Banking Law Outline

2012 Stanley I.
Langbein
Im not familiar with precisely what I said, but I stand by what I said,
whatever it was.
W. Mitt Romney (2012)
Banking Law and Regulation, Fall 2012: Handout IV
12 U.S. Code 371c1 Restrictions on transactions with affiliates

and known WHAT
TRANSACTIONS/transactions for certain
parties are affiliates?
KNOW
I.
HISTORICAL AND GENERAL BACKGROUND
2012 Stanley I. Langbein

A. BRIEF HISTORY OF BANK REGULATION IN THE UNITED STATES: TO 1980
1. Colonial era
a. Bank of England formed as central bank, 1694
b. Banks and corporate charters in the era were formed under
special grants, under royal government, by leave of the King
c. French attempts at creating central bank failed in early 1700s
d. Bubble Act of 1720 prohibited grant of charters, including bank
charters, in the colonies
e. Lack of banks and authority to form colonial banks among the
complaints of the colonies against the Crown
2. Period of the early Republic
a. Continental Congress chartered bank in 1781; bank was
rechartered by Pennsylvania, 1783, owing to doubts about
authority under Articles of Confederation to charter banks
b. Constitution (1787) silent on power of Federal government to
create banks whether because the subject was not important
enough to include or too important to get agreement on
c. After fight between Hamiltonian Federalists and Jeffersonian
republicans, First Bank of United States chartered in 1791
i.
ii.
iii.
Bank had 20-year term; expired and not renewed in 1811

Functioned as a central bank, limiting credit issuance by state banks
Bank was unpopular with state banks in consequence
d. States freely chartered banks, by legislative act; practice led to

abuses
e. Second Bank of the United States
i
iv.
v.
vi.
f.
Chartered in 1816, for 20-year term

Constitutionality upheld in McCulloch v. Maryland and Gibbons v.
Ogden, under necessary and proper clause (broad reading of
congressional power)
Efforts by state to tax its notes and thus destroy it
Supreme Court struck down state tax enactments as unconstitutional
under the supremacy clause
Andrew Jackson and the destruction of the Second Bank

i
vii.
viii.
ix.
x.
xi.
Congress enacted renewal of charter in 1832, in anticipation of

presidential election, thinking Jackson would not have dared veto the
legislation while running for re-election
Jackson vetoed the legislation in famous veto message that expresses
agrarian anti-bank views, antecedent of later populist attacks
Bank still had four years to run on charter
Jackson destroyed the bank in 1834 by withdrawing Federal Treasury
deposits in the bank
Act was illegal, and first Treasury Secretary refused to do it
Jackson replaced the Treasury Secretary with Attorney General Roger
Taney, who carried out the plan

xii.
Jackson awarded Taney by appointing him Chief Justice of the Supreme

Court, a post he held for 22 years, highlighted most especially by his
authorship of the notorious Dred Scott decision
3. Free banking era

a. In response to abuses in legislative chartering, New York in 1825
adopted a free incorporation law, allowing persons to form
corporations by compliance with ministerial requirements of
statute.
b. Law followed by a parallel free banking law in 1838, following
demise of Second Bank of the United States (and ensuing Panic
of 1837).
c. All other states followed suit with free incorporation and free
banking laws.
d. Era between mid-1830s and Civil War is the free banking era,
reasonably successful, but with frequent expansions of credit,
especially at the frontier, unchecked by any form of central
banking.
e. Crisis arose with Panic of 1857, demonstrating need to regulate
expansion of bank credit.
4. National Bank Act
a. Adopted in early 1863, repassed in December 1864.
b. Established system of national banks to assist in financing Civil
War.
c. Also was first statute to authorize paper currency
(greenbacks).
d. Remains in force, and may be the oldest major Federal
regulatory enactment still playing a vital role.
e. Essentially a Federal Free banking act; the first of the major
Federal statutes studied here.
f.
Sought to destroy state banks by taxing their notes, the obverse

of the states attack on the Second Bank of the United States.
g. Effort to drive out state banks failed because of the emergence

of checks and demand deposits (checking accounts), which
obviated the need of state banks for the notes taxed by the NBA.
h. Result was emergence of the dual banking system, with both
Federal and state governments chartering banks.
i.
National Bank notes functioned as currency, which resulted in

narrow reading by Comptroller of the Currency of Comptrollers
role, and of banks powers.
j.
Narrow interpretation of bank act was followed by the courts,

and resulted in limiting profitability of national banks, as
opposed to state banks.
3

5. Federal Reserve Act
a. Response to the panic of 1907, resulting from agreement among
government and bank officials to establish a central bank.
b. 1907 marked a shift in Comptrollers interpretation of the NBA,
recognizing greater latitude in powers of Comptroller and of
bank authority under the statute a stance rejected, initially, by
Supreme Court.
c. Statute enacted in 1913.
d. Established a system of 12 Federal reserve banks in different
regions of country, governed by a collegial board, originally
called the Federal Reserve Board, but changed in 1935 to what
it is now, the Board of Governors of the Federal Reserve System.
e. Banks could be members of Federal Reserve banks.
i
xiii.
xiv.
National banks required to be members

State banks could elect to be resulting in two kinds of state banks,
state member banks and state nonmember banks.
Members banks hold deposits in Federal Reserve Bank, and must also
own stock of Federal Reserve banks.
6. Period between Federal Reserve Act and Great Depression

a. First period of consolidation in banking industry.
b. Interest in branching led to original McFadden Act in 1926.
c. Bank diversification, including involvement in securities activity.
7. Era of the Great Depression
a. First thrift legislation
i
xv.
xvi.
Federal Home Loan Bank Act (1932) established system of Federal

home loan banks to provide lending assistance to thrifts.
Home Owners Loan Act (HOLA) (1933) first statute to provide for
Federal chartering of thrifts.
National Housing Act (1934) established deposit insurance for thrifts.
b. Banking Act of 1933

i
xvii.
xviii.
xix.
Four sections (16, 20, 21, 32) are the Glass-Steagall Act, separating
investment banking from commercial banking.
Established Federal deposit insurance for the first time, originally as
Section 12A of the Federal Reserve Act, moved to become the Federal
Deposit Insurance Act in 1950.
Imposed ceilings on interest banks could pay on deposits.
Expanded McFadden Act about bank branching.
c. Bank Conservation Act (1933) established special form of

bankruptcy resolution (conservatorship) for troubled banks.
d. Banking Act of 1935 refined deposit insurance and federal
reserve laws.
8. From Great Depression to the Crisis of the 1980s

a. Originally, Depression statutes created stable system of the 36-3 banker borrow at 3, lend at 6, and be on the golf course
by 3.
b. In 1950s, system was roiled by bank agitation on two fronts
consolidation (both through branching and acquisitions) and
activities restrictions.
c. In late 1950s and early 1960s, certain states, led by North
Carolina, began liberalizing bank restrictions, especially on
branching North Carolinas early moves resulted in its become
a major banking center by the 1980s.
d. Bank Holding Company Act passed in 1956.
i
xx.
xxi.
xxii.
Limited two things who could own a bank, and nonbanking activities
with which banks could be affiliated.
Originally limited to holding companies owning more than 1 bank
subsidiary.
Administered by Board of Governors, ultimately resulting in the Board
becoming the central agency regulating banks.
Savings and Loan Holding Company Act, with comparable provisions
governing thrifts, passed in 1959 or 1967.
e. In early 1960s, Comptroller Saxon, President Kennedys

Comptroller, adopted the Part 9 initiative, allowing national
banks (at bank level) wide range of new activities, including data
processing, leasing, travel agencies, standby letters of credit,
securities brokerage, insurance brokerage, mutual funds.
i
xxiii.
f.
Competitors challenged rulings in courts, in almost all cases

successfully, all in decisions of the 1960s.
Leasing and standby letters of credit survived, but only in cases
decided in late 1970s.
Congress responded with Bank Holding Company Amendments

of 1970.
xxiv.
xxv.
Extended BHCA to one-bank holding companies.

Attempted to concentrate efforts to expand bank activities to bank
affiliates, to be interpreted and administered by the Board of
Governors.
g. Financial Institutions Supervisory Act of 1966 gave expanded

flexible powers to FDIC in administering Federal Deposit
iNsurance Act.
i
xxvi.
xxvii.
Originally FDIC could only terminate the insurance or throw bank into
receivershiop.
Inflexible remedies gave FDIC no intermediate powers to prevent
bank trouble.
FISA created authority for cease-and-desist orders, civil money
penalties, and prohibition or removal of officers and directors.
9. Crisis of the 1980s: Background

a. President Nixon abrogated 1945 Bretton Woods Agreement,
under which exchange rates among currencies were fixed.
b. Abrogation of agreement led to worldwide inflation throughout
the 1970s.
5

c. Inflation was combated, beginning in 1979, by sharply rising
interest rates.
d. Situation was particularly hard on thrifts, which at the time were
limited to holding long-term residential mortgages.
i
xxviii.
xxix.
Rising interest rates meant fall in the value of long-term, fixed-rate

mortgages.
At the same time, rising interest rates on deposit funds increased
banks cost of funding.
Result was weakness or insolvency became widespread in the thrift
industry by the early 1980s.
e. Fluctuating interest rates led to widespread use of variable rate

contracts for the first time.
f.
Prevalence of variable rate contracts and fluctuating exchange

rates led to the emergence of derivatives, especially swaps.
i
xxx.
xxxi.
xxxii.
xxxiii.
Derivatives are contracts where value of the property is determined

with reference to another property, or index of values, which property
is called an underlying.
Swaps are contracts where one party, say, with variable rate loans
which will be receiving variable rate payments, but with fixed rate
obligations, agrees with another party, in the opposite position, to
swap payments with respect to the payments each receives.
This matches each partys receipts to what each is obligated to pay.
Parties do not swap the underlying property; they only agree to make
payments to eachother corresponding to what they have a right to
receive under the contract.
At first, swaps were with respect to interest rates and foreign exchange
rates.
B. BRIEF HISTORY OF BANK REGULATION IN THE UNITED STATES:

REVOLUTION OF 1980s AND 1990s
1. Thrift crisis
a. Dates from late 1970s
b. Politicians, both President and Congress kicked the can down
the road throughout the 1980s
c. FSLIC was insolvent throughout period, but not recapitalized.
d. Half measures adopted.
i
xxxiv.
xxxv.
Accounting measures (supervisory goodwill) masked capital position

of thrifts.
Congress liberalized restrictions on interstate and interindustry
(bank-thrift) combinations to let healthy thrifts takeover failing ones.
Limited bailout measures adopted in 1982 (Garn-St Germain) and
1987 (CEBA) (see below).
e. Finally resolved by FIRREA (1989).

i
xxxvi.
xxxvii.
xxxviii.
Abolished Federal Home Loan Bank Board (FHLBB) and FSLIC, and
integrated deposit insurance law governing banks and thrifts.
Provided backup bailout funds for thrifts.
Created RTC to resolve thrifts in 5-year period.
Adopted comprehensive new bankruptcy law for depository institutions
(banks and thrifts).

2. Development of new, exotic financial products
a. Swaps
i
xxxix.
xl.
xli.
Interest rate and currency swaps described above (see A-9-f).

Later emerged equity and commodity swaps (late 1980s).
Credit default swaps emerged in mid-1990s.
Banks became central dealers and market makers in swaps.
b. Securitizations
i
xlii.
xliii.
xliv.
Began in late 1960s with Ginnie Maes government effort to create a

secondary market for home mortgages.
Originator packages assets, sells them to a special purpose
vehicle, which issues securities, payments on which are derived from
payments on the underlying pool of assets.
Mortgage securitizations (private) encouraged by legislation adopted in
1984.
Began with mortgage securities; later practice spread to all classes of
loans, automobile loans, consumer loans, commercial & industrial
loans, small business loans, credit card receivables, student loans, etc.
3. Expansion of bank powers

a. Banks sought liberalization of three restrictions
i
xlv.
xlvi.
Interest rate caps inherited from Banking Act of 1933.

Activities restrictions of Glass-Steagall (1933 Act), on securities and
insurance activities.
Historical restrictions on interstate banking and branching.
b. First objective achieved by legislation in 1980.

c. Liberalization in 1980s (of latter two restrictions) was
undertaken entirely by regulatory action, approved by the
Courts under the Chevron doctrine, NOT by legislation.
d. Insurance powers for BHCs frozen by Garn-St Germaine in 1982;
insurance brokerage allowed for banks, beginning late 1980s
and early 1990s.
e. Interstate banking (BHC common ownership of separate banks
operating in different states) allowed under Supreme Court
decision in Northeast Bancorp and interstate compacts and state
legislation premised on regionality or reciprocity.
i
xlvii.
xlviii.
xlix.
l.
Regionality: legislation or compact allowed banks from states in one

region (e.g., New England) to own banks in any state in the region.
Reciprocity legislation allowed out-of-state banks to own banks in a
state if the home state of the out-of-state bank allowed banks of the
host state to acquire banks in the home state.
All such legislation excluded money center New York banks.
Led to emergence of superregional banks, like NationsBank and Banc
One, intermediate between community and money center banks.
New York money center banks gained limited interstate authority
through power to acquire failing thrifts, granted under Garn-St Germain
in 1982.
4. Legislation of the 1980s

a. Financial Institutions and Interest Rate Control Act (FIRIRCA)
(1978)
7

i
li.
lii.
Expanded powers of Federal thrifts beginning of blurring of lines

between thrifts and banks.
Revised and strengthened FDIC intermediate powers first recognized
in 1966 FISA.
Provided first authority for assisted acquisitions of thrifts; clarified FDIC
power to supervise purchase and assumption transactions.
b. Depository Institutions Deregulation and Monetary Control Act of

1980 (DIDRAMCA)
liii.
liv.
Eliminated caps on interest rates on checking accounts, except

corporate accounts.
Revised powers of Federal Reserve.
c. Garn-St Germain Act of 1982

i
lv.
lvi.
lvii.
lviii.
lix.
Extremely bad piece of legislation

Expanded powers of agencies to supervise assisted acquisitions of
troubled institutions, including interstate and interindustry acquisitions.
Life cap on deposit insurance from $25,000 to $100,000.
Greatly liberalized powers of Federal thrifts.
Provided limited bailout funds for FSLIC.
Imposed absolute limit on power of BHCs to engage in insurance
activity.
d. Competitive Equality in Bank Act of 1987 (CEBA)

i
lx.
lxi.
lxii.
Began as effort to expand bank insurance and securities powers, but

effort fizzled after 1986 elections changed control of Senate from
Republican to Democrat.
Refined definition of bank in BHCA.
Limited expanded thrifts powers.
More limited funds for partial bailout of thrifts.
e. Financial Institutions Reform Recovery and Enforcement Act of

1989 (FIRREA)
i
lxiii.
lxiv.
lxv.
lxvi.
lxvii.
lxviii.
f.
Passed quickly after 1988 elections.

Provided $155 billion bailout funds for thrift industry.
Integrated deposit insurance laws governing banks and thrifts.
Revised regulation of thrifts, creating Office of Thrift Supervision (OTS),
abolishing FSLIC and FHLBB.
Adopted new receivership and conservatorship laws governing
depository institutions.
Limited thrifts powers granted by earlier statutes.
Expanded powers of agencies with respect to intermediate sanctions.
FDIC Improvement Act of 1991 (FDICIA)

i
ii
iii
Like CEBA, began as effort to revise powers of banks and to allow

interstate banking, but effort fizzled in late fall 1991.
Greatly strengthened powers of FDIC, both as to sanctions and
receiverships.
Provided for prompt corrective action, least-cost resolution authority
(FDIA 13(c)(4); risk-based deposit insurance assessments (FDIA
11(a)), activities restrictions on state banks and thrifts.
5. Legislation of the 1990s

a. Finally gave legislative sanction to expansion of bank powers
(securities and insurance) and interstate expansion, though
ultimate legislation had relatively limited effect, since regulatory
action had given the banks virtually everything they wanted
already.
8

b. Riegle-Neal Interstate Banking and Branching Act of 1994
(IBBEA)
i
ii
iii
iv
v
Allowed interstate banking (through multiple bank subsidiaries of

common BHC) without restriction.
Allowed interstate branching for first time.
Effective date of interstate branching was delayed until June 1, 1997.
Interstate branching could be effected only by acquisition of existing
bank in host state; de novo interstate branching was allowed only if
host state opted in.
Last limitation on de novo interstate branching eliminated in 2010 by
Dodd-Frank, which eliminated the opt-in requirement.
c. Gramm-Leach-Bliley Act of 1999 (GLBA)

i
ii
iii
iv
v
Passed after failure to adopt legislation in 104th and 105th Congress.

