requested or applied for and received, 
or has signed, used, or authorized another person to use to obtain 
credit. Any credit card issued as a renewal or substitute in accordance 
with this paragraph becomes an accepted credit card when received by the 
cardholder.
---------------------------------------------------------------------------

    (b) Liability of cardholder for unauthorized use--(1) Limitation on 
amount. The liability of a cardholder for unauthorized use 22 
of a credit card shall not exceed the lesser of $50 or the amount of 
money, property, labor, or services obtained by the unauthorized use 
before notification to the card issuer under paragraph (b)(3) of this 
section.
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    \22\ Unauthorized use means the use of a credit card by a person, 
other than the cardholder, who does not have actual, implied, or 
apparent authority for such use, and from which the cardholder receives 
no benefit.
---------------------------------------------------------------------------

    (2) Conditions of liability. A cardholder shall be liable for 
unauthorized use of a credit card only if:
    (i) The credit card is an accepted credit card;

[[Page 213]]

    (ii) The card issuer has provided adequate notice 23 of 
the cardholder's maximum potential liability and of means by which the 
card issuer may be notified of loss or theft of the card. The notice 
shall state that the cardholder's liability shall not exceed $50 (or any 
lesser amount) and that the cardholder may give oral or written 
notification, and shall describe a means of notification (for example, a 
telephone number, an address, or both); and
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    \23\ Adequate notice means a printed notice to a cardholder that 
sets forth clearly the pertinent facts so that the cardholder may 
reasonably be expected to have noticed it and understood its meaning. 
The notice may be given by any means reasonably assuring receipt by the 
cardholder.
---------------------------------------------------------------------------

    (iii) The card issuer has provided a means to identify the 
cardholder on the account or the authorized user of the card.
    (3) Notification to card issuer. Notification to a card issuer is 
given when steps have been taken as may be reasonably required in the 
ordinary course of business to provide the card issuer with the 
pertinent information about the loss, theft, or possible unauthorized 
use of a credit card, regardless of whether any particular officer, 
employee, or agent of the card issuer does, in fact, receive the 
information. Notification may be given, at the option of the person 
giving it, in person, by telephone, or in writing. Notification in 
writing is considered given at the time of receipt or, whether or not 
received, at the expiration of the time ordinarily required for 
transmission, whichever is earlier.
    (4) Effect of other applicable law or agreement. If state law or an 
agreement between a cardholder and the card issuer imposes lesser 
liability than that provided in this paragraph, the lesser liability 
shall govern.
    (5) Business use of credit cards. If 10 or more credit cards are 
issued by one card issuer for use by the employees of an organization, 
this section does not prohibit the card issuer and the organization from 
agreeing to liability for unauthorized use without regard to this 
section. However, liability for unauthorized use may be imposed on an 
employee of the organization, by either the card issuer or the 
organization, only in accordance with this section.
    (c) Right of cardholder to assert claims or defenses against card 
issuer 24--(1) General rule. When a person who honors a 
credit card fails to resolve satisfactorily a dispute as to property or 
services purchased with the credit card in a consumer credit 
transaction, the cardholder may assert against the card issuer all 
claims (other than tort claims) and defenses arising out of the 
transaction and relating to the failure to resolve the dispute. The 
cardholder may withhold payment up to the amount of credit outstanding 
for the property or services that gave rise to the dispute and any 
finance or other charges imposed on that amount.25
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    \24\ This paragraph does not apply to the use of a check guarantee 
card or a debit card in connection with an overdraft credit plan, or to 
a check guarantee card used in connection with cash advance checks.
    \25\ The amount of the claim or defense that the cardholder may 
assert shall not exceed the amount of credit outstanding for the 
disputed transaction at the time the cardholder first notifies the card 
issuer or the person honoring the credit card of the existence of the 
claim or defense. To determine the amount of credit outstanding for 
purposes of this section, payments and other credits shall be applied 
to: (1) Late charges in the order of entry to the account; then to (2) 
finance charges in the order of entry to the account; and then to (3) 
any other debits in the order of entry to the account. If more than one 
item is included in a single extension of credit, credits are to be 
distributed pro rata according to prices and applicable taxes.
---------------------------------------------------------------------------

    (2) Adverse credit reports prohibited. If, in accordance with 
paragraph (c)(1) of this section, the cardholder withholds payment of 
the amount of credit outstanding for the disputed transaction, the card 
issuer shall not report that amount as delinquent until the dispute is 
settled or judgment is rendered.
    (3) Limitations. The rights stated in paragraphs (c)(1) and (2) of 
this section apply only if:
    (i) The cardholder has made a good faith attempt to resolve the 
dispute with the person honoring the credit card; and
    (ii) The amount of credit extended to obtain the property or 
services that result in the assertion of the claim or defense by the 
cardholder exceeds $50, and the disputed transaction occurred

[[Page 214]]

in the same state as the cardholder's current designated address or, if 
not within the same state, within 100 miles from that 
address.26
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    \26\ The limitations stated in paragraph (c)(3)(ii) of this section 
shall not apply when the person honoring the credit card: (1) Is the 
same person as the card issuer; (2) is controlled by the card issuer 
directly or indirectly; (3) is under the direct or indirect control of a 
third person that also directly or indirectly controls the card issuer; 
(4) controls the card issuer directly or indirectly; (5) is a franchised 
dealer in the card issuer's products or services; or (6) has obtained 
the order for the disputed transaction through a mail solicitation made 
or participated in by the card issuer.
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    (d) Offsets by card issuer prohibited. (1) A card issuer may not 
take any action, either before or after termination of credit card 
privileges, to offset a cardholder's indebtedness arising from a 
consumer credit transaction under the relevant credit card plan against 
funds of the cardholder held on deposit with the card issuer.
    (2) This paragraph does not alter or affect the right of a card 
issuer acting under state or Federal law to do any of the following with 
regard to funds of a cardholder held on deposit with the card issuer if 
the same procedure is constitutionally available to creditors generally: 
obtain or enforce a consensual security interest in the funds; attach or 
otherwise levy upon the funds; or obtain or enforce a court order 
relating to the funds.
    (3) This paragraph does not prohibit a plan, if authorized in 
writing by the cardholder, under which the card issuer may periodically 
deduct all or part of the cardholder's credit card debt from a deposit 
account held with the card issuer (subject to the limitations in 
Sec. 226.13(d)(1)).
    (e) Prompt notification of returns and crediting of refunds. (1) 
When a creditor other than the card issuer accepts the return of 
property or forgives a debt for services that is to be reflected as a 
credit to the consumer's credit card account, that creditor shall, 
within 7 business days from accepting the return or forgiving the debt, 
transmit a credit statement to the card issuer through the card issuer's 
normal channels for credit statements.
    (2) The card issuer shall, within 3 business days from receipt of a 
credit statement, credit the consumer's account with the amount of the 
refund.
    (3) If a creditor other than a card issuer routinely gives cash 
refunds to consumers paying in cash, the creditor shall also give credit 
or cash refunds to consumers using credit cards, unless it discloses at 
the time the transaction is consummated that credit or cash refunds for 
returns are not given. This section does not require refunds for returns 
nor does it prohibit refunds in kind.
    (f) Discounts; tie-in arrangements. No card issuer may, by contract 
or otherwise:
    (1) Prohibit any person who honors a credit card from offering a 
discount to a consumer to induce the consumer to pay by cash, check, or 
similar means rather than by use of a credit card or its underlying 
account for the purchase of property or services; or
    (2) Require any person who honors the card issuer's credit card to 
open or maintain any account or obtain any other service not essential 
to the operation of the credit card plan from the card issuer or any 
other person, as a condition of participation in a credit card plan. If 
maintenance of an account for clearing purposes is determined to be 
essential to the operation of the credit card plan, it may be required 
only if no service charges or minimum balance requirements are imposed.
    (g) Relation to Electronic Fund Transfer Act and Regulation E. For 
guidance on whether Regulation Z or Regulation E applies in instances 
involving both credit and electronic fund transfer aspects, refer to 
Regulation E, 12 CFR 205.5(c) regarding issuance and 205.6(d) regarding 
liability for unauthorized use. On matters other than issuance and 
liability, this section applies to the credit aspects of combined 
credit/electronic fund transfer transactions, as applicable.

