Regulation W

Regulation for banks | 20 March 2022

What is Regulation W

Regulation W, also known as “Affiliate Transactions” is a U.S. FRB regulation. Its purpose is to help ensure the safty and soundness of the U.S. banking system by prohibiting (transfering bad assets from one subsidiary to another, lending to affiliate without collateral) and/or limiting certain transactions between depository institutions, such as a bank and their affiliates to prevent abuse from its own non-bank affiliates.

In my view, the purpose is to prevent conflict of interest between client side of business and proprietary side (corporate) side of business.

Similar concepts in other industries:

  • Moody’s Analytics is separate from Moody’s rating services.
  • KPMG accounting practices are separated from its consulting services.

A Legal Entity is a subsidiary created by a parent company to isolate financial risk (and other risks). Legal status as a separate company makes its obligations secure even if the parent company goes bankrupt.

Regulation W focuse on flow and transactions betwen and among the entire organizaiton’s Legal Entities.

For example, CBNA (Citi Bank North America) is a direct, wholly owned subsidiary of Citigroup, Inc (parent).

Another example, Google is a direct, wholly owned subsidiary of Alphabet Inc.

Recall that Johnson&Johnson formed a new entity to contain all their baby power related business under one place, and let it bankrupt.

This kind of operation may not have been possible for a large bank though per Regulation W.

Why we need to understand Regulation W

Regulation W applies to transactions/flows between certain structures of an organizaiton, but not others.

For example, It applies to transactions and services between Bank Chain entities and Corporate Chain affiliates.

It does not apply to transactions and services solely within Bank Chain entities or solely within Corporate Chain entities.

Understanding Regulation W is important for understanding a bank’s product offerings, booking models and risk management.

Note that although Regulation W is a US regulation. It applies to a bank’s both domestic and foreign Chain Entities and Affiliates.

Rules

  1. Regulation W prohibits transactins that are unsafe or involve transfer of bad assets (sales of bad loans, any covered transactions with Volcker Restricted Funds, i.e. those funds for which the Bank is the direct or indirect investment manager/advisor,organizer, or sponsor)

  2. Permitted transactions between Bank Chain Entities and Corporate Chain Entity Affiliates must be carried out under market terms comparable to similar transactions with non-affiliates.

Section 23A places both quantitative and qualitative limits on certain covered transactions between a Bank Chain Entity and its affiliate. No more than 10% of the Bank’s capital/surplus with a single affliate No more than 20% of the Bank’s capital/surplus with all affliates

There are exemptions subject to safety and soundness requirements.

Section 23B says that covered transactions must be on market terms (within bid/ask or better) like with a 3rd party.

Allowed (covered) transactions

Some examples of covered transactions are:

  • Bank buys assets from affiliate
    • Example: Bank buys mortgage pools from a broker-dealer affiliate
  • Bank lends money to affiliate
    • Affiliate overdrafts in its deposit account from bank
    • Bank lends money to a 3rd party client, who uses the borrowed money to buy securites from affiliate
  • Bank issuance of letter of credit to affiliate
  • Bank buys in securities issued by affiliate
    • Bank gives a loan to a 3rd party client that’s collateralized with securites including parent company’s stock. The covered transacton is the amount of the loan that’s collateralized by parent company’s stock.
  • Bank acceptance of securites issued by affiliate

Responsibilites of different departments

Business

Intercompany servicing need to be documented with compliant agreements.

Operations

Responsible for reporting non-receipt of funds owed to the Bank Chain from an Affiliate as this creates an extension of credit.

Finance

Ensure fees are settled within 30 days. If not settled within 30 days, this creates a covered credit transaction under Regulation W and has to be reported.

Responsible for the negotiations of inter-affiliate agreements.

Compliance with Regulation W

Federal regulators take compliance with Regulation W very seriously. Bank employees take training lessons every year to reenforce understanind.