Congress told insurance, securities, and bank industry lobbies to work
out their differences and devise legislation they could all support they
did, as the only way to get the legislation through Congress.
Legislation allows banks to engage in activities financial in nature,
through either BHC subsidiaries (of financial holding companies) or
subsidiaries of the bank (financial subsidiaries), including all
insurance and securities activities and some merchant banking
activities.
Activities listed in laundry list at BHCA section 4(k)(4).
Authority is split between Treasury and Board of Governors concerning
recognition of and supervision of newly defined nonbank financial
activities.
C. THE CURRENT PERIOD AND THE FINANCIAL CRISIS OF 2007-2009

1. Onset of the financial crisis
a. Period 2001-2006 saw boom in residential real estate prices
i
ii
iii
Boom fueled by liberal real estate lending, esp. subprime mortgages

Role of government-sponsored enterprises, Federal National Mortgage
Association (FNMA, Fannie Mae) and Federal Home Loan Mortgage
Corporation (FHLMC, Freddie Mac)
Mortgage lending fueled by widespread securitization of mortgages
b. Prices began weakening in mid-2006

c. Weakening real estate markets led to souring of mortgages and
of securities backed by mortgages
d. First major difficulties in June 2007, with failure of two mortgage
securities hedge funds of investment firm Bear Stearns, one of
five major securities firms
e. Fed began reducing interest rates in August 2007
f.
Financial and stock markets peaked in October 2007, then began

long decline
g. Fed began emergency lending facilities, December 2007

2. Height of the crisis
a. Bear Stearns on brink of failure, March 2008

i
ii
Rescued by Fed-sponsored acquisition by JP Morgan Chase

Uncertain legal authority for Fed action
b. Failure of Freddie Mac and Fannie Mac

i
ii
iii
Weakness became apparent in early July 2008

Congress enacted legislation to organize insolvency of institution, early
August 2008.
Treasury invoked authority to place GSEs in conservatorship,
September 8, 2008.
c. Failure of Lehman Brothers, Sept. 15, 2008

i
ii
No Fed rescue
Triggered near collapse of system by Thursday, Sept. 19, 2008
d. Other failures September 2008

i
ii
iii
iv
Merrill Lynch acquired by Bank of America (Sept. 15)

AIG rescued (Sept. 17) second Maiden Lane partnerships
Washington Mutual acquired by JPMorganChase (assisted)
Wachovia acquired by Wells Fargo, unassisted, but contested
e. Nature of the crisis

i
ii
iii
Interbank lending froze, because banks were not sure who was or was
not insolvent
Web of credit default swaps and other counterparty arrangements
transmitted bankruptcy throughout the system.
Thus, securitizations lay at the root of the crisis, and derivatives
(swaps) were the primary means of spreading contagion.
3. Congressional and regulatory response

a. Expansion of Fed emergency lending facilities
b. Establishment of emergency FDIC guarantees
i
ii
Widespread failures of small banks

Led to remaining independent large securities firms (Goldman Sachs
and Morgan Stanley) acquiring small banks to become BHCs, so as to
avail themselves of the lending facilities.
c. Troubled Asset Relief Program (TARP)
10

i
ii
iii
iv
Established under Emergency Economic Stabilization Act (EESA) of

2008, enacted Oct. 3, 2008
Involved purchase of preferred stock by Treasury in all major banks
Objective was to restart interbank lending by giving assurance that
banks involved had adequate capital and were not insolvent
Most TARP instruments retired without loss to Treasury
d. Quantitative easing programs of 2009-2012

4. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(Dodd-Frank)
a. Title I establishes procedures for imposing standards on
systemically significant nonbank financial institutions
i
ii
iii
Establishes Financial Stability Oversight Council (FSOC)

Imposes stringent prudential standards on BHCs with more than $50
billion in assets.
Gives FSOC authority to designate nonbank financial companies as
systemically significant, and thus also subject to the prudential
standards.
b. Title II establishes receivership procedure for BHCs and

systemically significant nonbank financial companies, paralleling
procedures established by FIRREA for depository institutions.
c. Title III abolishes OTC, and transfers its functions to Comptroller,
Board, or FDIC, depending on type of institution regulated.
d. Titles IV and VI impose significant new restrictions on banks,
including subjecting derivatives and repurchase agreement to
lending limits, and to limits on interaffiliate transactions, and
Volcker rule, limiting proprietary trading and hedge fund and
private equity investments by banks and their affiliates.
e. Title VII imposes new regulation on swaps, including registration
of swap dealers and required trading of swaps through
clearinghouses, and reporting of data related to swaps.,
f.
Title IX sets forth new investor protections, including section

939A, requiring agencies to get ride of reliance on national
statistical rating organization (NSRO) ratings in agency
regulations.
g. Title X establishes a Consumer Financial Protection Bureau

(CFBP), which assumes authority for all existing consumer
protection legislation, authority transferred principally from the
Board.
h. Title XI establishes new Federal guidelines for mortgage lending.
D. BANK REGULATORY STATUTES
1. Four basic types of banking statute
a. Chartering: provides for organization of entity, and operates as a
basic corporate statute
11

b. Bank of last resort: provides for backup lending facilities to
ensure liquidity and to regulate flow of credit
c. Deposit insurance: insures depositors
d. Holding company: regulates who may own institution, and in
what kind of activities entities under common control with the
institution may engage
2. Commercial banks: regulatory statutes
a. Chartering: National Bank Act (1864), 12 U.S.C. 21-215
b. Bank of last resort: Federal Reserve Act (FRA) (1913), 12 U.S.C.
221-522
c. Deposit insurance: Federal Deposit Insurance Act (FDIA) (1935,
1950), 12 U.S.C. 1811-1835a
d. Bank Holding Company Act (BHCA) (1956), 12 U.S.C. 18411851
3. Thrifts (savings associations): regulatory statutes
a. Chartering: Home Owners Loan Act (HOLA) (1933), 12 U.S.C.
1461-1470
b. Bank of last resort: Federal Home Loan Bank Act (FHLBA) (1932),
12 U.S.C. 1421-1449
c. Deposit insurance: Federal Deposit Insurance Act (FDIA) (1935,
1950), 12 U.S.C. 1811-1835a
d. Savings and Loan Holding Company Act (SLHCA) (1967), 12
U.S.C. 1476a (also is section 10 of HOLA)
E. TYPES OF BANKING ORGANIZATIONS
1. Depository institutions
a. Banks
i
ii
iii
iv
v
vi
vii
viii
Definitions in BHCA and FDIA

No definition in NBA; NBA refers to national associations, or
associations for carrying on the business of banking:
Two types of definitions: chartering and functional
Chartering refers simply to statute under which entity is organized
Functional refers to what the organization does
Three basic functions for purposes of functional definition are taking
deposits; lending; and processing checks
FDIA uses chartering definition; BHCA incorporates FDIA chartering
definition and adds a functional one
History of BHCA definition: nonbank banks and CEBA amendment
b. Thrifts
i
ii
iii
Savings association definition in FDIA

Savings and loan associations
Distinction for savings banks
12

2. Holding companies
a. Bank holding company
i
ii
iii
iv
v
vi
vii
Definition in BHCA ( 2(a)(1): company that controls a bank

Definition of bank, see above
Definition of company does not have to be incorporated
(partnerships, trusts, etc.)
3-part definition of control
De jure control (25% or more of any class of voting stock)
De facto control (as determined by the Board)
5% presumptions
b. Savings and loan holding companies (definition parallel BHC

definition)
i
ii
Slight differences in control definition: more than 25% in SLHCA,

vs. 25% or more in BHCA
25% of voting shares in SLHCA vs. 25% of any class of voting shares in
SLHCA
3. Nonbank brother-sister affiliates

a. Definition of affiliate in BHCA generally any company
controlling, controlled by, or under common control with another
company
b. Carried over in Federal Reserve Act ( 23A-23B), but with
modifications (omission of subsidiaries of bank)
c. Same definition in SLHCA
d. Definition incorporated in FDIA ( 3(w)(6))
4. National bank subsidiaries
a. Definitions in BHCA 2(d) and FDIA 3(w)(4)
b. Take care with directly or indirectly and relation to definitions
of control
c. Operating subsidiaries
i
ii
iii
Wholly a creature of regulation no statutory category

Governed by 12 C.F.R. 5.34
Controversial when recognized (1960s), and still subject to some
controversy today
13

d. Financial subsidiaries
i
ii
Creature of GLBA (1999)

Defined by 12 U.S.C. 24a(g)(3), and governed by 12 U.S.C. 24a
e. Service corporations
i
ii
Governed by 12 U.S.C. 1861 et seq. (Bank Service Corporation Act)

Minor category not significant in contemporary bank regulation or
administration
5. Savings association subsidiaries

a. No financial subsidiaries
b. Service corporations have broader range of activities
c. Operating subsidiaries allowed
6. Financial companies under Dodd-Frank
a. Dodd-Frank ( 101(a)(4), 12 U.S.C. 5311(a)(4)) does not define
financial company or nonbank financial company.
b. Instead, it defines foreign nonbank financial company and
U.S. nonbank financial company.
i
ii
iii
In each case, definition is 2-part.

First part is where company is organized in U.S. to be a U.S. NBFC, in
other country to be a foreign NBFC.
Second part is whether company is predominantly engaged in
financial activities.
c. Predominantly engaged test

i
ii
iii
iv
Either 85% of gross revenues or consolidated assets from or related to

financial activities.
Financial activities are those treated as financial in nature under
section 4(k) of the BHCA, 12 U.S.C. 1843(k)) (includes both section
4(k)(4) (laundry list) activities and 4(k)(1) (defined by
Board/Treasury).
Board has regulatory authority to define predominantly engaged.
Statute specifies no time frame for measuring the 85% tests;
regulations say for year of company ending before September 30,
company becomes NBFC as of following September 30.
d. Exclusions
i
ii
Section 101(a)(4)(B) excludes BHCs from being treated as NBFCs.

Section 101(a)(4)(B) excludes various entities involved in swap
registration and information collection, and defined by Title VII of DoddFrank, as excluded from NBFC treatment.
14

e. Question whether banks and other DIs may be financial
companies
i
ii
iii
iv
f.
Given that the term is nonbank financial company, one wouldnt think
so.
However, there is no express exclusion of them in the statutory
language.
Since section 4(k)(4)(A) includes on laundry list lending and
exchanging money and securities, presumably most depository
institutions would meet either of the 85% tests.
Issue arises principally in connection with section 165(i)(2) of DoddFrank, concerning requirement of company-conducted stress tests, as
discussed below.
Dodd-Frank does define the term financial company for

purposes of Title II of Dodd-Frank (receivership process for
systemically significant companies) ( 201(a)(11)).
i
Includes all BHCs (no $50 billion limitation), and all supervised NBFCs
Also includes all companies predominantly engaged in section 4(k)

activities (with different definition of predominantly engaged:
ii
iii
iv
Also includes any subsidiary other than a DI subsidiary of any company

in the other 3 categories if the subsidiary is predominantly engaged
in financial activites
Predominantly engaged means company must meet 85% test with
respect to revenues, although that is a necessary but not sufficient
condition ( 201(b)), and FDIC has jurisdiction to write regulations
defining term
Apparent intention is to exclude DIs from this definition but done so
awkwardly, because DIs are expressly excluded from fourth categories
(subsidiaries), but not third (non-supervised companies predominantly
engaged).
F. JURISDICTION OF VARIOUS REGULATORS

1. Definition of appropriate Federal banking agency in FDIA 3(q) and
of member banks and nonmember banks in FDIA 3(d)
2. Comptroller in the case of national banks and Federal savings
associations
3. Board in the case of state member banks
4. FDIC in the case of state nonmember banks and state savings
associations
5. Board in the case of BHCs and SLHCs
6. Prior to July 21, 2011, OTS was AFBA for Federal thrifts and state
savings associations (excluding state savings banks, which were
always under the FDIC), and all SLHCs
a. Dodd-Frank abolished OTS, effective one year after effective
date of Dodd Frank (July 21, 2010)
b. Dodd-Frank transferred OTS functions as indicated above
II.
MONETARY SYSTEM AND POLICY

15

A. STRUCTURE OF THE FEDERAL RESERVE
1. Federal Reserve Banks
a. There are 12 regional Federal Reserve districts, with a bank in
each district.
b. The banks are located in Boston, New York, Philadelphia,
Richmond, Atlanta, Cleveland, Chicago, Minneapolis, St. Louis,
Kansas City, Dallas, San Francisco
c. The banks are incorporated under the FRA, the stock is owned
by member banks, and only member banks may hold deposits in
them.
d. FR banks are limited by law as to what they may invest in,
mostly safe investments like Treasury or agency securities, or
short-term commercial paper.
e. Each bank has a board of directors, and the directors are
appointed by the bank shareholders and usually are officers of
the member banks.
f.
The board select a president for each bank; these presidents

serve on the Federal Open Market Committee (FOMC), as
indicated below
2. Board of Governors of Federal Reserve System

a. This is official name: it is not the Federal Reserve Board.
b. Board of Governors is a government agency; it is an
independent regulatory commission, meaning its members,
though appointed by the President, serve for a term and cannot
be removed by the President except for cause.
Board has seven Governors.
c. Governors serve 14-year terms, are appointed by the President
with the advice and consent of the Senate.
d. Board has a Chair and Vice Chair, who are appointed by the
President from among the Governors for 4-year terms as Chair;
as a practical matter, though a Chair remains a Governor for the
remainder of his or her 14-year term, they ordinarily leave the
Board after their term as Chair expires.
e. Board is different from other bank and other Federal regulatory
agencies (FDIC and Comptroller) in that it does not have field
offices; it executes regulatory policy through the FR banks,
which in effect serve as the Boards field.
3. Federal Open Market Committee (FOMC)
a. Transactions between the Federal Reserve banks and member
banks are subject to policies established by the FOMC.
b. FOMC is a 12-member committee, comprising the 7 governors of
the Board of Governors, and five of the 12 bank presidents.
16

c. Four of the five bank presidents serve on a rotating basis; the
fifth is the president of the New York bank, who is a permanent
member of the FOMC.
d. The Chair of the Board of Governors serves and the Chair of the
FOMC, and the New York Fed President serves as the Vice Chair.
B. RESERVE REQUIREMENTS
1. Definition of money
a. Money is generally defined as currency plus demand deposits
(checking accounts).
i
ii
This is conventional definition of M2, used to measure the money

supply.
Broader definitions are used today, e.g., including money market
funds, because of the broader range of devices that serve the historic
function of checking accounts.
b. At the bank level, reserves are the counterpart of money to

consumers, and thus comprise (i) currency; and (ii) deposits at
Federal Reserve banks.
c. Deposits at Federal Reserve banks are thus the equivalent of a
member banks checking account.
2. Required reserve ratio
a. Board of Governors established a required reserve ratio (RRR)
which banks must maintain on a daily basis.
b. Required reserve ratio is the ratio of (x) the banks reserves to
(y) the banks outstanding deposits.
c. The current ratio is 10%, and has been since 1991.
d. Fed does not like to change the ratio frequently.
e. Changes in required ratio are extremely powerful tool in
controlling the money supply, as described below.
3. The miracle of deposit creation
a. When banks make a loan, they do not need to have anything
on hand which is disbursed to the borrower.
b. Rather, banks can merely create a deposit account in the
borrowers favor.
i
iii
iv
This is the normal way of disbursing a bank loan.