[[Page 215]]



Sec. 226.13  Billing error resolution.\27\
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    \27\ A creditor shall not accelerate any part of the consumer's 
indebtedness or restrict or close a consumer's account solely because 
the consumer has exercised in good faith rights provided by this 
section. A creditor may be subject to the forfeiture penalty under 
section 161(e) of the Act for failure to comply with any of the 
requirements of this section.
---------------------------------------------------------------------------

    (a) Definition of billing error. For purposes of this section, the 
term billing error means:
    (1) A reflection on or with a periodic statement of an extension of 
credit that is not made to the consumer or to a person who has actual, 
implied, or apparent authority to use the consumer's credit card or 
open-end credit plan.
    (2) A reflection on or with a periodic statement of an extension of 
credit that is not identified in accordance with the requirements of 
Secs. 226.7(b) and 226.8.
    (3) A reflection on or with a periodic statement of an extension of 
credit for property or services not accepted by the consumer or the 
consumer's designee, or not delivered to the consumer or the consumer's 
designee as agreed.
    (4) A reflection on a periodic statement of the creditor's failure 
to credit properly a payment or other credit issued to the consumer's 
account.
    (5) A reflection on a periodic statement of a computational or 
similar error of an accounting nature that is made by the creditor.
    (6) A reflection on a periodic statement of an extension of credit 
for which the consumer requests additional clarification, including 
documentary evidence.
    (7) The creditor's failure to mail or deliver a periodic statement 
to the consumer's last known address if that address was received by the 
creditor, in writing, at least 20 days before the end of the billing 
cycle for which the statement was required.
    (b) Billing error notice.28 A billing error notice is a 
written notice 29 from a consumer that:
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    \28\ The creditor need not comply with the requirements of 
paragraphs (c) through (g) of this section if the consumer concludes 
that no billing error occurred and voluntarily withdraws the billing 
error notice.
    \29\ The creditor may require that the written notice not be made on 
the payment medium or other material accompanying the periodic statement 
if the creditor so stipulates in the billing rights statement required 
by Secs. 226.6(d) and 226.9(a).
---------------------------------------------------------------------------

    (1) Is received by a creditor at the address disclosed under 
Sec. 226.7(k) no later than 60 days after the creditor transmitted the 
first periodic statement that reflects the alleged billing error;
    (2) Enables the creditor to identify the consumer's name and account 
number; and
    (3) To the extent possible, indicates the consumer's belief and the 
reasons for the belief that a billing error exists, and the type, date, 
and amount of the error.
    (c) Time for resolution; general procedures. (1) The creditor shall 
mail or deliver written acknowledgment to the consumer within 30 days of 
receiving a billing error notice, unless the creditor has complied with 
the appropriate resolution procedures of paragraphs (e) and (f) of this 
section, as applicable, within the 30-day period; and
    (2) The creditor shall comply with the appropriate resolution 
procedures of paragraphs (e) and (f) of this section, as applicable, 
within 2 complete billing cycles (but in no event later than 90 days) 
after receiving a billing error notice.
    (d) Rules pending resolution. Until a billing error is resolved 
under paragraph (e) or (f) of this section, the following rules apply:
    (1) Consumer's right to withhold disputed amount; collection action 
prohibited. The consumer need not pay (and the creditor may not try to 
collect) any portion of any required payment that the consumer believes 
is related

[[Page 216]]

to the disputed amount (including related finance or other 
charges).30 If the cardholder maintains a deposit account 
with the card issuer and has agreed to pay the credit card indebtedness 
by periodic deductions from the cardholder's deposit account, the card 
issuer shall not deduct any part of the disputed amount or related 
finance or other charges if a billing error notice is received any time 
up to 3 business days before the scheduled payment date.
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    \30\ A creditor is not prohibited from taking action to collect any 
undisputed portion of the item or bill; from deducting any disputed 
amount and related finance or other charges from the consumer's credit 
limit on the account; or from reflecting a disputed amount and related 
finance or other charges on a periodic statement, provided that the 
creditor indicates on or with the periodic statement that payment of any 
disputed amount and related finance or other charges is not required 
pending the creditor's compliance with this section.
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    (2) Adverse credit reports prohibited. The creditor or its agent 
shall not (directly or indirectly) make or threaten to make an adverse 
report to any person about the consumer's credit standing, or report 
that an amount or account is delinquent, because the consumer failed to 
pay the disputed amount or related finance or other charges.
    (e) Procedures if billing error occurred as asserted. If a creditor 
determines that a billing error occurred as asserted, it shall within 
the time limits in paragraph (c)(2) of this section:
    (1) Correct the billing error and credit the consumer's account with 
any disputed amount and related finance or other charges, as applicable; 
and
    (2) Mail or deliver a correction notice to the consumer.
    (f) Procedures if different billing error or no billing error 
occurred. If, after conducting a reasonable investigation,31 
a creditor determines that no billing error occurred or that a different 
billing error occurred from that asserted, the creditor shall within the 
time limits in paragraph (c)(2) of this section:
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    \31\ If a consumer submits a billing error notice alleging either 
the nondelivery of property or services under paragraph (a)(3) of this 
section or that information appearing on a periodic statement is 
incorrect because a person honoring the consumer's credit card has made 
an incorrect report to the card issuer, the creditor shall not deny the 
assertion unless it conducts a reasonable investigation and determines 
that the property or services were actually delivered, mailed, or sent 
as agreed or that the information was correct.
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    (1) Mail or deliver to the consumer an explanation that sets forth 
the reasons for the creditor's belief that the billing error alleged by 
the consumer is incorrect in whole or in part;
    (2) Furnish copies of documentary evidence of the consumer's 
indebtedness, if the consumer so requests; and
    (3) If a different billing error occurred, correct the billing error 
and credit the consumer's account with any disputed amount and related 
finance or other charges, as applicable.
    (g) Creditor's rights and duties after resolution. If a creditor, 
after complying with all of the requirements of this section, determines 
that a consumer owes all or part of the disputed amount and related 
finance or other charges, the creditor:
    (1) Shall promptly notify the consumer in writing of the time when 
payment is due and the portion of the disputed amount and related 
finance or other charges that the consumer still owes;
    (2) Shall allow any time period disclosed under Secs. 226.6(a)(1) 
and 226.7(j), during which the consumer can pay the amount due under 
paragraph (g)(1) of this section without incurring additional finance or 
other charges;
    (3) May report an account or amount as delinquent because the amount 
due under paragraph (g)(1) of this section remains unpaid after the 
creditor has allowed any time period disclosed under Secs. 226.6(a)(1) 
and 266.7(j) or 10 days (whichever is longer) during which the consumer 
can pay the amount; but
    (4) May not report that an amount or account is delinquent because 
the amount due under paragraph (g)(1) of the section remains unpaid, if 
the creditor receives (within the time allowed for payment in paragraph 
(g)(3) of this section) further written notice from the consumer that 
any portion of the billing error is still in dispute, unless the 
creditor also:

[[Page 217]]

    (i) Promptly reports that the amount or account is in dispute;
    (ii) Mails or delivers to the consumer (at the same time the report 
is made) a written notice of the name and address of each person to whom 
the creditor makes a report; and
    (iii) Promptly reports any subsequent resolution of the reported 
delinquency to all persons to whom the creditor has made a report.
    (h) Reassertion of billing error. A creditor that has fully complied 
with the requirements of this section has no further responsibilities 
under this section (other than as provided in paragraph (g)(4) of this 
section) if a consumer reasserts substantially the same billing error.
    (i) Relation to Electronic Fund Transfer Act and Regulation E. If an 
extension of credit is incident to an electronic fund transfer, under an 
agreement between a consumer and a financial institution to extend 
credit when the consumer's account is overdrawn or to maintain a 
specified minimum balance in the consumer's account, the creditor shall 
comply with the requirements of Regulation E, 12 CFR 205.11 governing 
error resolution rather than those of paragraphs (a), (b), (c), (e), 
(f), and (h) of this section.



Sec. 226.14  Determination of annual percentage rate.

    (a) General rule. The annual percentage rate is a measure of the 
cost of credit, expressed as a yearly rate. An annual percentage rate 
shall be considered accurate if it is not more than \1/8\ of 1 
percentage point above or below the annual percentage rate determined in 
accordance with this section.31a
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    \31a\ An error in disclosure of the annual percentage rate or 
finance charge shall not, in itself, be considered a violation of this 
regulation if: (1) The error resulted from a corresponding error in a 
calculation tool used in good faith by the creditor; and (2) upon 
discovery of the error, the creditor promptly discontinues use of that 
calculation tool for disclosure purposes, and notifies the Board in 
writing of the error in the calculation tool.
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    (b) Annual percentage rate for Secs. 226.5a and 226.5b disclosures, 
for initial disclosures and for advertising purposes. Where one or more 
periodic rates may be used to compute the finance charge, the annual 
percentage rate(s) to be disclosed for purposes of Secs. 226.5a, 226.5b, 
226.6, and 226.16 shall be computed by multiplying each periodic rate by 
the number of periods in a year.
    (c) Annual percentage rate for periodic statements. The annual 
percentage rate(s) to be disclosed for purposes of Sec. 226.7(d) shall 
be computed by multiplying each periodic rate by the number of periods 
in a year and, for purposes of Sec. 226.7(g), shall be determined as 
follows:
    (1) If the finance charge is determined solely by applying one or 
more periodic rates, at the creditor's option, either:
    (i) By multiplying each periodic rate by the number of periods in a 
year; or
    (ii) By dividing the total finance charge for the billing cycle by 
the sum of the balances to which the periodic rates were applied and 
multiplying the quotient (expressed as a percentage) by the number of 
billing cycles in a year.
    (2) If the finance charge imposed during the billing cycle is or 
includes a minimum, fixed, or other charge not due to the application of 
a periodic rate, other than a charge with respect to any specific 
transaction during the billing cycle, by dividing the total finance 
charge for the billing cycle by the amount of the balance(s) to which it 
is applicable 32 and multiplying the quotient (expressed as a 
percentage) by the number of billing cycles in a year.33
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    \32\ If there is no balance to which the finance charge is 
applicable, an annual percentage rate cannot be determined under this 
section.
    \33\ Where the finance charge imposed during the billing cycle is or 
includes a loan fee, points, or similar charge that relates to the 
opening of the account, the amount of such charge shall not be included 
in the calculation of the annual percentage rate.
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    (3) If the finance charge imposed during the billing cycle is or 
includes a charge relating to a specific transaction during the billing 
cycle (even if the total finance charge also includes any other minimum, 
fixed, or other charge not due to the application of a periodic rate), 
by dividing the total finance charge imposed during the billing cycle by 
the total of all balances and other amounts on which a finance

[[Page 218]]

charge was imposed during the billing cycle without duplication, and 
multiplying the quotient (expressed as a percentage) by the number of 
billing cycles in a year,34 except that the annual percentage 
rate shall not be less than the largest rate determined by multiplying 
each periodic rate imposed during the billing cycle by the number of 
periods in a year.35
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    \34\ See appendix F regarding determination of the denominator of 
the fraction under this paragraph.
    \35\ See footnote 33.
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    (4) If the finance charge imposed during the billing cycle is or 
includes a minimum, fixed, or other charge not due to the application of 
a periodic rate and the total finance charge imposed during the billing 
cycle does not exceed 50 cents for a monthly or longer billing cycle, or 
the pro rata part of 50 cents for a billing cycle shorter than monthly, 
at the creditor's option, by multiplying each applicable periodic rate 
by the number of periods in a year, notwithstanding the provisions of 
paragraphs (c)(2) and (3) of this section.
    (d) Calculations where daily periodic rate applied. If the 
provisions of paragraph (c)(1)(ii) or (2) of this section apply and all 
or a portion of the finance charge is determined by the application of 
one or more daily periodic rates, the annual percentage rate may be 
determined either:
    (1) By dividing the total finance charge by the average of the daily 
balances and multiplying the quotient by the number of billing cycles in 
a year; or
    (2) By dividing the total finance charge by the sum of the daily 
balances and multiplying the quotient by 365.

[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 47 FR 756, Jan. 7, 
1982; 48 FR 14886, Apr. 6, 1983; 54 FR 24688, June 9, 1989]



Sec. 226.15  Right of rescission.