No one but a bank can do this, because it is illegal for any entity other
than a bank to carry deposit accounts.
The borrower has cash, in the form of the deposit account, but the
bank has parted with nothing, but does have an asset (the loan
receivable), offset on the balance sheet by the deposit liability/
c. But for the RRR, banks could do this indefinitely, increasing

without limit the assets and liabilities on its books.
i
This creates risks of a panic, as one day the loans go bad, and then the
bank cant pay its depositors.
17

ii
The Federal Reserve Banks can in fact do just this (no RRR binds them),
and they are doing it right now.
d. The RRR limits banks deposit creation and thus their lending:
they may create deposit liabilities only in an amount 10 times
the increase in their reserves.
e. Thus, if a bank makes a loan of 100x, it must find 10x of
reserves, either cash or deposits through the Federal Reserve, to
support the deposit created.
4. Federal funds market
a. It is virtually impossible for banks to monitor their reserve
position exactly, but they must meet the RRR on a nightly basis.
b. Predictably, at the end of a day some banks end up in excess
reserve positions, and some in deficit position.
c. These are adjusted by loans of Federal funds from banks in
excess positions to banks in deficit positions.
d. The loans are ordinarily effected through repurchase, or
repo transactions, in which the bank borrowing Fed funds
sells Treasury or other securities to the funds-lender, subject
to the sellers obligation to repurchase the securities at a
fixed later date.
e. The repo is later unwound by the retransfer of the securities to
the borrower, in exchange for Federal funds, which the borrower
now has.
f.
Looked at from the funds-borrowers standpoint, this is a

repurchase transaction; from the funds-lenders standpoint, it
is a reverse repurchase transaction.
g. Rather than style the transaction as a sale of securities, it can

be structured as a loan of the securities: then the transaction
is a securities lending transaction from the funds-borrowers
standpoint, and a securities borrowing transaction from the
funds-lenders standpoint.
h. Thus the terms repurchase, reverse repurchase, securities
lending, and securities borrowing transactions described
functionally identical transactions.
i.
These transactions will have a prevailing interest rate, which is

the Federal funds rate.
5. Nonmember banks are subject to the reserve requirements.

C. OPEN MARKET OPERATIONS
1. Fed conducts open market operations in order to control the Federal
funds rate and thus control the outstanding money supply.
18

2. When the Fed buys securities (usually Treasury securities) from a
member banks, it pays for the securities with funds it borrows from
the bank, in the form of increasing the amount of the sellers deposits
at the bank.
3. When the Fed sells securities, conversely, it charges the purchasing
bank by reducing the amount of that member banks deposit accounts.
4. Thus, when the Fed buys securities, it adds reserves to the system,
increasing the money supply (and putting downward pressure on the
Federal funds rate).
5. Thus, when the Fed sells securities, it drains reserves from the
system, decreasing the money supply (and putting upward pressure on
the Federal funds rate).
D. THE DISCOUNT AND FEDERAL FUNDS RATES
1. A third tool of monetary policy is the discount rate.
2. The discount rate is the rate of interest Federal Reserve banks charge
for emergency loans to member banks at the Federal Reserves
discount window.
3. The use of the discount window, and the use of the discount rate in
monetary policy, is disfavored.
a. Banks dont like to use the discount window, because they fear it
creates a stigma, making them look like they are in need of
emergency funds.
b. The Board does not like to use the discount rate because it has
uncertain effects, because the Board cannot control the volume
of demand for discount loans.
c. Thus, for the most part the Board leaves the discount rate tied
to the Federal funds rate (e.g., the Fed funds rate plus % (50
basis points).
d. At the onset of the financial crisis, in August 2007, the Feds first
monetary move was to reduce the spread between the discount
rate and the Federal funds rate from 100 to 50 basis points.
e. Jim Cramer came on TV when the Fed did this, and said this was
the move the market needed to move the Dow Jones Industrial
average to 14,500.
f.
At the time, the Dow Jones industrial average was about 13,600.
g. The Dow Jones industrial average has to this date never reached
14,500
4. Because both the discount rate and reserve requirement are disfavored
as tools of ongoing monetary policy, monetary policy is effected largely
by changes in the Federal funds rate.
19

5. Federal funds rate is a target rate: it does not represent a rate the
Federal Reserve Banks charge in transactions to which those banks
are a party.
a. Rate represents rate banks charge eachother on loans of Federal
funds, in repo transactions, as described above.
b. Fed controls the rate by modulating the volume of reserves in
the system, as described above.
6. Reliance on Federal funds rate also has the effect of greatly enhancing
the role of private interests in formulating policy.
a. Discount rate and reserve requirements are set by the Board,
which comprises exclusively public officials, appointed in
keeping with constitutional procedures.
b. Federal funds rate is set by the FOMC, on which privately
appointed Federal Reserve bank presidents have 5 votes.
c. Reserve banks presidents are notorious more hawkish
concerned with fighting inflation and opposed to expansionary
monetary policy than their publicly appointed counterparts.
d. Both the current Administration and the current Fed Chairman
have expressed some uneasiness about the role of private
interests in formulating policy of this kind.
E. THE GOALS OF MONETARY POLICY AND THE EFFECT OF MONETARY POLICY
ON THE ECONOMY
III.
ENTRY INTO FEDERAL REGULATORY REGIME
20

A. DEPOSITORY INSTITUTIONS
1. Formation and Approval Requirements (National Banks)
a. National banks are formed by adoption of articles of association
(12 U.S.C. 21), and an organization certificate (12 U.S.C. 22),
b. The Comptroller examines the certificate and the condition and
capital of the association, and issues a certificate of authority to
commence business if it determines the organization is in
compliance with law and organized for lawful purposes ( 2627).
c. As the statute reads and as it was originally interpreted by the
Comptroller (1863-1907), Comptrollers role was largely
ministerial, the OCC viewed itself as having little authority to
deny approval of an application.
d. FDIA (in 1933) adopted standards for qualifying for deposit
insurance, now codified at 12 U.S.C. 1816.
i
ii
iii
iv
Seven criteria generally related to stability and solvency of the

proposed institution.
One exception is the convenience and needs of the community,
which tends to relate to existing banks in the area to be served.
Current Comptrollers regulations view this factor as protectionist,
and downplay it.
In any event, there is little new bank formation now, in the wake of the
financial crisis, and in fact has been little new bank formation in the
past 30 years, as the period even before the financial crisis was
marked by consolidation in the industry, with the number of
commercial banks falling from around 20,000 to below 7000 now.
e. Comptroller applies these standards in approving banks, in

consultation with FDIC; but the Comptroller controls the decision
process.
f.
Similarly, if the bank forms a new BHC at same time, the process
of approving the BHC is simultaneous with the approval of the
bank, and, under the regulations of both the Board and the OCC,
is done by the OCC, in consultation with the Board.
2. Judicial Review
a. NBA sets forth no provision for judicial review of determinations
by the Comptroller.
b. Comptrollers action is thus informal action, i.e., it is neither
rulemaking, nor adjudication.
c. In the Overton Park decision (1970), the Supreme Court held
such informal actions are subject to judicial review; it also
approved a limit form of de novo review, including questioning
administrators in court.
d. In Camp v. Pitts (1973), the Supreme Court (with changed
membership in the interim) limited Overton Park in a case
involving an effort to review the Comptrollers disapproval of an
application for a new bank charter.
21

i
ii
Court held the action was reviewable.

It held, however, that the decision should be on the basis of the
administrative record, not on the basis of a de novo decision by the
District Court.
e. Period of 1960s-1970s saw considerable litigation in which

parties sought judicial review of the Comptrollers
determinations, either by unsuccessful applicants or by
competitors challenging successful applications.
f.
There was also considerable support voiced for judicial

involvement in the Comptrollers determinations.
g. Despite this activity and interest, there are only one or two
decisions actually reversing the Comptrollers action.
h. In practical effect, then, though under Pitts judicial review is
available, it is unlikely to be availing; counsel needs to seek its
desired result at the administrative level.
3. Thrift Institutions
a. HOLA is different from NBA in its approach to corporate
organization; it gives administrators (now OCC) authority to
prescribe regulations for the organization, incorporation,
examination, operation, and regulation of Federal savings
associations (12 U.S.C. 1464(a)(2)).
b. Accordingly, under HOLA, provisions for organization, merger,
governance, etc. of thrifts is done by regulation (and subject to
administrative discretion), not by statute.
c. De la Cuesta decision confirms this view of HOLA, noting statute
gives administrators authority over thrifts from their corporate
cradle to their corporate grave.
d. Deposit insurance standards (12 U.S.C. 1816) apply to thrifts
as well as banks.
e. Accordingly, applicable standards governing approval of newly
formed thrifts are similar to those governing banks.
f.
Also applicable to thrifts are observations made above with

respect to banks: there are few new thrifts formed at the present
time, and have been few in the preceding 30 years; and judicial
review of administrative decisions is likely to be unavailing.
B. HOLDING COMPANIES
1. Bank Holding Companies
a. Section 3(a) of the BHCA (12 U.S.C. 1842(a)) lists five events
that require prior approval of the Board.
i
ii
iii
iv
Any action that causes a company to become a BHC

Any action that causes a bank to become a subsidiary of a BHC
Any BHC to acquire shares of bank resulting in more than 5%
ownership of voting shares of the bank
Any BHC to acquire all the assets of a bank
22

v
Any BHC to merge or consolidate with another BHC.
b. Thus, if a newly formed bank forms a BHC at the time of its

formation, the action would come within any of the first three
categories (company becomes a BHC; bank becomes subsidiary
of the BHC; BHC acquires at least 5% control).
c. Similarly, if existing bank forms new BHC, it comes within any of
the three categories.
i
ii
iii
Bank becomes subsidiary; company becomes BHC; BHC acquires 5%

control of bank.
Standard way of forming a holding company involves bank forming two
tiers of subsidiaries, the first tier a nonbank, and the second a bank,
and then merging the parent bank into the second-tier subsidiary, with
shareholders of the parent bank receiving stock in the first-tier
subsidiary as consideration for the transaction.
This triangular merger technique avoids problems of making individual
transfers of stock, and also limits ability of dissenting shareholders to
obstruct the transaction.
d. Categories in section 3(a) cover most, but not all, transactions in

which a party (or existing bank) acquires another bank.
i
ii
iii
iv
v
vi
vii
viii
If the acquiring party is a BHC which purchases the stock of the target
bank, or the stock of the target BHC, transaction, transaction falls
within the second and third category.
If the acquiring party is a company that is not already a BHC,
transaction then falls within all of the first 3 categories.
If the transaction involves the merger of two BHCs, it is within the fifth
category (also may be within the second and third, depending on how
one looks at things).
If the transaction involves acquisition of the assets of a bank by the
BHC, transaction is within the fourth category.
Major exception is if the assets of a bank are acquired by another bank,
whether or not the latter is a bank subsidiary of a BHC, or where two
banks are merged.
Those transactions fall under section 18(c) of the FDIA, and require the
approval of the AFBA of the resulting bank (in the case of a merger) or
the acquiring bank (in the case of an asset acquisition).
Also, in certain circumstances, an acquiring party will not constitute a
company within the meaning of the BHCA; such transactions are not
subject to the approval requirement of section 3(a).
Transactions of that kind are, however, subject to section 7(j) of the
FDIA, the Change in Bank Control Act, which requires the approval of
the AFBA when a bank is acquired by individuals or parties acting in
concert.
2. Financial Holding Companies

a. FHC is a BHC that is authorized to engage, either directly or
through nonbank subsidiaries, in the expanded list of a
nonbank financial activities allowed by section 4(k) of the
BHCA, as amended by GLBA.
b. To be an FHC, one must first be a BHC: as provided above, this
requires prior approval of the Board.
c. However, for a BHC to become a FHC, the BHC must only meet
certain criteria; make an election; and notify the Board of the
election.
23

d. Conditions for engaging in expanded financial activities are set
forth in section 4(l).
i
ii
iii
iv
All depository institution subsidiaries of the BHC (and the BHC itself)
must be well capitalized.
All depository institution subsidiaries of the BHC (and the BHC itself)
must be well managed.
Well capitalized means the company meets capital thresholds of 5% for
the leverage requirement; 6% for the Tier 1 risk-weighted assets; and
10% for the total capital risk-weighted assets standard (as opposed to
4%, 4%, and 8% to be adequately capitalized.
Well managed means the institution has a composite rating of 1 or 2 in
the report of the institutions most recent examination.
e. Company must file an election with the Board to be an FHC, and

a certification that it meets the well-managed and wellcapitalized criteria (section 4(l)(1)(C)) but election is not
subject to Board approval.
i
ii
f.
Under section 4(m), Board may find that an FHC does not meet the
statutory criteria.
If the Board so finds, FHC is required to execute an agreement with
Board to correct the conditions, and if the FHC fails to execute such an
agreement, the Board can limit further activities by the FHC or, after a
180-day period, order divestiture of nonbank activities or of the
depository institution subsidiary.
When an FHC engages in a new activity, it is required to notify

the Board, but does not need to obtain prior approval by the
Board for the new activity.
i
ii
iii
iv
v
Section 4(k) provides for 2 categories of nonbank financial activities in

which FHCs are permitted to engage.
Section 4(k)(4) sets forth a laundry list of activities which are
permissible, which includes all insurance and securities activities,
mutual fund activity, and, subject to limitations, merchant banking
activities.
Section 4(k)(1) also authorizes the Board, in consultation with the
Treasury, to permit additional activities determined to be financial in
nature or incidental to or complementary to activities which are
financial in nature.
Board may authorize such additional activities by regulation (the result
of rulemaking) or by order (the outcome of an adjudication).
Since the enactment of GLBA in 1999, the Board has not designated
many new activities as financial in nature, and as a practical matter,
after the financial crisis, is not enthusiastic about doing so in the
contemporary environment.
g. If an activity is allowable under section 4(c)(8) or as a

complementary activity, BHC/FHC must give 60 days prior
notice to Board of engaging in activity.
i
ii
iii
Under section 4(j)(4), BHCs that meet certain managerial and

capitalization criteria are exempt from the notice requirement for (c)(8)
activities only if the activity does not exceed 10% of the risk-weighted
assets of the BHC.
Section 4(j)(5)(A) permits companies meeting those criteria to engage
in activities with 10 days subsequent notice if activity is permitted by
regulation.
Section 4(j)(5)(B) permits companies meeting those criteria to engage
in activities with 12 days prior notice if activity is permitted by order.
24

h. For activities on the section 4(k)(4) laundry list, FHC must
provide Board with 30 days subsequent notice before engaging
in activity (section 4(k)(6)).
i.
If bank seeks to have an activity not on the 4(k)(4) laundry list

designated as financial in nature under 4(k)(1), it must secure
prior approval of the Board.
3. Savings and Loan Holding Companies

a. Formation of SLHC, or an entitys becoming a SLHC, does not as
such require prior approval of Board; SLHC is required to register
as such within 90 days of becoming a SLHC ( 1467a(b)(1)).
b. Section 10(e) (12 U.S.C. 1467a(e)) requires prior approval of
the Board of acquisition transactions.
i
ii
iii
iv
v
If any SLHC acquires control of a savings associations or another SLHC.

If a SLHC acquires by merger, consolidation, or asset purchase another
savings association, another SLHC, or the assets of either.
If SLHC acquires more than 5% of voting shares of savings association
of SLHC not already a subsidiary.
Section 10(e)(1)(B) requires approval if non-SLHC acquires control of
savings association directly or indirectly.
BHCs are permitted to acquire savings associations under section 4(i)
of the BHCA, and approval is required under that section.
c. Definition of permissible SLHC activities and affiliations is set

forth in HOLA 10(c)(1)-(2).
i
iv
Definition does not include activities on the section 4(k) laundry list, so
SLHCs may not engage de novo in those activities,
However, companies engaged in those activities are permitted to
acquire savings associations under HOLA 10(c)(9)(A)(ii), so affiliations
are permitted by reverse acquisitions.
d. SLHCs are permitted to engage in any activity permitted to BHCs

under section 4(c)(8), but must secure prior approval of the
Board before doing so (HOLA section 10(b)(2)(F)(i), (b)(4)(A)).
C. DEPOSITORY INSTITUTION SUBSIDIARIES
1. Financial Subsidiaries
a. 12 U.S.C. 24a(a)(2) sets forth conditions for holding a financial
subsidiary.
i
ii
iii
iv
v
Depository institution and depository institution affiliates must be well

managed and well capitalized.
No requirement that BHC of depository institution be well capitalized or
well managed.
Asset limit to lesser of 45% of assets of parent bank or $50 billion.
Rating requirement ( 24a(a)(3) must be in first or second 50 insured
banks in size, and have outstanding rated debt section 939A
modification of ratings requirement.
Deduction from capital of national bank (24a(c)).
b. Statute appears to require prior approval of Comptroller before

bank can form a financial subsidiary or engage in new activities
( 24a(a)(2)(F)).
25

c. Regulations require only notice to Comptroller.
i
ii
iii
At any time, bank may file a certification with Comptroller that it meets
statutory requirements to have a FinSub (12 C.F.R. 5.39(i)(1)).
Bank must provide notice of actually acquiring or forming FinSub at the
time it acquires or forms the subsidiary (12 C.F.R. 5.39(i)(1)).
When new activity is undertaken, FinSub is required only to provide
notice to the Comptroller, under the rules applicable to operating
subsidiaries.
2. Operating Subsidiaries
a. Comptrollers regulations set forth a laundry list of activities
permissible for OpSubs (12 C.F.R. 5.34(e)(5)(v)).
b. Regulations required only 10 days subsequent notice of forming
OpSub or engaging in new activity, if activities are on the
laundry list of activities permissible for OpSubs (12 C.F.R.
5.34(e)(5)(i)).
c. If OpSub is to engage in activity that is permissible but not on
laundry list of activities permissible for OpSubs, parent bank
must file application for prior approval (12 C.F.R. 5.34(e)(5)
(ii)).
d. If bank forms a new OpSub or engages newly in an activity in
one OpSub, and the activity has been approved previously for a
separate OpSub, neither notice nor application for approval need
be filed (12 C.F.R. 5.34(e)(5)(v)).
3. Subsidiary Organizations of Savings Associations
D. FINANCIAL COMPANIES UNDER DODD-FRANK
1. Financial companies come under Dodd-Frank when designated by the
FSOC
2. FSOC makes one of two determinations (113(a)(1))
a. Material financial distress at the US NBFC could pose a threat
to the financial stability of the Untied States
b. Nature, scope, size, scale, concentration, interconnectedness,
or mix of the activities . . . could pose a threat to the financial
stability of the Untied States
c. Section 113(a)(2) lists considerations FSOC is to take into
account
3. FSOC composition and procedure
a. 10 members from 8 agencies, plus insurance appointment,
plus Treasury Secretary
b. Treasury Secretary is Chair of FSOC
c. Acts by 2/3 vote (so 7-3 if all present and voting)
d. Majority must include Chair (Treasury Secy), so in effect
Treasury has a veto over anything FSOC does
26

e. Difference between Dodd-Frank and GLBA resolution of
Treasury/Board competition
4. To date, no designations
a. Slow start for FSOC/Title I
b. Companies resist being designated
c. 3 companies were first to be

designated, in June-July 2013
i AIG and GE Capital did not protest
designation
ii Prudential Financial Corp. did
oppose proposed designation, but
Board rejected its appeal, and Pru
did not seek judicial review
IV.
POWERS OF BANKING INSTITUTIONS
27

A. NATIONAL BANKS: BUSINESS OF BANKING
1. Structure of statutory definition (12 U.S.C. 24(Seventh))
a. Two part description: business of banking (general description
of powers), and limitational language following it
b. Limitational language is part of Glass-Steagall Act ( 16 of
Banking Act of 1933)
c. Limitational language not repealed by GLBA
d. Business of banking language is two-part
i
ii
iii
5 enumerated powers
Necessary and incidental language
Question whether incidental means to business of banking, or more
narrowly to one of enumerated powers
2. Origin and history of business of banking language

a. Originated in New York free banking legislation of 1838
b. Language imported with little change into NBA (1863)
c. Decision in Curtis v. Leavitt (1857) by NY Court of Appeals took
broad view of powers clause in case involving question
whether banks could borrow (apart from deposits)
d. U.S. Supreme Court in early years of NBA (1867-90) made
ambiguous statements about NBA powers language
e. Beginning in 1890s, Supreme Court consistently held that
national banks had only the powers expressly given by statute,
and such incidental powers as were strictly necessary to the
express powers
f.
After World War II, expansion of international trade brought focus

on questions whether national banks could issue letters of credit
(or guarantees).
i
ii
iii
Long simmering question under state banking laws, but never frontally
addressed by any Federal court
Dispute led to arguments for a broad reading of national bank
powers
Some articles took very crabbed view of Supreme Court precedent
suggesting a narrow view
g. Saxon Part 9 initiative of the 1960s

i
ii
iii
iv
v
James Saxon was President Kennedys Comptroller

Issued regulations as Part 9 of 12 CFR, allowing banks wide range of
new activities: insurance brokerage; securities brokerage; mutual fund
sponsorship; data processing; courier activity; travel agencies; leasing;
standby letters of credit
Initiative inspired in 1962, when adoption of investment tax credit led
to proliferation of tax-flavored leasing as a substitute for lending
Competitors challenged Comptrollers actions in Court under Warren
Courts expanded concepts of standing, including competitors standing
Competitor industries won every case in the 1960s including
Supreme Court decision striking down mutual fund powers (under
Glass-Steagall prong of statutory definition
28

vi
In 1970s, leasing and standby letter of credit powers upheld by courts

of appeals
3. Arnold Tours decision is leading statement of judicial stance of the era

a. Invalidated travel agency power recognized by Comptroller
b. Rejected notion of broad view of business of banking as
authorizing bank powers unconnected to enumerated powers
c. View was intermediate between broad and narrow views
recognized room for incidental powers beyond those
enumerated, but said new powers must have connection to one
of the enumerated powers
d. Comptroller views decision as articulating the narrow view
4. Comptrollers position in the 1980s
a. Renewed expansive view
b. Most significant innovation concerned Glass-Steagall prong and
bank-eligible securities, and new derivatives (mainly swaps):
Comptroller ruled that it was within the business of banking to
deal in any derivatives if the underlying property was bankeligible
c. Led to the emergence of banks as central players in the swaps
markets as market makers, dealers, traders, counterparties,
etc.
d. \Later view expanded with respect to equity, commodity, and
credit default swaps, to allow bank activity even where
underlying property was not bank eligible
e. Broad view accepted, but unclear what the parameters of
standard were
f.
Best statement is in Interpretive Letter 494

i
ii
iii
iv
whether the activity is similar to the types of activities permitted by

the Act and not expressly prohibited;
whether the activity is a generally adopted method of banks or one
in which banks have traditionally engaged;
whether the activity in question has grown out of the business needs
of the country, or would promote the convenience of the banks
business for itself or for its customers;
whether the activity is usual and useful to the bank, or is expected of
the bank, in performing its functions in the current competitive climate.
5. VALIC decision of Supreme Court (1995) resolved matter in favor of

Comptroller/banks, holding what constitutes business of banking is
within the discretion of the Comptroller under Chevron decision.
a. Comptrollers discretion must be exercise within reasonable
bounds
b. Decision upheld authority of national banks to broker (market)
annuity contracts
29

c. Key footnote said travel agency business would be outside
reasonable bounds
B. NATIONAL BANKS: GLASS-STEAGALL AND INVESTMENT SECURITIES
1. Statutory language imposes three sets of restrictions on national banks
with respect to investment securities
a. Underwriting
b. Dealing (i.e., market making)
c. Holding as investment (obligations of any one issuer limited to
10% of the banks capital)
2. Statute then relaxes restrictions as to three categories of securities
a. U.S. government obligations and general obligations of state and
local governments are generally exempt from all 3 restrictions
b. Obligations of certain international multilateral lending facilities,
e.g., the World Bank, Asian Development Bank, etc., are exempt
from the underwriting and dealing restrictions, but subject to the
10% limit on bank holdings
c. Other obligations (including foreign government obligations) are
subject to all 3 limitations
3. 1984 statute added another category, which now includes certain
mortgage securities and Small Business Investment Company
securities, which are the obverse of the second category they are
subject to the underwriting and dealing restrictions, but free of the
10% limitation
4. Regulations (12 C.F.R 1.2-1.3) define these as types of securities
a. Type I are free of all 3 restrictions (mostly government
securities).
b. Type II may be underwritten and dealt, but are subject to the
10% limitation.
c. Type III are other categories, subject to all 3 restrictions.
d. Type IV are the obligations subject to the underwriting-dealing
restriction, but free of the 10% limitation.
e. Regulations define a Type V, comprising pass-through
obligations, backed by any of the other 4 categories, which are
subject to whatever restrictions apply to the obligations backing
them; in addition, these obligations are subject to a limitation in
total of 25% of banks capital.
5. Under the regulations, all holdings (including Type III) must be
investment grade and marketable, as defined by the regulations.
a. Prior to Dodd-Frank, regulations defined investsment grade
with respect to ratings of national statistical rating organizations
(NSROs).
30

b. Section 939A of Dodd-Frank directed all agencies to review their
regulations, and eliminate any references to or dependency on
NSRO ratings.
c. Comptroller amended regulations to replace ratings-based
determination with subjective standard.
d. New standard imposes compliance costs, especially hard on
smaller banks, who must now observe detailed guidance on
due diligence to be performed with respect to all obligations to
determine whether they are investment grade, as newly
defined.
6. Statute also states flatly that except as otherwise provided no
national bank may hold stock in any corporation.
a. Statute otherwise provides for things like community
development corporations and small business investment
corporations (permissible nonfinancial equity investments).
b. Comptrollers controversial interpretation is that this limitation
applies only to stock held for investment.
c. This latter reading underlies the Comptrollers view, held
consistently for 50 years, that banks may own stock in operating
subsidiaries, formed to perform separately activities the bank
may engage in.
d. Supreme Court dissent in Waters v. Wachovia Corp. noted that
Supreme Court had never upheld the Comptrollers view, that
Congress in GLBA had limited that view, and suggested that the
dissenters, at least, might not uphold the power.
e. Comptroller also has controversial view of banks authority to
hold stock (investment asset) as hedge to position of the bank
with respect to equity swap positions taken by the bank as
market maker.
C. BANK HOLDING COMPANIES: CLOSELY RELATED TO BANKING
1. Section 4(a)(1) of the BHCA generally prohibits a BHC from acquiring
control of any company that is not a bank, and section 4(a)(2) prohibits
BHCs from engaging in any activities other than managing or
controlling banks, and other subsidiaries authorized by the BHCA, or
activities permitted by section 4(c)(8).
2. Section 4(c)(8) permits BHCs to acquire shares of a company the
activities of which had been determined by the Board by regulation or
order under this paragraph as of the day before November 12, 1999, to
be so closely related to banking as to be a proper incident thereto.
3. November 12, 1999 is effective date of GLBA
4. Prior to GLBA, Board authorized new nonbanking, financial activities
under this power, by regulation (rulemaking) or order (adjudication).
31

5. GLBA, as language indicates, freezes Boards power to authorize new
activities to BHC which are not FHCs.
a. FHCs may engage in any (c)(8) activity, because any activities
approved pre-GLBA are expressly included on the 4(k)(4)
laundry list (4(k)(4)(G)).
b. Non-FHC BHCs, including new BHCs, may engage in these
activities they are thus not grandfathered, per se.
c. No new activities can be approved after GLBA; for activities not
approved by 11/12/99, approval must be as financial in nature
or incidental or complementary, under section 4(k)(1).
6. Question arises as to securities activities for non-FHC BHCs.
a. Under pre-GLBA law, 12 U.S.C. 377 prohibited banks from
affiliating with companies engaged principally in securities
activities.
i
ii
iii
Provision was section 20 of Banking Act of 1933, part of Glass-Steagall

Act.
Provision was repealed by GLBA.
This was provision that constituted repeal of Glass-Steagall by GLBA
but, as noted above, section 16 (12 U.S.C 24(Seventh)) remains in
effect.
b. Beginning in early 1980s, Board permitted affiliates of banks to

underwrite certain types of bank-like paper (e.g., commercial
paper, mortgage securities) in brother-sister affiliates,
subsidiaries of the banks BHC.
i
ii
iii
iv
v
Originally, activity was limited to 5% of revenue of subsidiary Board

interpreted this to mean company was not engaged principally in
securities business.
Key element in computing 5% limitation was whether to include bankeligible securities those, like Treasury securities, that banks are
permitted to hold under section 16 in the denominator.
Over dissent of Paul Volcker, then Board Chair, the Board held that
bank-eligible securities could be computed.
Rare for Board to act over dissent of a Chair.
Result was that BHCs could stuff section 20 subsidiaries with assets
which otherwise would be held by the bank to comply with the hokey
engaged principally interpretation.
c. Board successively liberalized rules governing section 20

subsidiaries.
i
ii
iii
iv
By 1989, had expanded securities firms could underwrite to include

most stocks and bonds.
In 1990, increased tolerable percentage of revenues to 10%
In 1997, increased tolerable percentage of revenues to 25%
Latter move was response to failure of 104th Congress (first Republicancontrolled Congress in 40 years) to enact comprehensive legislation
permitting bank affiliations with insurance companies and securities
firms.
Increase to 25%, coupled with rule counting bank-eligible securities,
in practical effect eliminated any real barrier to affiliations between
banks and securities firms; thus, effective elimination of the GlassSteagall wall was accomplished almost entirely by administrative
action, and GLBA merely confirmed a fait accompli.
32

d. After GLBA, question arises whether non-FHC BHCs can exercise
the securities powers recognized pre-GLBA.
i
ii
iii
iv
Section 4(c)(8) seems to say so says BHCs can continue to do what

they could do as of GLBA effective date.
But section 20, the basis of the authority, or at least of the limitations
on it, is no longer law.
Boards position is that non-FHC BHCs can do only what they could do
before GLBA, including the restrictions.
Question of little practical import, since most BHCs that seek securities
powers qualify as FHCs to be free of superfluous restrictions.
D. FINANCIAL HOLDING COMPANIES: FINANCIAL IN NATURE

1. Section 4(k)(1) permits FHCs to engage in any activity, or acquire
shares of a company engaged in, two categories.
a. Activities that are financial in nature or incidental to a financial
activity
b. Activities that are complementary to a financial activity, which
do not pose a substantial risk to the safety or soundness of
depository institutions or the financial system generally.
2. Statute provides a procedure for recognizing new activities as
a. Board may consider proposals, but must notify and consult with
Treasury concerning them (section 4(k)(2)).
b. Similarly, any proposal raised to or by Treasury must be sent to
Board for review.
c. Board makes final decision in either case (section 4(k)(2)(B)(ii)).
d. Treasury here acts through Assistant Secretary (Financial
Institutions), a policy branch of the Office of the Secretary, NOT
the Comptroller.
e. Statute lists factors to be considered (competitive and
technological) in section 4(k)(3).
f.
Treasury consultation not involved if proposed activity is only

complementary to financial activity, because only FHCs and
FHC subsidiaries may engage in those activities; financial
subsidiaries may not
3. Section 4(k)(5)(B) directs the Board to consider whether certain

activities are financial in nature.
a. Lending, exchanging, transferring, etc. financial assets other
than money or securities this means, mostly, commodities
b. Providing any device or instrumentality for transferring money
or other financial assets this means things like clearinghouse
functions
c. Arranging, effecting, or facilitating financial transactions for the
account of third parties
33

4. Section 4(k)(4) sets forth a laundry list of activities considered
a. List includes insurance, securities, mutual funds, including
brokerage and underwriting of them the activities banks
sought for 25 years leading up to GLBA to be permitted to
undertake/
b. MEMORIZE laundry list
c. Also permits merchant banking (sections 4(k)(4)(H)-(I)
(investments in nonfinancial firms), subject to restrictions
i
ii
iii
iv
Must be through a securities or insurance affiliate