    (a) Consumer's right to rescind. (1)(i) Except as provided in 
paragraph (a)(1)(ii) of this section, in a credit plan in which a 
security interest is or will be retained or acquired in a consumer's 
principal dwelling, each consumer whose ownership interest is or will be 
subject to the security interest shall have the right to rescind: each 
credit extension made under the plan; the plan when the plan is opened; 
a security interest when added or increased to secure an existing plan; 
and the increase when a credit limit on the plan is increased.
    (ii) As provided in section 125(e) of the Act, the consumer does not 
have the right to rescind each credit extension made under the plan if 
such extension is made in accordance with a previously established 
credit limit for the plan.
    (2) To exercise the right to rescind, the consumer shall notify the 
creditor of the rescission by mail, telegram, or other means of written 
communication. Notice is considered given when mailed, or when filed for 
telegraphic transmission, or, if sent by other means, when delivered to 
the creditor's designated place of business.
    (3) The consumer may exercise the right to rescind until midnight of 
the third business day following the occurrence described in paragraph 
(a)(1) of this section that gave rise to the right of rescission, 
delivery of the notice required by paragraph (b) of this section, or 
delivery of all material disclosures,36 whichever occurs 
last. If the required notice and material disclosures are not delivered, 
the right to rescind shall expire 3 years after the occurrence giving 
rise to the right of rescission, or upon transfer of all of the 
consumer's interest in the property, or upon sale of the property, 
whichever occurs first. In the case of certain administrative 
proceedings, the rescission period shall be extended in accordance with 
section 125(f) of the Act.
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    \36\ The term material disclosures means the information that must 
be provided to satisfy the requirements in Sec. 226.6 with regard to the 
method of determining the finance charge and the balance upon which a 
finance charge will be imposed, the annual percentage rate, the amount 
or method of determining the amount of any membership or participation 
fee that may be imposed as part of the plan, and the payment information 
described in Sec. 226.5b(d)(5)(i) and (ii) that is required under 
Sec. 226.6(e)(2).
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    (4) When more than one consumer has the right to rescind, the 
exercise of the right by one consumer shall be effective as to all 
consumers.

[[Page 219]]

    (b) Notice of right to rescind. In any transaction or occurrence 
subject to rescission, a creditor shall deliver 2 copies of the notice 
of the right to rescind to each consumer entitled to rescind. The notice 
shall identify the transaction or occurrence and clearly and 
conspicuously disclose the following:
    (1) The retention or acquisition of a security interest in the 
consumer's principal dwelling.
    (2) The consumer's right to rescind, as described in paragraph 
(a)(1) of this section.
    (3) How to exercise the right to rescind, with a form for that 
purpose, designating the address of the creditor's place of business.
    (4) The effects of rescission, as described in paragraph (d) of this 
section.
    (5) The date the rescission period expires.
    (c) Delay of creditor's performance. Unless a consumer waives the 
right to rescind under paragraph (e) of this section, no money shall be 
disbursed other than in escrow, no services shall be performed, and no 
materials delivered until after the rescission period has expired and 
the creditor is reasonably satisfied that the consumer has not 
rescinded. A creditor does not violate this section if a third party 
with no knowledge of the event activating the rescission right does not 
delay in providing materials or services, as long as the debt incurred 
for those materials or services is not secured by the property subject 
to rescission.
    (d) Effects of rescission. (1) When a consumer rescinds a 
transaction, the security interest giving rise to the right of 
rescission becomes void, and the consumer shall not be liable for any 
amount, including any finance charge.
    (2) Within 20 calendar days after receipt of a notice of rescission, 
the creditor shall return any money or property that has been given to 
anyone in connection with the transaction and shall take any action 
necessary to reflect the termination of the security interest.
    (3) If the creditor has delivered any money or property, the 
consumer may retain possession until the creditor has met its obligation 
under paragraph (d)(2) of this section. When the creditor has complied 
with that paragraph, the consumer shall tender the money or property to 
the creditor or, where the latter would be impracticable or inequitable, 
tender its reasonable value. At the consumer's option, tender of 
property may be made at the location of the property or at the 
consumer's residence. Tender of money must be made at the creditor's 
designated place of business. If the creditor does not take possession 
of the money or property within 20 calendar days after the consumer's 
tender, the consumer may keep it without further obligation.
    (4) The procedures outlined in paragraphs (d)(2) and (3) of this 
section may be modified by court order.
    (e) Consumer's waiver of right to rescind. (1) The consumer may 
modify or waive the right to rescind if the consumer determines that the 
extension of credit is needed to meet a bona fide personal financial 
emergency. To modify or waive the right, the consumer shall give the 
creditor a dated written statement that describes the emergency, 
specifically modifies or waives the right to rescind, and bears the 
signature of all the consumers entitled to rescind. Printed forms for 
this purpose are prohibited, except as provided in paragraph (e)(2) of 
this section.
    (2) The need of the consumer to obtain funds immediately shall be 
regarded as a bona fide personal financial emergency provided that the 
dwelling securing the extension of credit is located in an area declared 
during June through September 1993, pursuant to 42 U.S.C. 5170, to be a 
major disaster area because of severe storms and flooding in the 
Midwest.36a In this instance, creditors may use printed forms 
for the consumer to waive the right to rescind. This exemption to 
paragraph (e)(1) of this section shall expire one year from the date an 
area was declared a major disaster.
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    \36a\ A list of the affected areas will be maintained by the Board.
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    (3) The consumer's need to obtain funds immediately shall be 
regarded as a bona fide personal financial emergency provided that the 
dwelling securing the extension of credit is located in an area declared 
during June through

[[Page 220]]

September 1994 to be a major disaster area, pursuant to 42 U.S.C. 5170, 
because of severe storms and flooding in the South.36b In 
this instance, creditors may use printed forms for the consumer to waive 
the right to rescind. This exemption to paragraph (e)(1) of this section 
shall expire one year from the date an area was declared a major 
disaster.
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    \36b\ A list of the affected areas will be maintained and published 
by the Board. Such areas now include parts of Alabama, Florida, and 
Georgia.
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    (4) The consumer's need to obtain funds immediately shall be 
regarded as a bona fide personal financial emergency provided that the 
dwelling securing the extension of credit is located in an area declared 
during October 1994 to be a major disaster area, pursuant to 42 U.S.C. 
5170, because of severe storms and flooding in Texas.36c In 
this instance, creditors may use printed forms for the consumer to waive 
the right to rescind. This exemption to paragraph (e)(1) of this section 
shall expire one year from the date an area was declared a major 
disaster.
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    \36c\ A list of the affected areas will be maintained and published 
by the Board. Such areas now include the following counties in Texas: 
Angelina, Austin, Bastrop, Brazos, Brazoria, Burleson, Chambers, 
Fayette, Fort Bend, Galveston, Grimes, Hardin, Harris, Houston, Jackson, 
Jasper, Jefferson, Lee, Liberty, Madison, Matagorda, Montgomery, 
Nacagdoches, Orange, Polk, San Augustine, San Jacinto, Shelby, Trinity, 
Victoria, Washington, Waller, Walker, and Wharton.
---------------------------------------------------------------------------

    (f) Exempt transactions. The right to rescind does not apply to the 
following:
    (1) A residential mortgage transaction.
    (2) A credit plan in which a state agency is a creditor.

[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 24688, June 9, 
1989; 58 FR 40583, July 29, 1993; 59 FR 40204, Aug. 5, 1994; 59 FR 
63715, Dec. 9, 1994]



Sec. 226.16  Advertising.