Objective must be to hold for ultimate resale at a profit
Must be intended to be held for limited period of time (10-15 years
under regulations)
FHC must not routinely manage or operate entity regulations specify
degree of involvement FHC officers may have in management of
merchant banking (private equity) arrangement
d. List does not include: commodities activity; real estate

development
5. Board/Treasury are not active in determining activities not on the
laundry list to be either financial in nature, or incidental or
complementary to them.
a. Bank of America asked Board shortly after GLBA to determine
both real estate brokerage and real estate development were
b. Board/Treasury never acted on the proposal.
c. Apart from limited rulings (acting as a finder, principally
operating a website with links) was permitted, but not much
more.
d. Post-financial crisis, agencies are not enthusiastic about
expanding nonbanking activities of financial institutions.
e. Terms financial in nature, incidental, and complementary
are left largely undefined
E. FINANCIAL SUBSIDIARIES: FINANCIAL IN NATURE
1. Touchstone of financial subsidiary powers is same as for FHCs
activities financial in nature but there are some differences defined
by the statute.
2. Statutory language permits activities financial in nature or incidental
to a financial activity, 12 U.S.C. 24a(a)(2)(A)(i), but does not include
reference to activity complementary to a financial activity.
3. Statutory language permits finsubs to engage in activities that are
permitted for national banks to engage in directly ( 24a(a)(2)(A)(ii)).
34

a. For the most part, bank powers are narrower than BHC or FHC
powers
b. In some instances, however (notably data processing powers),
Comptroller has recognized broader powers for banks than
Board has for BHCs.
c. In these limited instances, financial subsidiaries have broader
powers than FHCs or FHC nonbank subsidiaries.
4. Certain powers are prohibited to financial subsidiaries.
a. Merchant banking limited to FHCs ( 24a(a)(2)(B)(iii)) (and
widely undertaken by FHCs)
b. Insurance underwriting, including underwriting annuities (
24a(a)(2)(B)(i)) (permitted to FHCs, but not widely undertaken
by them)
c. Real estate development and real estate investment ( 24a(a)(2)
(B)(ii)) (still not allowed to FHCs either, but if allowed to FHCs,
will still not be available to Finsubs)
V.
REGULATION OF BANK LENDING AND INVESTMENT ACTIVITIES
35

A. USURY RESTRIC TIONS ( 85)
1. 12 U.S.C. 85 permits national banks to charge the rate allowed by
the laws of the State . . . where the bank is located, or, if greater, 1%
in excess of the discount rate on 90-day commercial paper in effect at
the Federal Reserve bank for the district where the bank is situated.
2. Tiffany National Bank decision (1875) holds that if State law provides a
usury rate applicable to banks that is different from the rate applicable
to other lenders, national banks may charge whichever rate is greater
the so-called most favored lender principle: National banks have
been National favorites.
3. Marquette National Bank decision holds that bank is located in one
state and borrower in another (credit card solicitation), the governing
rate is that where the bank is physically located that is the state
where the bank is located for purposes of 85.
a. Practical effect of decision is to greatly limit significance of usury
laws, whether Federal or State.
b. Decision is reason so many credit card companies and credit
card banks locate in high-usury rate, smaller states (e.g., South
Dakota, Nebraska, Delaware).
4. After the advent of interstate branching (1997), questions arose where
bank was located when bank had branches in multiple states.
a. Comptroller held bank was located where the loan transaction
occurred.
b. Comptroller ruled loan transaction occurred was based on 3
circumstances: where the loan was approved; where the
application was made; and where the funds were disbursed.
c. In practical effect, rulings made it easy for banks to determine
unilaterally where the loan took place.
d. Thus, under these rulings, even if, say, the borrower was a New
Jersey resident, and the bank had branches in Pennsylvania or
New Jersey, the bank could, by manipulating where the loan was
approved or disbursed, on its own make the loan take place in
Pennsylvania, and thus ensure that the Pennsylvania rate, not
the New Jersey rate, applied to the transaction.
B. LENDING (EXPOSURE) LIMITS ( 84)
36

1. 12 U.S.C. 84(a)(1) limits total loans and extensions of credit by a
national bank to a person not fully secured by collateral having a
market value at least equal to the amount of the loan may not exceed
15% of the capital and unimpaired surplus of the institution.
2. 12 U.S.C. 84(a)(2) limits total loans and extensions of credit by a
national bank to a person fully secured by readily marketable
collateral having a market value, as determined by reliable and
continuously available price quotations, at least equal to the amount
of the loan may not exceed 10% of the capital and unimpaired
surplus of the institution.
3. So, a 25% limit total.
4. Statute sets forth articulate definition of loans and extensions of
credit, and person.
a. Comptrollers regulations set forth common enterprise
standard, under which all loans used for the benefit of a person
in a common enterprise are aggregated, even if loans are made
to several nominal borrowers.
b. Regulation upheld and enforced in Del Junco v. Conover.
c. Del Junco v. Conover also required bank directors to indemnify
bank for any loss occurring on account of the unlawful loans.
i
ii
iii
iv
Decision was first under 1978 amendments to FDIA 8(b), which

authorizes regulators to require affirmative action to correct a
violation in connection with a cease and desist order.
Directors argued that they lacked scienter, but Comptroller and Court
rejected the argument.
In this respect Del Junco was not followed by Seventh Circuit in en banc
decision in Larrimore v. Comptroller, which limited reimbursement to
cases of unjust enrichment.
Del Junco ruling limited (or overruled) by Congress in FIRREA (1989), by
enactment of section 8(b)(6)(A), which limits monetary remedies in
connection with cease and desist orders to cases of either unjust
enrichment or reckless disregard.
5. Section 610 of Dodd-Frank added 84(b)(1)(C), to extend the lending

limits to cover exposures arising from repurchase agreements and
derivatives transactions.
C. PREEMPTION OF STATE LAW
37

1. Comptroller has taken aggressive position in recent years (3 decades)
in holding various state laws pre-empted when applied to national
banks.
a. De la Cuesta decision (of FHLBB, predecessor of OTS, which in
turn is predecessor of Comptroller as affects savings
associations) is early example: held California law prohibiting
due-on-sale clauses could be pre-empted by OTS regulation.
b. Signal decision in that it allowed state statutory law (enacted by
democratically elected legislatures) to be overridden by Federal
administrative regulation (promulgated by appointed officials).
2. Forms of pre-emption
a. Express pre-emption
b. Conflict (issue) pre-emption
c. Field (area) pre-emption
3. 2 controversial 2005 administrative rulings
a. Ruling pre-empting state real estate regulations, especially
regarding appraisals of residential real property
b. Ruling providing that Federal statute conferring exclusive
visitorial rights on Comptroller precludes state officials from
enforcing state consumer laws against national banks holds
state law to be enforced by Comptroller (invalidated in 2009 by
Supreme Court decision in Cuomo v. Clearinghouse, see below)
4. Watters v. Wachovia National Bank (2006)
a. Question concerned application of Michigan law requiring
registration of mortgage brokers to operating subsidiary of
national bank
b. Michigan law provided an exemption to the bank itself, but
required licensing of the subsidiary
c. 5-3 decision of Supreme Court sided with Comptroller and bank
and held the law was pre-empted as interfering with operation of
national bank
d. Dissent of Justice Stevens (joined by Chief Justice Roberts and
Justice Scalia) questioned validity of operating subsidiary
regulation of Comptroller, and held in any event the Michigan
requirements did not significantly interfere with operation of the
NBA.
e. Majority comprised three liberals (respect for Federal authority)
and two conservatives, Justices Alioto and Kennedy (respect for
corporate interests).
5. Cuomo v. Clearinghouse (2009)
38

a. Invalidated Comptrollers 2005 regulation holding Comptrollers
visitorial authority gives it exclusive power to enforce state
law against national banks.
b. 5-4 decision, with Justice Scalia writing the opinion of the Court
on behalf of himself and four liberals (anti-corporate decision)
(unusual grouping of Justices).
c. Only decision in last 30 years where Court has ruled against the
industry and Comptroller on regulatory (i.e., non-receivership)
matter.
D. TRANSACTIONS WITH AFFILIATES
1. Section 23A of the FRA (12 U.S.C. 371c) imposes four requirements.
a. Most important: limit on covered transactions with any single
affiliate to 10% of unimpaired capital and surplus; and Limit on
total of covered transactions with all affiliates to 20% of
unimpaired capital and surplus ( 23A(a)(1))
b.
Requirement that covered transactions between member bank

and affiliate be on terms and conditions consistent with safe and
sound banking practice ( 23A(a)(4))
c. Prohibition of purchase of low quality asset from affiliate (

23A(a)(3))
d. Collateral requirement for some (not all) covered transactions (
23A(c))
2. Covered transactions
a. Defined by 23A(b)(7))
b. Loans or extension of credit to affiliate
c. Purchase of investment securities of affiliate
d. Purchase of assets from affiliate
e. Acceptance of affiliates securities as collateral for loan or
extension of credit to any person
f.
Letter of credit, acceptance, guarantee on behalf of affiliate
g. Dodd-Frank adds repurchase agreements, etc., and derivatives

transactions to category of covered transactions ( 23A(b)(7)(F)(G)
i
ii
Parallels amendment to lending limits

New section 23A(f)(4) allows netting arrangements in computation of
the 10% and 20% limits.
3. Affiliate
39

a. Generally, any company that controls the member bank or is
controlled by a company that controls the member bank (
23A(b)(1)(A))
b. Includes a bank subsidiary of the bank ( 23A(b)(1)(B)), but
excludes any other subsidiary ( 23A(b)(2))
i
iii
iv
But see below with reference to financial subsidiaries

Also excludes any subsidiary of any other (brother-sister) member
bank
But bank subsidiary of a brother-sister bank is an affiliate
c. Brother-sister banks (member banks separately held as

subsidiaries of the same BHC) are affiliates, but see below re
exemption of transactions
d. Control definition parallel BHCA definition ( 23A(b)(3)), with
slight differences
i
ii
Special rule ( 23A(b)(11)) creates rebuttable presumption of control

for merchant banking entities of which a company holds 15% or more
of equity capital
Responsibility of company of shareholder to rebut presumption
e. Special rules for companies controlled by trusts, interlocking

directorates, etc. ( 23A(b)(1)(C)-(D)), and authority on Board to
determine any company to be an affiliate ( 23A(b)(1)(E))
f.
Exclusions for special purpose companies, e.g., safe deposit box

companies, or realty holding companies ( 23A(b)(2)(B)-(E))
4. Exemptions for interbank transactions

a. Applies to transactions between a bank subsidiary or bank
parent or brother-sister bank if 80%-of-voting shares control (by
parent or subsidiary) or common control (by BHC of both
brother-sister banks)
b. Exempt from collateral requirements and percentage limitations
only low-quality asset and safety-and-soundness rules apply
a. Subject to the low-quality asset rule, purchasing loans from bank
affiliates ( 23A(d)(6))
c. Credit for uncollected items and interbank deposits also exempt
i
ii
Still subject to safety-and-soundness rule

Exemption without regard to 80%-of-voting stock rule
d. Interbank transactions are less significant than they were before

effective date of Riegle-Neal, because BHC structures with
multiple banks are fewer than they were before interstate
branching was allowed
5. Other exemptions
a. Transactions secured by government or government-guaranteed
obligations, or by segregated deposit account
40

b. Purchase of assets with readily identifiable and publicly available
market quotations, subject to the low-quality asset rule,
purchasing loans ( 23A(d)(6))
c. Transactions in shares of special purpose companies ( 23A(d)
(5), BHCA 4(c)(1))
d. Agencies have authority (important) to exempt transaction if in
the public interest and consistent with the purposes of section
23A
i
ii
iii
iv
v
vi
vii
Prior to Dodd-Frank, exemption authority rested exclusively with Board.

In financial crisis, Board made controversial use of exemption
authority, esp. with respect to Citibank and Bank of America/Merrill
Lynch, to enable BHCs to shore up their failing securities affiliates
Dodd-Frank limited Boards authority by requiring notification to FDIC,
and authorizing FDIC within 60 days to object to exemption on grounds
that it presents unacceptable risk to the DIF
FDIC objection is apparently final
In addition, Congress extended authority to make exemptions to other
agencies Comptroller in the case of national banks and Federal
savings associations, FDIC jointly with Board in the case of nonmember
banks
Comptroller determination subject to same 60-day FDIC review as
Board determination
Board apparently retains authority to act on its own, subject to
notification to FDIC, in the case of any DI
6. Financial subsidiaries
a. Financial subsidiaries are treated as affiliates ( 23A(e)(2))
b. Prior to Dodd-Frank, finsubs were exempted from the 10% rule,
but subject to the 20% rule
c. Dodd-Frank amended section 23A(e) to make Finsubs subject to
both rules
d. Investment in securities of Finsub by a bank affiliate are treated
as invested in the parent bank, and reinvested in the Finsub (
23A(e)(4)(A))
e. Loans to Finsub by a bank affiliate are treated as lent to the
parent bank, and relent in the Finsub ( 23A(e)(4)(B))
7. Low-quality asset rule
a. Low-quality asset defined by 23A(b)(10)
b. Asset classified as substandard, doubtful, or loss, or treated
as other loans especially mentioned in most recent report of
examination of affiliate
c. Asset in nonaccrual status
d. Asset on which principal or interest payments are more than 30
days past due
e. Asset renegotiated or compromised because of deteriorating
financial condition of the obligor
41

f.
Most of these rules would apply to interbank transactions; note

that the exemption for 80% commonly owned banks does not
extend to the low-quality asset rule
g. Also note observation above on the reduced frequency of

interbank transactions
h. Low-quality asset may not be used to satisfy the collateral
requirement to any extent ( 23A(c)(3))
8. Collateral rule
a. Applies to any loan, extension of credit, guarantee, acceptance,
letter of credit, and, after Dodd-Frank, securities lending
transaction or derivative transaction.
b. Requirement is 100% if collateral is U.S. government obligations
or government-guaranteed obligation; notes, etc., eligible for
rediscount at the Federal Reserve; or segregated and earmarked
deposit account.
c. Requirement is 110% if collateral is obligations of a state or local
government (U.S.);
d. Requirement is 120Tif collateral is other debt instruments or
receivables.
e. Requirement is 130% if collateral is stock, leases, or other
personal property.
f.
Collateral level must be met at the time of the transaction, and

maintained throughout the life of the outstanding obligation of
the affiliate.
9. Section 23B (12 U.S.C. 371c-1)

a. Applies to 5 categories of transactions (section 23B(2))
i
ii
iii
iv
v
vi
Covered transactions, as defined in section 23A, including exemptions

Sale of assets to affiliate
Payment of money or furnishing services to affiliate
Transactions in which affiliate acts as broker or receives a fee
Transactions with third party in which affiliate has a financial interest,
or if affiliate is participant in the transaction
Transactions deemed to be with an affiliate if proceeds of transactions
are transferred to or used for the benefit of affiliate.
b. Requires transactions to be on terms comparable to those

involving unaffiliated entity, or, if there are no such comparable
transactions, which would in good faith be offered to an
unaffiliated party
c. Three other prohibitions
i
Purchase of assets from an affiliate as a fiduciary, unless permitted by

trust instrument, court order, or the law of the jurisdiction governing
the trust.
42

ii
iii
Purchase of securities of which affiliate is the underwriting, during the

period of the underwriting, except with express approval of bank board
of directors on a determination that purchase is in best interests of the
bank without regard to the fact that the affiliate is principal
underwriter.
No advertising or agreement stating or suggesting that bank is in
any way: responsible for the obligations of the affiliate (section
23B(c).
d. Affiliate has same meaning as in section 23A, except that no

bank is included as an affiliate and thus no interbank
transactions are subject to the rule (section 23B(d)(1)).
e. Board has authority to make exemptions
i
ii
iii
VI.
Prior to Dodd-Frank, authority was exclusive to the Board.