    (a) Actually available terms. If an advertisement for credit states 
specific credit terms, it shall state only those terms that actually are 
or will be arranged or offered by the creditor.
    (b) Advertisement of terms that require additional disclosures. If 
any of the terms required to be disclosed under Sec. 226.6 is set forth 
in an advertisement, the advertisement shall also clearly and 
conspicuously set forth the following:36 d
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    \36 d\ The disclosures given in accordance with Sec. 226.5a do not 
constitute advertising terms for purposes of the requirements of this 
section.
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    (1) Any minimum, fixed, transaction, activity or similar charge that 
could be imposed.
    (2) Any periodic rate that may be applied expressed as an annual 
percentage rate as determined under Sec. 226.14(b). If the plan provides 
for a variable periodic rate, that fact shall be disclosed.
    (3) Any membership or participation fee that could be imposed.
    (c) Catalogs and multiple-page advertisements. (1) If a catalog or 
other multiple-page advertisement gives information in a table or 
schedule in sufficient detail to permit determination of the disclosures 
required by paragraph (b) of this section, it shall be considered a 
single advertisement if:
    (i) The table or schedule is clearly and conspicuously set forth; 
and
    (ii) Any statement of terms set forth in Sec. 226.6 appearing 
anywhere else in the catalog or advertisement clearly refers to that 
page on which the table or schedule begins.
    (2) A catalog or multiple-page advertisement complies with this 
paragraph if the table or schedule of terms includes all appropriate 
disclosures for a representative scale of amounts up to the level of the 
more commonly sold higher-priced property or services offered.
    (d) Additional requirements for home equity plans--(1) Advertisement 
of terms that require additional disclosures. If any of the terms 
required to be disclosed under Sec. 226.6(a) or (b) or the payment terms 
of the plan are set forth, affirmatively or negatively, in an 
advertisement for a home equity plan subject to the requirements of 
Sec. 226.5b, the advertisement also shall clearly and conspicuously set 
forth the following:
    (i) Any loan fee that is a percentage of the credit limit under the 
plan and an estimate of any other fees imposed for opening the plan, 
stated as a single dollar amount or a reasonable range.
    (ii) Any periodic rate used to compute the finance charge, expressed 
as

[[Page 221]]

an annual percentage rate as determined under section Sec. 226.14(b).
    (iii) The maximum annual percentage rate that may be imposed in a 
variable-rate plan.
    (2) Discounted and premium rates. If an advertisement states an 
initial annual percentage rate that is not based on the index and margin 
used to make later rate adjustments in a variable-rate plan, the 
advertisement also shall state the period of time such rate will be in 
effect, and, with equal prominence to the initial rate, a reasonably 
current annual percentage rate that would have been in effect using the 
index and margin.
    (3) Balloon payment. If an advertisement contains a statement about 
any minimum periodic payment, the advertisement also shall state, if 
applicable, that a balloon payment may result.36 e
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    \36 e\ See footnote 10b.
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    (4) Tax implications. An advertisement that states that any interest 
expense incurred under the home equity plan is or may be tax deductible 
may not be misleading in this regard.
    (5) Misleading terms. An advertisement may not refer to a home 
equity plan as ``free money'' or contain a similarly misleading term.

[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 13867, Apr. 6, 
1989; 54 FR 24688, June 9, 1989; 54 FR 28665, July 7, 1989; 58 FR 40583, 
July 29, 1993; 59 FR 40204, Aug. 5, 1994; 59 FR 63715, Dec. 9, 1994]



                      Subpart C--Closed-End Credit



Sec. 226.17  General disclosure requirements.

    (a) Form of disclosures. (1) The creditor shall make the disclosures 
required by this subpart clearly and conspicuously in writing, in a form 
that the consumer may keep. The disclosures shall be grouped together, 
shall be segregated from everything else, and shall not contain any 
information not directly related 37 to the disclosures 
required under Sec. 226.18.38 The itemization of the amount 
financed under Sec. 226.18(c)(1) must be separate from the other 
disclosures under that section.
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    37 The disclosures may include an acknowledgment of 
receipt, the date of the transaction, and the consumer's name, address, 
and account number.
    \38\ The following disclosures may be made together with or 
separately from other required disclosures: the creditor's identity 
under Sec. 226.18(a), the variable rate example under Sec. 226.18(f)(4), 
insurance or debt cancellation under Sec. 226.18(n), and certain 
security interest charges under Sec. 226.18(o).
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    (2) The terms finance charge and annual percentage rate, when 
required to be disclosed under Sec. 226.18 (d) and (e) together with a 
corresponding amount or percentage rate, shall be more conspicuous than 
any other disclosure, except the creditor's identity under 
Sec. 226.18(a).
    (b) Time of disclosures. The creditor shall make disclosures before 
consummation of the transaction. In certain residential mortgage 
transactions, special timing requirements are set forth in 
Sec. 226.19(a). In certain variable-rate transactions, special timing 
requirements for variable-rate disclosures are set forth in 
Sec. 226.19(b) and Sec. 226.20(c). In certain transactions involving 
mail or telephone orders or a series of sales, the timing of disclosures 
may be delayed in accordance with paragraphs (g) and (h) of this 
section.
    (c) Basis of disclosures and use of estimates. (1) The disclosures 
shall reflect the terms of the legal obligation between the parties.
    (2)(i) If any information necessary for an accurate disclosure is 
unknown to the creditor, the creditor shall make the disclosure based on 
the best information reasonably available at the time the disclosure is 
provided to the consumer, and shall state clearly that the disclosure is 
an estimate.
    (ii) For a transaction in which a portion of the interest is 
determined on a per-diem basis and collected at consummation, any 
disclosure affected by the per-diem interest shall be considered 
accurate if the disclosure is based on the information known to the 
creditor at the time that the disclosure documents are prepared for 
consummation of the transaction.
    (3) The creditor may disregard the effects of the following in 
making calculations and disclosures.
    (i) That payments must be collected in whole cents.
    (ii) That dates of scheduled payments and advances may be changed 
because

[[Page 222]]

the scheduled date is not a business day.
    (iii) That months have different numbers of days.
    (iv) The occurrence of leap year.
    (4) In making calculations and disclosures, the creditor may 
disregard any irregularity in the first period that falls within the 
limits described below and any payment schedule irregularity that 
results from the irregular first period:
    (i) For transactions in which the term is less than 1 year, a first 
period not more than 6 days shorter or 13 days longer than a regular 
period;
    (ii) For transactions in which the term is at least 1 year and less 
than 10 years, a first period not more than 11 days shorter or 21 days 
longer than a regular period; and
    (iii) For transactions in which the term is at least 10 years, a 
first period shorter than or not more than 32 days longer than a regular 
period.
    (5) If an obligation is payable on demand, the creditor shall make 
the disclosures based on an assumed maturity of 1 year. If an alternate 
maturity date is stated in the legal obligation between the parties, the 
disclosures shall be based on that date.
    (6)(i) A series of advances under an agreement to extend credit up 
to a certain amount may be considered as one transaction.
    (ii) When a multiple-advance loan to finance the construction of a 
dwelling may be permanently financed by the same creditor, the 
construction phase and the permanent phase may be treated as either one 
transaction or more than one transaction.
    (d) Multiple creditors; multiple consumers. If a transaction 
involves more than one creditor, only one set of disclosures shall be 
given and the creditors shall agree among themselves which creditor must 
comply with the requirements that this regulation imposes on any or all 
of them. If there is more than one consumer, the disclosures may be made 
to any consumer who is primarily liable on the obligation. If the 
transaction is rescindable under Sec. 226.23, however, the disclosures 
shall be made to each consumer who has the right to rescind.
    (e) Effect of subsequent events. If a disclosure becomes inaccurate 
because of an event that occurs after the creditor delivers the required 
disclosures, the inaccuracy is not a violation of this regulation, 
although new disclosures may be required under paragraph (f) of this 
section, Sec. 226.19, or Sec. 226.20.
    (f) Early disclosures. If disclosures required by this subpart are 
given before the date of consummation of a transaction and a subsequent 
event makes them inaccurate, the creditor shall disclose before 
consummation: 39
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    \39\ For certain residential mortgage transactions, 
Sec. 226.19(a)(2) permits redisclosure no later than consummation or 
settlement, whichever is later.
---------------------------------------------------------------------------

    (1) Any changed term unless the term was based on an estimate in 
accordance with Sec. 226.17(c)(2) and was labelled an estimate;
    (2) All changed terms, if the annual percentage rate at the time of 
consummation varies from the annual percentage rate disclosed earlier by 
more than \1/8\ of 1 percentage point in a regular transaction, or more 
than \1/4\ of 1 percentage point in an irregular transaction, as defined 
in Sec. 226.22(a).
    (g) Mail or telephone orders--delay in disclosures. If a creditor 
receives a purchase order or a request for an extension of credit by 
mail, telephone, or any other written or electronic communication 
without face-to-face or direct telephone solicitation, the creditor may 
delay the disclosures until the due date of the first payment, if the 
following information for representative amounts or ranges of credit is 
made available in written form to the consumer or to the public before 
the actual purchase order or request:
    (1) The cash price or the principal loan amount.
    (2) The total sale price.
    (3) The finance charge.
    (4) The annual percentage rate, and if the rate may increase after 
consummation, the following disclosures:
    (i) The circumstances under which the rate may increase.
    (ii) Any limitations on the increase.
    (iii) The effect of an increase.
    (5) The terms of repayment.
    (h) Series of sales--delay in disclosures. If a credit sale is one 
of a series made under an agreement providing that

[[Page 223]]

subsequent sales may be added to an outstanding balance, the creditor 
may delay the required disclosures until the due date of the first 
payment for the current sale, if the following two conditions are met:
    (1) The consumer has approved in writing the annual percentage rate 
or rates, the range of balances to which they apply, and the method of 
treating any unearned finance charge on an existing balance.
    (2) The creditor retains no security interest in any property after 
the creditor has received payments equal to the cash price and any 
finance charge attributable to the sale of that property. For purposes 
of this provision, in the case of items purchased on different dates, 
the first purchased is deemed the first item paid for; in the case of 
items purchased on the same date, the lowest priced is deemed the first 
item paid for.
    (i) Interim student credit extensions. For each transaction 
involving an interim credit extension under a student credit program, 
the creditor need not make the following disclosures: the finance charge 
under Sec. 226.18(d), the payment schedule under Sec. 226.18(g), the 
total of payments under Sec. 226.18(h), or the total sale price under 
Sec. 226.18(j).

[46 FR 20892, Apr. 7, 1981, as amended at 52 FR 48670, Dec. 24, 1987; 61 
FR 49246, Sept. 19, 1996]



Sec. 226.18  Content of disclosures.

    For each transaction, the creditor shall disclose the following 
information as applicable:
    (a) Creditor. The identity of the creditor making the disclosures.
    (b) Amount financed. The amount financed, using that term, and a 
brief description such as the amount of credit provided to you or on 
your behalf. The amount financed is calculated by:
    (1) Determining the principal loan amount or the cash price 
(subtracting any downpayment);
    (2) Adding any other amounts that are financed by the creditor and 
are not part of the finance charge; and
    (3) Subtracting any prepaid finance charge.
    (c) Itemization of amount financed. (1) A separate written 
itemization of the amount financed, including: 40
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    40 Good faith estimates of settlement costs provided for 
transactions subject to the Real Estate Settlement Procedures Act (12 
U.S.C. 2601 et seq.) may be substituted for the disclosures required by 
paragraph (c) of this section.
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    (i) The amount of any proceeds distributed directly to the consumer.
    (ii) The amount credited to the consumer's account with the 
creditor.
    (iii) Any amounts paid to other persons by the creditor on the 
consumer's behalf. The creditor shall identify those persons.41
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    41 The following payees may be described using generic or 
other general terms and need not be further identified: public officials 
or government agencies, credit reporting agencies, appraisers, and 
insurance companies.
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    (iv) The prepaid finance charge.
    (2) The creditor need not comply with paragraph (c)(1) of this 
section if the creditor provides a statement that the consumer has the 
right to receive a written itemization of the amount financed, together 
with a space for the consumer to indicate whether it is desired, and the 
consumer does not request it.
    (d) Finance charge. The finance charge, using that term, and a brief 
description such as ``the dollar amount the credit will cost you.''
    (1) Mortgage loans. In a transaction secured by real property or a 
dwelling, the disclosed finance charge and other disclosures affected by 
the disclosed finance charge (including the amount financed and the 
annual percentage rate) shall be treated as accurate if the amount 
disclosed as the finance charge:
    (i) Is understated by no more than $100; or
    (ii) Is greater than the amount required to be disclosed.
    (2) Other credit. In any other transaction, the amount disclosed as 
the finance charge shall be treated as accurate if, in a transaction 
involving an amount financed of $1,000 or less, it is not more than $5 
above or below the amount required to be disclosed; or, in a transaction 
involving an amount financed of more than $1,000, it is not

[[Page 224]]