Dodd-Frank amended provision to require notice to FDIC and authority
of FDIC to block exemption within a 60-day period
Dodd-Frank left section 23B exemption authority with the Board,
regardless of identity of bank involved; no authority in Comptroller of
joint authority with FDIC comparable to that created under section 23B.
DEPOSITS AND DEPOSIT INSURANCE
43

A. INSURABLE DEPOSITS
1. Section 3(l) of the FDIA defines deposit as the unpaid balance of
money or its equivalent received or held by a bank in the usual course
of business and for which it has given or is obligated to give credit,
either conditionally or unconditionally, to a commercial . . . account, or
which is evidenced by . . . a letter of credit or a traveler's check on
which the bank is primarily liable: Provided, That, without limiting the
generality of the term 'money or its equivalent,' any such account or
instrument must be regarded as evidencing the receipt of the
equivalent of money when credited or issued in exchange for checks or
drafts or for a promissory note upon which the person obtaining any
such credit or instrument is primarily or secondarily liable . .
2. Philadelphia Gear decision of the Supreme Court (1986) took narrow
view of definition when question was whether a standby letter of credit
backed by a contingent promissory note constituted a deposit.
a. Justice OConnors opinion for the Court cited legislative history
to find that Congress was concerned with protecting the hard
earnings of depositors and found that the contingent
promissory note did not represent hard earnings.
b. Dissent (Justices Marshall, Blackmun, Rehnquist) argued that
plain language of statute appeared to make the letter of credit a
deposit.
c. Issue was raised because there is doubt about the provability
of banks obligation under a standby letter of credit in
bankruptcy claims are required to be fixed at the time the
bankruptcy is instituted, and if the SBLOC, outstanding at the
time bankruptcy is instituted but payable only upon events
occurring subsequently, there is split of authority whether it is to
be regarded as provable.
3. Definition plainly covers bank liabilities that are not simple deposit
liabilities including, e.g., outstanding cashiers or travelers checks,
most commercial letters of credit, etc.
4. Current deposit insurance limit is $250,000.
a. Limits applies to aggregate deposits in a particular institution;
there is no limit per person, so anyone can have a series of
$250,000 deposits in multiple institutions, with no limit on the
aggregate ( 11(a)(1)(C), (E)).
44

b. After 2010, amount is adjusted for inflation at 5-year intervals
(rounded to the nearest $10,000) ( 11(a)(1)(F))
c. Special rules for government depositors, employee plans.
5. Some question about the significance of deposit limit.
a. Generally, institutions are resolved by purchase and
assumption transactions, whereunder a successor institution
takes over most or all deposit liabilities of a failing bank,
ordinarily in exchange for a payment from the FDIC which is less
than the FDIC would have to pay in a liquidation of the
institution.
b. The successor institution is interested in the acquired deposit
base as a source of customers for loans and other products, and
is likely to be especially interested in the larger deposits.
c. For this reason, depositors rarely lose money, even on uninsured
deposits.
d. In addition, in October 2008, at the height of the financial crisis,
to prevent bank runs, the FDIC temporarily insured deposits in
excess of the maximum, under the Temporary Liquidity
Guarantee Program.
e. Source of authority for FDICs action was the open bank
assistance provision of section 13(g)(4) of the FDIA, 12 U.S.C.
1823(g)(4).
B. FUNDING OF DEPOSIT INSURANCE
1. Funding of deposit insurance has changed over time; little need to
know historical details; current rules derive from 2006 legislations, as
amended by the Emergency Economic Stabilization Act of 2008 and
Dodd-Frank.
a. Deposit insurance for banks first adopted by Banking Act of
1933 (as section 12A of the Federal Reserve Act; amended in
1935, and provisions moved to 12 U.S.C. 1811 et seq. and
renamed the Federal Deposit Insurance Act in 1950
b. National Housing Act of 1934 adopted deposit insurance for
thrifts, funded through the Federal Savings and Loan Insurance
Corporation (FSLIC), administered by the Federal Home Loan
Bank Board (FHLBB)
c. FIRREA repealed the National Housing Act, and abolished both
the FHLBB and FSLIC.
i
Unified the deposit insurance law, making the FDIA (extensively

amended by FIRREA) applicable to thrifts as well as banks.
45

ii
iii
iv
v
Made insurance for both funded under the FDIC, but created two
separate funds the Bank Insurance Fund (BIF) and the Savings
Association Insurance Fund (SAIF)
Insurance funds were to be capitalized to the extent of 1.25% of
insurable deposits.
Because of difficulties in the thrift industry, SAIF premiums were much
higher than BIF premiums, leading to incentives for thrifts to convert
to bank charters during the early and mid-1990s.
Stabilization in the banking industry in the early 1990s led to
overfunding of the BIF, so that most bank insurance premiums were
reduced to zero by the late 1990s, and remained there for some time.
d. 2006 legislation abolished the separate SAIF and BIF funds and
combined them under the unified Deposit Insurance Fund (DIF).
i
ii
Legislation revised method of assessing deposit insurance premiums

Further amendments made by EESA (2008) and Dodd-Frank.
2. DIF is maintained at level determined by a designated reserve ratio,

multiplied by estimated insured deposits.
a. Ratio established each calendar year, by FDIC rulemaking
(notice and comment) before beginning of the year ( 1(b)(3)
(A)).
b. Minimum ratio is 1.35% ( 7(b)(3)(B)).
i
ii
iii
If ratio falls below minimum, FDIC is to establish a DIF restoration plan

( 7(b)(3)(E)).
Must be restored within 8 years.
FDIC has authority to waive assessments for banks with consolidated
assets less than $10 billion.
c. Maximum amount is 1.5%.

i
ii
iii
iv
If amount exceeds this amount, FDIC may pay dividends to insured

institutions to refund the excess.
FDIC has sole discretion to limit any such dividends.
Method of calculation and payment to be determined by rulemaking.
Not terribly operative right now: as a consequence of financial crisis,
DIF is currently underfunded, and subject to a restoration plan to be
completed by 2020.
d. Section 7(e)(3) provides for credits based on assessments paid

before 1996.
i
ii
Adopted so that new institutions cant free ride on payments made

by longstanding banks.
May be suspended under a restoration plan, up to .03% (3/10,000) of
institutions assessment base.
e. Dodd Frank 331(b) directs FDIC to amend its regulations to

redefine the assessment base, which now is deposits as the
average consolidated total assets of the insured depository
institution during the assessment period, minus average
tangible equity.
i
ii
Imposes penalty on nondeposit funding by banks.

Seen as more realistic in light of protection given deposits in excess of
the maximum insured amounts and nondepositor creditors in
resolution process.
46

iii
iv
Generally favors small banks, which rely less heavily than large banks
on nondeposit funding.
Large banks complain about this.
3. DIF borrowing authority

a. Under 12 U.S.C. 1824, DIF has authority to borrow from the
Treasury, up to a limit of $100 billion.
i
ii
Limit was temporarily raised to $500 billion (to end of 2010) during
financial crisis.
Loans are to be repaid from assessments on the banks.
b. DIF may also borrow from Federal Financing Bank and from
Federal Home Loan Banks.
c. DIF may borrow from insured depository institutions, but only to
an extent repayable from future assessments.
C. RISK-BASED ASSESSMENTS
1. Instituted in 1991, under FDICIA, directed by 7(b)(1)(A)
2. Under regulations, institutions risk profile is determined by two
principal factors
a. Institutions composite CAMELS rating on the last exam
b. Institutions capital adequacy ratio
3. Doolin Savings decision suggests limited power of institution to secure
review of its assessment rating
a. Doolin contested its assessment by refusing to pay its insurance
premium
b. FDIC responded by terminating Doolins insured status under
8(a).
c. Fourth Circuit upheld termination
i
ii
iii
PART III.
VII.
Rejected Doolins challenge that FDIC was required by statute to rely

on objective, rather than subjective, criteria
Rejected Doolins argument that it was required either by statute or by
the Constitution to grant Doolin a hearing in connection with the
determination of its risk statuts
Rejected argument that FDIC was biased
STABILITY OF FINANCIAL ORGANIZATIONS
CAPITAL STANDARDS
47

A. BACKGROUND AND STATUTORY BASIS
1. Capital adequacy rules now regarded as the central element in bank
regulation, in protecting the safety and soundness of institutions.
2. Capital adequacy standards were not imposed historically in the United
States, they first came into usage in the early 1980s.
3. In First National Bank of Bellaire, Court of Appeals rejected
Comptrollers effort to treat as an unsafe and unsound practice an
institutions failure to meet an industrywide capital standard.
4. Congress responded, in the International Lending Standards Act of
1984.
a. 12 U.S.C. 3907(a) authorizes all bank regulatory agencies to
adopt capital standards.
b. 12 U.S.C. 3907(b) provides that failure to meet capital
standards may be treated by agencies as an unsafe and
unsound practice, subject to cease and desist proceedings under
section 8(b) of the FDIA, 12 U.S.C. 1818(b).
c. ILSA was Congress first opportunity to reverse the ruling in First
National Bank of Bellaire.
d. Consequence is confusing, because it means that statutory
authorization for what is now the central element of regulations
does not appear in the major regulatory statutes (NBA, FRA,
FDIA, and BHCA), but rather in a collateral provision of the law
5. Subsequent statutes fortify the role and statutory authorization of
capital standards.
a. FIRREA explicitly requires the imposition of 3 kinds of capital
standards on thrifts. (12 U.S.C. 1464(t)).
i
ii
iii
Leverage limits
Risk-based capital requirements
Tangible capital requirement
b. Prompt corrective action provisions adopted by FIRREA require

agencies to adopt risk-weighted standards and leverage
standards, but explicitly create authority to abandon either if
agencies determine they are no longer appropriate
c. Dodd-Frank 616 amends the BHCA (12 U.S.C,. 1844(b)), the
SLHCA (12 U.S.C. 1467a(g)(1)), and ILSA ( 3907(a)(1)) to
provide that capital standards adopted should be
countercyclical, an authority required by Basel III, as described
below.
48

d. Dodd-Frank 125 and 165, 12 U.S.C. 5325, 5365 expressly
require leverage and risk-based standards to be imposed as
prudential standards on $50 billion BHCs and supervised
NBFCs
e. Dodd-Frank 171, 12 U.S.C. 5371 expressly requires
leverage and risk-based standards to be imposed as prudential
standards on all DIs and DIHCs
B. EVOLUTION OF THE CAPITAL STANDARDS
1. Prior to late 1980s, earliest capital standards were primitive leverage
standards.
a. Risk-weighted standards originated in Europe
b. U.S. has retained leverage standards continuously even after the
adoption of risk-weighted rules
2. Basel Committee on Bank Supervision (BCBS)
a. Located in Basel, Switzerland
b. Founded in 1975 as a committee of the Bank for International
Settlements (BIS)
c. Originally founded by a Group of 10, now administered by a
considerably larger group
d. Recommendations are not binding law, but are highly respected
and regarded as authoritative
e. Nevertheless, Committees formulation is adapted by each
country under the countrys domestic law
3. Development of Basel I (1985-89)
a. First U.S. regulations defining risk-weighted standards were
developed bilaterally between the Fed and the Bank of England
(United Kingdom) in 1986.
b. These were shortly thereafter supplemented by proposed
regulations reflecting the multilateral agreement effected by the
BCBS.
c. Original Basel I rules were intended only for large, internationally
active banks.
d. U.S. regulatory officials nevertheless imposed those standards
on all institutions.
4. Elaboration of Basel I (1989-98)
a. Three major areas of bank activity were only emerging at the
time Basel I was finalized, and were only very incompletely
addressed by Basel I.
49

i
ii
iii
Swaps (derivatives)
Securitization
Proprietary trading
b. Basel I also was self-consciously limited to measuring credit risk

i.e., the risk a bank would not be repaid by an obligor, and left
other types of distinguishable risks out
i
ii
iii
iv
v
vi
vii
viii
Operational riskj
Interest rate risk
Market risk
Concentration risk
Liquidity risk
Compliance risk
Strategic risk
Reputational risk
c. Basel I addressed swaps in early 1990s.

i
ii
iii
iv
v
Basel I as originally promulgated addressed only simple forms of

swaps, interest rate and currency swaps.
Late 1980s and early 1990s saw emergence of more coimplicated
kinds, equity and commodity swaps.
First question addressed was whether to allow qualified netting
arrangements, for which BCBS finalized rules in 1992.
Then Committee finalized rules implicating current credit exposure
and potential future exposure calculations, including the tables set
forth in the current rules.
Most of this development was pioneered by Basel, as European
institutions were as involved with swaps as were American ones.
d. Basel I adopted market risk rules to cover proprietary trading.

i
ii
iii
Rules were first to use banks internal rating systems.

Rules predicated on value-at-risk (VaR) computations finalized by 1994.
Again, this work was done predominantly in Europe.
e. Securitization rules emerged mostly in the United States.

i
ii
iii
Agencies first addressed recourse and direct credit substitutes in

advance notices of rulemaking in 1994-95.
Over 5 years, developed rules which now appear in section 4 of the
appendices defining Basel I.
Rules depended heavily on rating of securities by national statistical
rating organizations (NSROs).
5. Basel II (1998-2006)
a. BCBS developed Basel II rules, incorporating Basel I and the
three major innovations, over eight-year period.
b. Semi-final document issued in 2004, final document in 2006.
c. Vastly more ramified and complex than Basel I.
d. Heavy reliance on internal ratings and NSRO ratings in final
rules.
i
ii
iii
Deregulatory in nature
Controversial when both proved decidedly unreliable
Discredit of Basel II after the financial crisis some blamed Basel II
rules for the fiasco.
50

e. Very slow and spotty implementation of rules in the United
States, as discussed below
6. Basel III (2009- )
a. Still in process of development
b. Strengthening of regulation after the financial crisis
C. LEVERAGE STANDARD
1. Leverage standard is ratio of Tier 1 capital to assets, as reflected on
the balance sheet
2. Minimum requirement is 3% or 4%
a. 3% if institutions has a composite CAMELS rating of 1 (highest
rating)
b. 4% otherwise
3. Leverage requirement is 5% to be well-capitalized (irrespective of
CAMELS rating)
4. Leverage requirement has remained the same for 25 years
5. No leverage requirement under Basel I or Basel II; Basel III will have
one
6. Despite all the development and complexity of risk-weighted rule, the
capital standard that is strictest for most institutions is the leverage
rule
D. BASEL I AND RISK-WEIGHTED RULES [SUPERSEDED MATERIALS IS IN

FUNNY TYPE)
1. Risk weighted asset ratio is ratio of capital to risk-weighted
assets
a. There are two ratios: Tier 1 ratio and total capital ratio
b. Only the numerator is different for the two: denominator is
risk-weighted assets in both
c. Minimum required ratio is 4% for Tier 1; 8% for total
d. To be well capitalized, required ratios are 6% and 10%
e. Total capital ratio cannot be more than twice Tier 1 ratio
f. Capital ratios are ordinarily tested on a consolidated basis
51
ii
(i.e., 80% or more owned subsidiaries are looked

through, and the parent is treated as owning the
assets, subject to the liabilities, and holding capital of
the subsidiary)
Exception, under 24a(c) is for financial subsidiaries
of national banks, whose stock and assets are
excluded from the computation of banks ratios
2. Computation of risk-weighted assets

a. On balance sheet assets are assigned a risk weight,
ordinarily corresponding to the identity of the obligor
b. There are four risk weight categories (0%; 20%; 50%;
100%)
c. Risk weight is multiplied by asset carrying value, and
included in determining total RWA
d. Off balance sheet items are multiplied by one of five
percentages (0, 10, 20, 50, and 100), multiplied by
carrying value of item to arrive at a credit equivalent
amount.
e. CEA is then multiplied by appropriate risk weight factor to
arrive at amount included in RWA.
f. Swap exposures and certain interests in securitizations are
subject to special rules to determine amount added to RWA
with respect to them.
g. There is an additional add-on for market risk, which, alone
among the additions, can change what is included in
capital to support it.
3. Risk weights
a. 0 per cent categories is mostly for currency; and
government obligations (of OECD central governments), as
well as deposits in the Federal Reserve and stock in Federal
Reserve banks
i
iii
iv
OECD is mostly developed countries of the world

(about 30).
Category demands revision, since many OECD
countries (e.g., Greece, Spain) have sharply reduced
credit standing in wake of the European debt crisis.
Also includes obligations fully guaranteed by OECD
central governments.
52
b. 20 per cent category is mostly for obligations of banks in