more than $10 above or below the amount required to be disclosed.
    (e) Annual percentage rate. The annual percentage rate, using that 
term, and a brief description such as ``the cost of your credit as a 
yearly rate.''42
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    42 For any transaction involving a finance charge of $5 or 
less on an amount financed of $75 or less, or a finance charge of $7.50 
or less on an amount financed of more than $75, the creditor need not 
disclose the annual percentage rate.
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    (f) Variable rate. (1) If the annual percentage rate may increase 
after consummation in a transaction not secured by the consumer's 
principal dwelling or in a transaction secured by the consumer's 
principal dwelling with a term of one year or less, the following 
disclosures: \43\
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    \43\ Information provided in accordance with Secs. 226.18(f)(2) and 
226.19(b) may be substituted for the disclosures required by paragraph 
(f)(1) of this section.
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    (i) The circumstances under which the rate may increase.
    (ii) Any limitations on the increase.
    (iii) The effect of an increase.
    (iv) An example of the payment terms that would result from an 
increase.
    (2) If the annual percentage rate may increase after consummation in 
a transaction secured by the consumer's principal dwelling with a term 
greater than one year, the following disclosures:
    (i) The fact that the transaction contains a variable-rate feature.
    (ii) A statement that variable-rate disclosures have been provided 
earlier.
    (g) Payment schedule. The number, amounts, and timing of payments 
scheduled to repay the obligation.
    (1) In a demand obligation with no alternate maturity date, the 
creditor may comply with this paragraph by disclosing the due dates or 
payment periods of any scheduled interest payments for the first year.
    (2) In a transaction in which a series of payments varies because a 
finance charge is applied to the unpaid principal balance, the creditor 
may comply with this paragraph by disclosing the following information:
    (i) The dollar amounts of the largest and smallest payments in the 
series.
    (ii) A reference to the variations in the other payments in the 
series.
    (h) Total of payments. The total of payments, using that term, and a 
descriptive explanation such as ``the amount you will have paid when you 
have made all scheduled payments.''44
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    44 In any transaction involving a single payment, the creditor 
need not disclose the total of payments.
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    (i) Demand feature. If the obligation has a demand feature, that 
fact shall be disclosed. When the disclosures are based on an assumed 
maturity of 1 year as provided in Sec. 226.17(c)(5), that fact shall 
also be disclosed.
    (j) Total sale price. In a credit sale, the total sale price, using 
that term, and a descriptive explanation (including the amount of any 
downpayment) such as ``the total price of your purchase on credit, 
including your downpayment of  $____.'' The total sale price is the sum 
of the cash price, the items described in paragraph (b)(2), and the 
finance charge disclosed under paragraph (d) of this section.
    (k) Prepayment. (1) When an obligation includes a finance charge 
computed from time to time by application of a rate to the unpaid 
principal balance, a statement indicating whether or not a penalty may 
be imposed if the obligation is prepaid in full.
    (2) When an obligation includes a finance charge other than the 
finance charge described in paragraph (k)(1) of this section, a 
statement indicating whether or not the consumer is entitled to a rebate 
of any finance charge if the obligation is prepaid in full.
    (l) Late payment. Any dollar or percentage charge that may be 
imposed before maturity due to a late payment, other than a deferral or 
extension charge.
    (m) Security interest. The fact that the creditor has or will 
acquire a security interest in the property purchased as part of the 
transaction, or in other property identified by item or type.
    (n) Insurance and debt cancellation. The items required by 
Sec. 226.4(d) in order to exclude certain insurance premiums and debt 
cancellation fees from the finance charge.
    (o) Certain security interest charges. The disclosures required by 
Sec. 226.4(e) in

[[Page 225]]

order to exclude from the finance charge certain fees prescribed by law 
or certain premiums for insurance in lieu of perfecting a security 
interest.
    (p) Contract reference. A statement that the consumer should refer 
to the appropriate contract document for information about nonpayment, 
default, the right to accelerate the maturity of the obligation, and 
prepayment rebates and penalties. At the creditor's option, the 
statement may also include a reference to the contract for further 
information about security interests and, in a residential mortgage 
transaction, about the creditor's policy regarding assumption of the 
obligation.
    (q) Assumption policy. In a residential mortgage transaction, a 
statement whether or not a subsequent purchaser of the dwelling from the 
consumer may be permitted to assume the remaining obligation on its 
original terms.
    (r) Required deposit. If the creditor requires the consumer to 
maintain a deposit as a condition of the specific transaction, a 
statement that the annual percentage rate does not reflect the effect of 
the required deposit.45
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    45 A required deposit need not include, for example: (1) An 
escrow account for items such as taxes, insurance or repairs; (2) a 
deposit that earns not less than 5 percent per year; or (3) payments 
under a Morris Plan.

[46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981, as amended at 52 
FR 48670, Dec. 24, 1987; 61 FR 49246, Sept. 19, 1996]



Sec. 226.19  Certain residential mortgage and variable-rate transactions.

    (a) Residential mortgage transactions subject to RESPA--(1) Time of 
disclosures. In a residential mortgage transaction subject to the Real 
Estate Settlement Procedures Act (12 U.S.C. 2601 et seq.) the creditor 
shall make good faith estimates of the disclosures required by 
Sec. 226.18 before consummation, or shall deliver or place them in the 
mail not later than three business days after the creditor receives the 
consumer's written application, whichever is earlier.
    (2) Redisclosure required. If the annual percentage rate at the time 
of consummation varies from the annual percentage rate disclosed earlier 
by more than \1/8\ of 1 percentage point in a regular transaction or 
more than \1/4\ of 1 percentage point in an irregular transaction, as 
defined in Sec. 226.22, the creditor shall disclose all the changed 
terms no later than consummation or settlement.
    (b) Certain variable-rate transactions.\45\a If the 
annual percentage rate may increase after consummation in a transaction 
secured by the consumer's principal dwelling with a term greater than 
one year, the following disclosures must be provided at the time an 
application form is provided or before the consumer pays a non-
refundable fee, whichever is earlier:\45\b
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    \45\a Information provided in accordance with variable-
rate regulations of other federal agencies may be substituted for the 
disclosures required by paragraph (b) of this section.
    \45\b Disclosures may be delivered or placed in the mail 
not later than three business days following receipt of a consumer's 
application when the application reaches the creditor by telephone, or 
through an intermediary agent or broker.
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    (1) The booklet titled Consumer Handbook on Adjustable Rate 
Mortgages published by the Board and the Federal Home Loan Bank Board, 
or a suitable substitute.
    (2) A loan program disclosure for each variable-rate program in 
which the consumer expresses an interest. The following disclosures, as 
applicable, shall be provided:
    (i) The fact that the interest rate, payment, or term of the loan 
can change.
    (ii) The index or formula used in making adjustments, and a source 
of information about the index or formula.
    (iii) An explanation of how the interest rate and payment will be 
determined, including an explanation of how the index is adjusted, such 
as by the addition of a margin.
    (iv) A statement that the consumer should ask about the current 
margin value and current interest rate.
    (v) The fact that the interest rate will be discounted, and a 
statement that the consumer should ask about the amount of the interest 
rate discount.
    (vi) The frequency of interest rate and payment changes.

[[Page 226]]

    (vii) Any rules relating to changes in the index, interest rate, 
payment amount, and outstanding loan balance including, for example, an 
explanation of interest rate or payment limitations, negative 
amortization, and interest rate carryover.
    (viii) At the option of the creditor, either of the following:
    (A) A historical example, based on a $10,000 loan amount, 
illustrating how payments and the loan balance would have been affected 
by interest rate changes implemented according to the terms of the loan 
program disclosure. The example shall reflect the most recent 15 years 
of index values. The example shall reflect all significant loan program 
terms, such as negative amortization, interest rate carryover, interest 
rate discounts, and interest rate and payment limitations, that would 
have been affected by the index movement during the period.
    (B) The maximum interest rate and payment for a $10,000 loan 
originated at the initial interest rate (index value plus margin, 
adjusted by the amount of any discount or premium) in effect as of an 
identified month and year for the loan program disclosure assuming the 
maximum periodic increases in rates and payments under the program; and 
the initial interest rate and payment for that loan and a statement that 
the periodic payment may increase or decrease substantially depending on 
changes in the rate.
    (ix) An explanation of how the consumer may calculate the payments 
for the loan amount to be borrowed based on either:
    (A) The most recent payment shown in the historical example in 
paragraph (b)(2)(viii)(A) of this section; or
    (B) The initial interest rate used to calculate the maximum interest 
rate and payment in paragraph (b)(2)(viii)(B) of this section.
    (x) The fact that the loan program contains a demand feature.
    (xi) The type of information that will be provided in notices of 
adjustments and the timing of such notices.
    (xii) A statement that disclosure forms are available for the 
creditor's other variable-rate loan programs.