OECD countries; general obligations of subordinate political
units of OECD countries; and obligations of central
governments of non-OECD countries
c. 50 per cent category is mostly for residential mortgages
(secured by 1- to 4-family dwellings) and for revenue
obligations
d. 100 per cent category is for everything else (including,
e.g., deposits in banks of non-OECD countries
4. CEAs for OBSIs
a. 100 per cent risk category includes certain securities
lending or repurchase agreement (where the bank
indemnifies a customer against loss) and certain recourse
of DCS arrangements in securitizations
b. 50 per cent category includes performance-related
contingencies, which means mostly standby letters of
credit, and loan commitments extending more than one
year (from the date of the original commitment), as well as
revolving commitments, irrespective of maturity
c. 20 per cent category is short-term, self-liquidating
commitments, i.e., mostly commercial letters of credit
d. 10 perc cent category is for unused portions of assetbacked commercial paper facilities with an original
maturity of one year or less
e. 0 per cent category is for unused commitments with
original maturity one year or less
5. Tier 1 capital
a. Tier 1 capital comprises mostly common stock and
accumulated surplus
b. Also includes perpetual, noncumulative preferred stock
c. Includes minority interests in consolidated subsidiaries
6. Tier 2 capital
a. Amount of Tier 2 capital cannot exceed the amount of Tier
1 capital
b. Allowances for loan and lease losses are includible, subject
to a maximum of 1.25% of RWA
53
c. Perpetual and long-term (20 years or more) preferred stock

is includible
d. Mandatorily convertible debt securities and hybrid capital
instruments are includible
e. Intermediate term (5-20 years) preferred stock and term
subordinated debt includible, up to a limit of 50% of Tier 1
capital, reduced by deductions from capital
f. Up to 45% of unrealized gains on available-for-sale
securities includible, subject to discretion of the agencies
to exclude if they determine amounts are not properly
value
7. Deductions from capital
a. The carrying value of certain assets, mostly intangible
assets, must be deducted from Tier 1 capital.
b. Goodwill must be deducted.
c. Mortgage servicing rights do not have to be deducted this
is proposed to be changed in Basel III.
d. Nonmortgage servicing rights and other servicing must be
deducted, but only if they exceed certain specified limits.
e. Equity investments in nonfinancial companies must be
deducted in part.
i
ii
iii
Principal nonfinancial equity investments that a bank

may have are investments in community
development entities, and in small business
investment corporations, allowed under special
provisions of law.
FHC may also have merchant banking investments
under BHC 4(k)(4)(H)-(I).
Deduction is 8% for amount of investment, up to
15% of Tier 1 capital; 12% for amount between 15%
and 25% of Tier 1 capital; and 25% for amounts in
excess of that
8. Rules for securitizations

a. Under some securitizations, originator retains some risk
(subordinate position) to enhance the credit position of
senior tranches in the securitization.
54
b. Capital adequacy guidelines call these recourse positions

if the position is one retain by an originator, and direct
credit substitutes if they are acquired by another party or
institution.
c. After a 4-year period of notice, comment, and dialogue
with affected communities, the four banking agencies in
1998 published final rules for dealing with these positions,
rules that depended heavily upon NSRO ratings of the
position.
d. Long-term positions that are traded were subject to four
risk weights
i
ii
iii
iv
20% for the 2 highest investment grades

50% for the third highest investment grade
100% for the lowest investment grade
200% for one grade below investment grade
e. Short-term positions that are traded were subject to three

risk weights
i
lxix.
ii
20% for the highest investment grades

50% for the second highest investment grade
f. Untraded positions were eligible for the same treatment,

but required to be rated by more than one NSRO
i
ii
Ratings required to be based on same criteria as for

traded positions, and to be publicly available
If ratings are different, lowest rating is determinative
of risk weight.
g. Positions that were not rated or traded but senior and

preferred in all respect to a traded position may use the
risk weight assigned to the traded position.
h. Positions not rated or rated below the lowest investment
grade could be accounted for under any of 3 defined
methods, subject to conditions imposed on each method.
i
ii
iii
Internal ratings method

Program ratings
Computer program
i. Special rules for a variety of types of securitization

interests
i
ii
iii
Credit-enhancing interest-only (I/O) strips

Participation certificates retained in mortgage loan
swaps
Residual interests
55
iv
Low-level exposure rule
E. BASEL II
1. Developed over period 1998-2004; adopted in final form, revised, 2006
(Basel Committee on Banking Supervision, International Convergence of Capital Measurement
and Capital Standards A Revised Framework Comprehensive Version (June 2006),
http://www.bis.org/publ/bcbs128.pdf, [hereinafter Basel IIBasic Doc]

2. Three pillars (Basel IIBasic Doc 4, p.6)
a. Minimum capital requirements
b. Supervisory review
c. Market discipline
3. Minimum capital requirements: different categories of risk (Basel IIBasic
Doc 40, 44; p. 6)
a. Credit risk (carryover from Basel I)
b. Operational risk: multiply figure for risk times 12.5
c. Market risk
i
ii
Carryover from Basel I

Multiply figure for risk times 12.5
4. Credit risk: two or three approaches (Basel IIBasic Doc 50)

a. Standardized approach (simpler, smaller banks measuring credit
in standardized manner, supported by external credit ratings
b. Foundation internal ratings based approach
c. Internal ratings based approach, requiring banks to use their
internal credit rating systems (Basel IIBasic Doc 211-214)
d. Supplemental use of securitization framework in connection with
IRB approaches
5. Operational risk: three approaches of increasing sophistication (Basel
IIBasic Doc 644)
a. Basic indicator approach (Basel IIBasic Doc 649)
b. Standardized approach (Basel IIBasic Doc 652)
c. Advanced measurement approach (AMA) (Basel IIBasic Doc 664)
i
ii
Designed for use in conjunction with IRB approach to credit risk

For large, sophisticated banks
6. Implementation in the United States

a.
56

F. BASEL III
1. Currently in process of development; basic document published in
2010 as Basel Committee on Banking Supervision, Basel III: A global regulatory framework
for more resilient banks and banking systems (December 2010 (rev June 2011)),
http://www.bis.org/publ/bcbs189.pdf, pp. 1-12, 29-30, 51-52, 54-60 [hereinafter

Basel IIIBasic Doc].
2. Supplements Basel II, rather than replacing it, in response to the
financial crisis, which BCBS attributes in part to weak capital levels and
excessive leverage in banks (Basel IIIBasic Doc 1, 4, 7-8)
3. Three additions to armamentarium of capital regulation
a. Leverage ratios
b. Capital buffers
c. Liquidity requirements
4. Leverage ratios
a. Required in U.S. throughout period of capital requirements, but
not required under either Basel I or Basel II
b. First international requirement of leverage ratio
5. Capital buffers
a. Two separate requirements: capital conservation buffer, and
countercyclical buffer
b. Capital conservation buffer is addition 2.5% requirement of Tier
1 capital
c. Countercyclical buffer to be developed internally by individual
countries
6. Liquidity requirements
a. Liquidity coverage ratio parallels U.S. proposed regulations
requirement of liquidity buffer (Basel IIIBasic Doc 40-41)
i
ii
To consist of high-quality liquid assets

Assets must be unencumbered
b. Net stable funding ratio parallels parallels U.S. proposed

regulations requirement of contingency funding plan (Basel
IIIBasic Doc 42)
c. Monitoring requirements presage parallel requirements in U.S.
regulation (Basel IIIBasic Doc 43)
7.
Implementation in United States

57

G. JULY 2013 U.S. REGULATIONS IMPLEMENTING BASEL II AND BASEL III
1. Risk weighted asset ratio is ratio of capital to risk-weighted assets
a. There are three ratios: common equity Tier 1 ratio (CET1R); Tier
1 ratio; and total capital ratio
b. Only the numerator is different for the two: denominator is
standardized risk-weighted assets (SRWA) in all three
c. Minimum required ratio is 4.5% for common equity Tier 1; 6%
for Tier 1 capital; 8% for total
d. Capital ratios are ordinarily tested on a consolidated basis
i.
ii.
(i.e., 80% or more owned subsidiaries are looked through, and the parent is treated as
owning the assets, subject to the liabilities, and holding capital of the subsidiary)
Exception, under 24a(c) is for financial subsidiaries of national banks, whose stock and
assets are excluded from the computation of banks ratios, and deducted from CET1
e. Different rules apply for advanced approaches institutions

than for non-advanced approaches (non-AA) institutions
i.
AA institutions have consolidated assets of $500 billion or more; there are only
8 such institutions based in U.S., although many more foreign institutions of
that size are operating here
U.S regulations governing AA institutions have been in force since 2006,
although they were phased in and amended significantly in July 2013
Rules for standardized institutions were not adopted under Basel II; rules under
both Basel II and III were first proposed in August 2012 and finalized in July
2013
Materials herein relate solely to standardized rules; rules for advanced
approaches organizations are not covered, except with respect to question of
countercyclical capital buffer
ii.
iii.
iv.
f.
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.
x.
Basel III rules also require a capital conservation buffer

Buffer is computed by taking the smallest excess of an institutions capital over
the required minimum among the three capital ratios: this is the institutions
capital conservation buffer ratio
Buffer then determines limits on amounts institution may pay out as dividends
or discretionary bonuses
Limit is expressed as a percentage of the institutions eligible earnings, from
the four quarters preceding the quarter for which the buffer is computed
Limitation is then determined according to tranches measured by increments
of 0.625% in the capital conservation buffer ratio
Thus, if CCBR is between 0 and 0.625%, no amount may be paid out as
dividends or discretionary bonues
Between 0.625% and 1.25%, 20% of eligible earnings may be paid out
Between 1.25% and 1.875%, 40% of eligible earnings may be out
Between 1.875% and 2.5%, 60% of eligible earnings may be out
Above 2.5%, there is no limit on payment of dividends or bonuses
Rules for AA institutions are more complicated; they must retain a capital
conservation buffer amount:
2. 2013 final regulations

a. Issued July 2013
58

b. Have complicated phase-in and effective dates
c. Have extensive list of definitions in section 2, listed alphabetically;
definitions must be consulted to comprehend regulations
d. Final regulations systematized prior rules, and put them in systematic
order; prior rules were set out in discursive Appendices to agencies
regulations, and were quite difficult to follow at certain points, also
were incomplete as to what the rules actually were
e. All 3 agencies are promulgating the regulations, and the Board will
promulgate regulations for both BHCs/SLHCs, and state member
banks
f.
Regulations refer to prior rules as general risk weighted rules
3. Computation of risk-weighted assets (in general)

a. On balance sheet exposures are assigned a risk weight,
ordinarily corresponding to the identity of the obligor, but often
determined by the character of the asset or exposure involved
b. Risk weight is multiplied by exposure amount, and included in
determining total SRWA
c. Off balance sheet items have more complex rules
i
i.
ii.
iii.
Off balance sheet items (other than derivatives) are multiplied by one
of five percentages (0, 10, 20, 50, and 100), multiplied by carrying
value of item to arrive at a credit equivalent amount.
.CEA is then multiplied by appropriate risk weight factor to arrive at
amount included in RWA
Derivatives (over-the-counter swaps) are subject to special rules,
requiring reflecting the sum of the current market value of the
position (if positive), plus, in any case, an potential exposure
amount reflect inherent risk in the transactions
Derivatives and repo-style transactions that are traded on
clearinghouses under new Dodd-Frank rules are defined as cleared
transactions and have a distinct set of rules applied to them
d. Special, complex rules apply to other kinds of exposures

i
iv.
v.
Special rules apply to securitization exposures.

Special rules apply to equity exposures.
Narrowly applicable rules apply to certain transactions which are
unsettled.
e. Special, complex rules apply to credit enhancements with

respect to some exposures
i
vi.
f.
Rules provide allowances for guarantees and credit derivatives

Rules provide for collateralized transactions
There is an additional add-on for market risk, which, alone

among the additions, can change what is included in capital to
support it.
59

4. Exposure amount
a. Complicated definition in section 2
b. On-balance sheet items
i
vii.
viii.
ix.
Generally, exposure amount is the carrying value of the asset, i.e.,

the amount carried on the balance sheet
For most marketable securities, this amount is marked to market,
i.e., reflects current market value as of the date of the financial
statement
Rules allow banks to make an election to exclude Accumulated Other
Comprehensive Income (AOCI) from capital (AOCI election)
For banks making an AOCI election, exposure amount is generally
historic cost of the asset
a. Special definition of exposure amount applies for other exposures

i
lxx.
x.
xi.
xii.
xiii.
Off-balance sheet items

OTC derivatives
Cleared transactions
Unsettled transactions
Securitization exposures
Equity exposures
5. Risk weights (general rules) (Section 32) of on-balance sheet items

a. Old rules had four basic risk weights 0, 20, 50, 100
i
xiv.
xv.
xvi.
These are still basically preserved, but subject to much more

complicated categories
Basic categories were: 0 for U.S. (and other OECD) government
obligations; 20 for state and local GO and bank obligations; 50 for
residential mortgages and state and local revenue obligations; 100 for
everything else still underlying framework of new rules
Also, new rules often impose risk weights higher than 100 150, 200,
300, 400, up to 1250
Higher than 100 risk weight is essentially comparable to raising the
capital requirement, e.g., 200 per cent risk weight is like raising capital
requirements for that exposure to 9, 12, 16
b. Sovereign exposures (central governments)

i
xvii.
xviii.
xix.
xx.
xxi.
xxii.
xxiii.
xxiv.
United States: 0 per cent risk weight to government obligations,

obligations unconditionally guaranteed by US or its agencies, agency
obligations; 20 per cent to obligations conditionally guaranteed by U.S.
Other sovereign determined by country risk classification (CRC)
There are 7 classifications promulgated by OECD, 1 to 7
Risk weight is 0 for countries rated 0-1; 20 for those rated 2 3; 50 for
those rated 3; 100 for 4-6; 150 for countries rated 7; 150 for countries
in sovereign default
For unrated OECD countries, weight is 0; for unrated non-OECD
countries, weight is 100
OECD is mostly developed countries of the world (about 30).
Almost all OECD countries are unrated, so CRC is zero, this includes
troubled Eurozone PIGS countries (Portugal, Ireland, Greece, Spain),
some of whom have verged near default -- tricky, tricky, tricky
MDB exposures have 0 risk weight
GSE exposures that are not equity have 20 per cent risk weight; GSE
preferred stock has 100 per cent risk weight; other equity exposures
subject to equity exposure rules
60

c. Exposures to depository institutions
i
xxv.
xxvi.
Generally, 20 per cent risk weight to depository institution exposures

to U.S. institutions
Foreign depository institutions exposures determined by CRC of
institutions home country: risk weight is generally 1 level higher per
CRC tranche, except stays at 150 for countries with a 7 (Cuba, Libya);
and at 100 for non-rated non-OECD governments; and at 150 if home
country is in sovereign default
Equity exposures to depository institutions is 100 per cent if equity is
counted as capital by investee institution, and no subject to special
rules for deductions from capital; if subject to those rules, exposure is
eliminated from SRWA
d. Exposures to public sector entities (PSEs)

i
xxvii.
xxviii.
PSEs are defined as subnational governments, like states or

municipalities in U.S.
General obligations of PSEs are subject to same risk weights exposures
to depository institutions.
Revenue obligations of PSEs are subject to risk weights of 50 for U.S. or
0-1 country PSEs and unrated OECD country PSEs; 100 for 2-3 and
unrated non-OECD countries; 150 for 4-7 and sovereign default
countries
e. First-lien Residential mortgage exposures

i
xxix.
xxx.
xxxi.
xxxii.
f.
Must be secured by property either owner-occupied or rented;

underwritten by prudent standards, including LTV standards; not more
then 90 days past due; and not restructured or modified\
HAMP modifications dont count as modifications for this purpose
If same lender, may combine junior lien with first lien in determining
exposure amount
100 per cent risk weight for residential mortgages not meeting
requirements
Special rules for statutory multifamily mortgages and pre-sold
uncancelled constructions loans (both 50 percent); cancelled pre-sold
construction loans (100); and high volatility commercial real estate
loans (150 per cent) (never mind what these are)
Corporate exposures risk-weighted at 100 per cent

i
xxxiii.
Corporate exposures defined as everything for which a risk weight is

not specifically prescribed
Thus, includes many items not ordinarily thought of as corporate
e.g., consumer loans, credit card receivables, automobile loans,
student loans, commercial & industrial loans to sole proprietorships,
partnerships, or S corporations, etc.\
g. Various additional rules

i
ii
iii
iv
0 per cent: cash, deposits at Federal Reserve banks; stock in FR banks;