[52 FR 48670, Dec. 24, 1987; 53 FR 467, Jan. 7, 1988, as amended at 61 
FR 49246, Sept. 19, 1996; 62 FR 63443, Dec. 1, 1997]



Sec. 226.20  Subsequent disclosure requirements.

    (a) Refinancings. A refinancing occurs when an existing obligation 
that was subject to this subpart is satisfied and replaced by a new 
obligation undertaken by the same consumer. A refinancing is a new 
transaction requiring new disclosures to the consumer. The new finance 
charge shall include any unearned portion of the old finance charge that 
is not credited to the existing obligation. The following shall not be 
treated as a refinancing:
    (1) A renewal of a single payment obligation with no change in the 
original terms.
    (2) A reduction in the annual percentage rate with a corresponding 
change in the payment schedule.
    (3) An agreement involving a court proceeding.
    (4) A change in the payment schedule or a change in collateral 
requirements as a result of the consumer's default or delinquency, 
unless the rate is increased, or the new amount financed exceeds the 
unpaid balance plus earned finance charge and premiums for continuation 
of insurance of the types described in Sec. 226.4(d).
    (5) The renewal of optional insurance purchased by the consumer and 
added to an existing transaction, if disclosures relating to the initial 
purchase were provided as required by this subpart.
    (b) Assumptions. An assumption occurs when a creditor expressly 
agrees in writing with a subsequent consumer to accept that consumer as 
a primary obligor on an existing residential mortgage transaction. 
Before the assumption occurs, the creditor shall make new disclosures to 
the subsequent consumer, based on the remaining obligation. If the 
finance charge originally imposed on the existing obligation was an add-
on or discount finance charge, the creditor need only disclose:

[[Page 227]]

    (1) The unpaid balance of the obligation assumed.
    (2) The total charges imposed by the creditor in connection with the 
assumption.
    (3) The information required to be disclosed under Sec. 226.18(k), 
(l), (m), and (n).
    (4) The annual percentage rate originally imposed on the obligation.
    (5) The payment schedule under Sec. 226.18(g) and the total of 
payments under Sec. 226.18(h) based on the remaining obligation.
    (c) Variable-rate adjustments. 45c An adjustment to the 
interest rate with or without a corresponding adjustment to the payment 
in a variable-rate transaction subject to Sec. 226.19(b) is an event 
requiring new disclosures to the consumer. At least once each year 
during which an interest rate adjustment is implemented without an 
accompanying payment change, and at least 25, but no more than 120, 
calendar days before a payment at a new level is due, the following 
disclosures, as applicable, must be delivered or placed in the mail:
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    \45c \Information provided in accordance with variable-rate 
subsequent disclosure regulations of other federal agencies may be 
substituted for the disclosure required by paragraph (c) of this 
section.
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    (1) The current and prior interest rates.
    (2) The index values upon which the current and prior interest rates 
are based.
    (3) The extent to which the creditor has foregone any increase in 
the interest rate.
    (4) The contractual effects of the adjustment, including the payment 
due after the adjustment is made, and a statement of the loan balance.
    (5) The payment, if different from that referred to in paragraph 
(c)(4) of this section, that would be required to fully amortize the 
loan at the new interest rate over the remainder of the loan term.

[46 FR 20892, Apr. 7, 1981, as amended at 52 FR 48671, Dec. 24, 1987]



Sec. 226.21  Treatment of credit balances.

    When a credit balance in excess of $1 is created in connection with 
a transaction (through transmittal of funds to a creditor in excess of 
the total balance due on an account, through rebates of unearned finance 
charges or insurance premiums, or through amounts otherwise owed to or 
held for the benefit of a consumer), the creditor shall:
    (a) Credit the amount of the credit balance to the consumer's 
account;
    (b) Refund any part of the remaining credit balance, upon the 
written request of the consumer; and
    (c) Make a good faith effort to refund to the consumer by cash, 
check, or money order, or credit to a deposit account of the consumer, 
any part of the credit balance remaining in the account for more than 6 
months, except that no further action is required if the consumer's 
current location is not known to the creditor and cannot be traced 
through the consumer's last known address or telephone number.



Sec. 226.22  Determination of annual percentage rate.

    (a) Accuracy of annual percentage rate. (1) The annual percentage 
rate is a measure of the cost of credit, expressed as a yearly rate, 
that relates the amount and timing of value received by the consumer to 
the amount and timing of payments made. The annual percentage rate shall 
be determined in accordance with either the actuarial method or the 
United States Rule method. Explanations, equations and instructions for 
determining the annual percentage rate in accordance with the actuarial 
method are set forth in appendix J to this regulation.45d
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    \45d\ An error in disclosure of the annual percentage rate or 
finance charge shall not, in itself, be considered a violation of this 
regulation if: (1) The error resulted from a corresponding error in a 
calculation tool used in good faith by the creditor; and (2) upon 
discovery of the error, the creditor promptly discontinues use of that 
calculation tool for disclosure purposes and notifies the Board in 
writing of the error in the calculation tool.
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    (2) As a general rule, the annual percentage rate shall be 
considered accurate if it is not more than \1/8\ of 1 percentage point 
above or below the annual percentage rate determined in accordance with 
paragraph (a)(1) of this section.

[[Page 228]]

    (3) In an irregular transaction, the annual percentage rate shall be 
considered accurate if it is not more than \1/4\ of 1 percentage point 
above or below the annual percentage rate determined in accordance with 
paragraph (a)(1) of this section.46
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    46 For purposes of paragraph (a)(3) of this section, an 
irregular transaction is one that includes one or more of the following 
features: multiple advances, irregular payment periods, or irregular 
payment amounts (other than an irregular first period or an irregular 
first or final payment).
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    (4) Mortgage loans. If the annual percentage rate disclosed in a 
transaction secured by real property or a dwelling varies from the 
actual rate determined in accordance with paragraph (a)(1) of this 
section, in addition to the tolerances applicable under paragraphs 
(a)(2) and (3) of this section, the disclosed annual percentage rate 
shall also be considered accurate if:
    (i) The rate results from the disclosed finance charge; and
    (ii)(A) The disclosed finance charge would be considered accurate 
under Sec. 226.18(d)(1); or
    (B) For purposes of rescission, if the disclosed finance charge 
would be considered accurate under Sec. 226.23(g) or (h), whichever 
applies.
    (5) Additional tolerance for mortgage loans. In a transaction 
secured by real property or a dwelling, in addition to the tolerances 
applicable under paragraphs (a)(2) and (3) of this section, if the 
disclosed finance char