gold bullion held in vaults and offset by bullion liabilities; cash items in
collection process where no counterparty credit risk
20 per cent to cash items in the process of collection
100 per cent to deferred tax assets that arise from temporary
differences that can be realized from NOL carrybacks
250 per cent for intangibles not deducted from capital (mortgage
servicing assets; deferred tax assets that arise arise from temporary
differences that cannot be realized from NOL carrybacks
h. Defaulted obligations
i
Assets 90 days or more past due have 150 risk weight if unsecured and
unguaranteed
61

xxxiv.
xxxv.
If secured or guaranteed, may have the risk weight assigned under the
guarantee or collateral rules.
DPC property (acquired by foreclosure) has risk weight in hands of a DI
it would have in the hands of a HC if the DI is otherwise without power
to acquire or hold the poroperty
6. Off-balance sheet items

a. Off-balance sheet exposure amounts multiplied by credit
conversion factors (CCFs), corresponding to credit equivalent
amounts of prior regulations.
b. 100 per cent risk category includes off-balance sheet securities
lending and borrowing and repurchase agreements (measured
by amounts subject to repurchase, lending, or borrowing); creditenhancing representations and warranties; guarantees forward
agreements; and financial standby letters of credit
c. 50 per cent category includes performance-related
contingencies, which means mostly standby letters of credit,
performance bonds, and bid bonds; and loan commitments
extending more than one year (from the date of the original
commitment) that are not unconditionally cancelable by the
bank
d. 20 per cent category is short-term, self-liquidating
commitments, i.e., mostly commercial letters of credit, with a
maturity of one year or less; and loan commitments extending
one year or less (from the date of the original commitment) that
are not unconditionally cancelable by the bank
e. 0 per cent category is for unused commitments with original
maturity one year or less
7. OTC Derivatives
a. Banks exposure amount is sum of current credit exposure
(CCE) plus potential future exposure (PFE).
b. CCE is the mark-to-fair value (daily) of a swap, if positive; or
zero, if not.
c. PFE is determined by multiplying notional principal amount
(NPA) of contracts by coefficients set forth on a table,
corresponding to the remaining maturity of the contract and the
nature of the underlying property.
d. The CCE and PFE sum represents the manner in which the
amount of collateral required under collateralized swaps is
computed.
e. If there is a master netting agreement of swaps with any
counterparty, CCE and PFE may be computed on a netting set
basis.
i
Net CCE is determined by netting current values of all contracts in the

set.
62

ii
xxxvi.
f.
Then you computed two things: the gross amount of the PFEs; and the
ratio of the net CCE to the gross amount of the CCEs
The \net PFEs is then determined as a weighted average, using 40%
of the gross amount of the PFE, and 60% the gross PFE multiplied by
the ratio of net CCE to gross CCE
Regulations permit collateralized derivatives to recognize

collateralization under the simple approach, or, if
collateralized daily, the collateral haircut approach, described
below.
g. Regulations permit credit derivatives purchased or sold to be

accounted for without regard to counterparty credit risk (i.e., as
guarantees) and require equity derivatives to be treated as
equity exposures.
h. Special rules provided for banks that act as clearing agents for
OTC derivatives.
8. Cleared transactions (repo-style transactions and swaps)
a. For cleared transactions, the exposure amount is the exposure
amount for the derivative (or netting set), plus the amount of
any collateral posted by the clearing member client (or clearing
member) that is not bankruptcy remote.
b. For the client, the exposure amount is then risk-weighted at 2
per cent, if the collateral arrangement protects the client from
loss in the event of the simultaneous bankruptcy of the clearing
member and other clients of the clearing member; 4 per cent
otherwise, assuming the central counterparty is qualified.
c. For the member, the exposure amount is risk weighted at 2 per
cent if the CCP is a QCCP.
d. If the central counterparty is not qualified, risk weight is
determined under the general risk weighting rules based on the
nature of CCP (generally will be 100% for corporate CCP).
e. Collateral that is bankruptcy remote must be risk-weighted
under general (section 32) rules.
f.
9.
Complex rules governing exposure of clearing member for

default fund contribution to clearinghouse beyond scope of this
course.
Guarantees and credit derivatives

a. Regulations (section 36) permit substitution of the risk weight of
a guarantor or protection provider under a credit derivative for
risk weight of the protected exposure.
b. Guarantee broadly defined to include, inter alia, insurance
contracts and letters of credit
c. Treatment limited to eligible guarantees and eligible credit
derivatives
63

i.
Definitions strict in terms of enforceability of protection contract.

i
Credit derivative definition strict in terms of events which trigger right
to payment under the contracdt.
d. Special rules provide for adjustment of the notional amount of a

guarantee or credit derivative where there are maturity or
currency mismatches between protection contract and protected
exposure.
e. Special rules govern credit derivatives under which restructuring
is not a credit event.
10.Collateralization
a. In certain circumstances, institution is permitted to substitute
risk weight of collateral for risk weight of exposure, under either
simple approach or collateral haircut approach.
b. Simple approach substitutes risk weight of collateral for risk
weight of secured exposure.
i.
For repurchase, securities lending, securities borrowing transactions, collateral

is the securities lent, borrowed, or sold.
i
For such transactions, risk weight is not permitted to be less than 20
per cent. i.e., when Treasury securities are the collateral, the risk
weight will generally be 20 per cent (the weight for most interbank
exposures), not the 0 per cent RW associated with the collateral.
xxxvii.
Exceptions to 20 per cent floor when collateral is marked to market
daily for cash on deposit (0 per cent) or Treasury securities (10 per
cent), if bank discounts collateral by 20 per cent..
xxxviii.
The amount involved is the opening exposure amount for repo-style
transactions under the cleared transaction rules of section 35.
c. The collateral haircut approach is available for three types of

transactions.
i
xxxix.
xl.
xli.
xlii.
xliii.
Eligible margin loans, collateralized derivative transactions, and repostyle transactions

Uses market price volatility indexes set forth in tables to regulations,
based on type of collateral and in the case of some exposures
remaining term to maturity.
Exposure amount is set at the excess of the value of all exposures
protected by a given category of collateral over the value of the
collateral, plus the absolute value of the net position times the
volatility haircut set forth on the table
If the currency denomination of the collateral is different from the
currency in which the transaction is to be settled, an additional amount
is added, as the absolute value of the net position in the different
currency, times a volatility haircut specific to that currency
Upward adjustments are made where (1) there are more than 5000
transactions in a netting set in a quarter; (2) there is illiquid collateral;
or (3) there have been more than 2 margin disputes that lasted longer
than the holding period of the transactions over 2 previous calendar
quarters.
Banks are permitted to use their own internal estimates of supervisory
haircuts subject to stringent conditions on the internal measurement of
haircuts.
11.Unsettled transactions
64

a. Rules apply to transactions that are supposed to be settled
within five business days, excluding cleared transactions, repostyle transactions, OTC derivatives subject to one-way cash
payments.
b. For transactions, delivery versus payment, or payment versus
payment, where payment and delivery or reciprocal payments
are supposed to be simultaneous or within 5 days, RW must be
assigned against value of deliverables of 100 per cent if
payment not made for 5-15 days; 625% for 16-30 days; 937.5%
for delay of 16-30 days; and 1250% for delay in excess of 45
days.
c. For non-DvP and non-PvP transactions, risk weight must be
applied if payment not made by scheduled date; for five days,
risk weight is determined under section 32 rules, after five days,
RW is 1250 per cent.
12.Securitization exposures
a. Rules for securitizations are complex, and much stricter than
rules under prior regulations
i
ii
Principal difference is FDIC regulations use the simplified supervisory

formula approach (SSFA), as opposed to other regulations which use
the unsimplified supervisory formula approach (SFA), which uses a
lot of calculus and is a lot harder to explain.
Discussion here is of FDIC regulations, not general regulations
b. Regulations impose conditions for traditional and syuthetic

securitizations as a condition for using methods to apply a risk
weight of less than 1250 per cent; conditions generally relate to
the effective separation of the risk from the underlying assets
from the securitizing institution.
c. Regulations also require, as a condition for using a risk weight
under 1250 per cent, that institution demonstrate to the
satisfaction of the [AGENCY] a comprehensive understanding of
the features of a securitization exposure that would materially
affect the performance of the exposure, and that the [BANK]s
analysis must be commensurate with the complexity of the
securitization exposure and the materiality of the exposure in
relation to its capital, and give a long, articulate list of what the
institution must demonstrate it understands.
i
xliv.
Requirement reflects view that under pre-crisis conditions, banks (and

rating agencies) frequently did NOT understand the details and nature
of securitization vehicles in part the fault of their LAWYERS.
Requirement also demonstrates the complexity of this field and these
rules and why it is FOLLY even though it is IMPORTANT to try to teach
even the rudiments of these rules to LAW STUDENTS.
65

xlv.
xlvi.
xlvii.
Of critical importance to operation of these rules is that the bank and

its accountants understand (i) the amount of risk in the securitization
that is junior (subordinated) to any risk retained by the bank (the
banks attachment point); and (ii) the banks maximum exposure to
the securitization (when added to the attachment point, its
detachment point) (which, of course, requires understanding the
amount of risk in the securitization that is senior (the bank is
subordinated to) to any risk retained by the bank
Assume for instance (we will use this example throughout) that the
banks responsibility kicks in after 40% of the securitization principal is
lost, and is limited to 30% of the securitization principal; so that the
tranches senior to the banks amount to 30% of the principal.
The banks attachment point is 40% (.4), and its detachment point
is 70% (.7).
d. Exposure amount in securitization is generally the carrying value

of the exposure on the balance sheet.
i
ii
iii
These are generally marked to market.

For AOCI opt-out banks, (and repo-style transactions, eligible margin
loans, etc.), the exposure amount is generally historic cost, i.e.,
carrying value net of unrealized appreciation or depreciation.
For off-balance sheet securitizations, exposure amount is notional
value of the securitization.
e. Subject to numerous and complex exceptions, banks are

permitted to use one of two methods for computing risk weight
assigned to securitization positions: the simplified supervisory
formula (SSFA) approach; or the gross-up approach (GUA).
f.
The SSFA requires bank know five data points.

i
xlviii.
xlix.
l.
li.
Weighted average risk weights for underlying exposures (e.g., if all

securitized assets are first-lien residential mortgages qualifying for the
50% rate, this would be 50%; if all were credit card receivables, this
would be 100%)
Rate of defaults or troubled status of underlying exposures
Attachment point
Detachment points
Whether securitizations are original securitizations or resecuritizations
g. Rules for SSFA depend on attachment and detachment point.

i
lii.
liii.
liv.
lv.
lvi.
First, multiply the weighted average risk weight for the exposures
times the amount of the exposures (actually this number is adjusted
slightly to account for default on underlying exposures)
Assume a weighted average of 50%, and total exposures of $10
million: this number is $5 million.
If the attachment point (amounts subordinated to bank) exceeds the
weighted average, then generally the risk weight is the SSFA
coefficient, which, in the absence of substantial defaults in underlying
assets, will be a very small number (see h-v below)
If the detachment point is less than the weighted average, the risk
weight is 1250 per cent (amount taken account in risk-weighting
exceeds banks responsibility, hence bank expected to bear the
losses)
SSFA formula thus applies only where the attachment point is less than
the weighted average risk weight, which in turn is less than the
detachment point.
In our example, the attachment point is 40%; the weight average is
50%; the detachment point is 70%, so the SSFA formula would apply.
66

h. SSFA risk weight is weighted average, based on the portion of
the banks exposure below and above the weighted
average.
i
lvii.
lviii.
lix.
lx.
lxi.
lxii.
lxiii.
i.
Gross-up amount is simpler calculation and ordinarily will result

in lower capital requirement.
i
lxiv.
lxv.
lxvi.
lxvii.
j.
Portion below is multiplied by 1250 per cent.

Portion above is multiplied by 1250 per cent, multiplied by a
coefficient, the SSFA coefficient, calculated in complicated ways, but
generally will be a very small number, except in the presence of
substantial weakness in underlying exposures.
In our example, 1/3 of banks exposure is below weighted average
RW, and 2/3 above.
Use .50 as the SSFA weighted- average risk weight of underlying
exposures (assumes all underlying exposures are qualifying residential
mortgages at 50% risk weight).
Coefficient used for weighting exposure above risk-weight portion in
this case is .003372.
Thus, 1/3 of the exposure is risk-weighted at 1250 per cent (416.67 per
cent) and 2/3 at .003372 times 1250 per cent (4.215 per cent) (2.81
per cent), so that the total risk weight of the exposure is 419.48 per
cent.
So inclusion in risk-weighted assets would be 419.48 per cent of $3
million, or $12.5844 million.
This capital requirement is much greater than required under any prior
rules.
Generally, amount senior to attachment point is the credit equivalent

amount of the exposure (in our example, 60% of $10 million, or $6
million)
Risk weight is weighted average risk weight of underlying exposures
(50% in our example) (but may not be less than 20%)
RWA would be 50% of $6 million, or $3 million
Compares to $12.5844 million under SSFA.
Note both amounts exceed maximum potential loss under the
securitization ($3 million).
Securitizations to which gross-up amount and SSFA do not apply,

must risk weight securitization exposure at 1250 per cent ($37.5
million in example).
i
ii
Special rules for asset-backed commercial paper programs.

Limited recognition of credit risk mitigants on securitization programs.
k. Tier 1 capital
13.Equity exposures
a. Equity exposures are accounted for under various methods.
i
lxviii.
Straight equity exposures account for under Simple Risk Weight Asset
(SRWA) method.
Exposures to investment funds accounted for under one of 3
lookthrough approaches: the full lookthrough approach; simple
modified lookthrough approach; or alternative modified lookthrough
approach
b. Exposure amount is carrying value, modified for AOCI opt-out

institutions; or notional amount for off-balance-sheet equity
exposures
67

c. SRWA approach risk weights
i
lxix.
lxx.
lxxi.
lxxii.
lxxiii.
lxxiv.
lxxv.
0 per cent for exposures to MDBs, European Commission, European

Central Bank, etc., institutions whose obligations qualify for zero per
cent risk weight (stock of FR banks)
20 per cent for exposures to Farmer Mac, FHLBs, or PSEs
100 per cent for community development exposures, excluding SBICs,
certain others; effective portion of hedge pairs; certain investment
funds
250 per cent for significant (more than 10%) investments in
unconsolidated financial institutions not deducted from capital
300 per cent for publicly traded equities
400 per cent for other equities
600 per cent for certain highly leveraged investment funds
Special rules for effective hedges
d. Full look-through method for exposures to investment funds

applies risk-weights to the various holdings of the fund, times
the institutions pro rata share of the fund
e. Simple modified through method applies highest risk-weight
applicable to any holding of the fund, times the carrying value of
the institutions interest in the fund
f.
Alternative modified through method applies risk-weights

applicable to various holdings of the fund, applied to each risk
weight category of the fund based on the maximum holding in
such risk weights permitted by the funds prospectus and
organic documents.
14.Common equity Tier 1 capital comprises mostly common stock and

accumulated surplus
15.Additional Tier 1 capital includes perpetual, noncumulative preferred
stock
16.Tier 2 capital
a. Allowances for loan and lease losses are includible, subject to a
maximum of 1.25% of RWA
b. Perpetual and long-term (20 years or more) preferred stock is
includible
c. Mandatorily convertible debt securities and hybrid capital
instruments are includible
Intermediate term (5-20 years) preferred stock and term subordinated debt
includible, up to a limit of 50% of Tier 1 capital, reduced by deductions from
capital
d. Up to 45% of unrealized gains on available-for-sale securities
includible, subject to discretion of the agencies to exclude if they
determine amounts are not properly value
17.Deductions from capital
68
a. The carrying value of certain assets, mostly

intangible assets, must be deducted from
Tier 1 capital.
b. Goodwill must be deducted.
c. Most deferred tax assets must be deducted.
d. Nonmortgage servicing rights and other
servicing must be deducted, but only if they
exceed certain specified limits.
e. Rules for investments in financial
institutions
i Complex definition of financial
institution
ii Institutions must deduct any of their own
stock they hold, e.g., Treasury stock.
lxxvi. If institutions have arrangements for
reciprocal cross holdings of stock,
institution must deduct any stock of the
other institution so held from capital
lxxvii. Rules seek to prevent banks and HCs
from evading capital requirements
through holding their own stock
f. Investments in unconsolidated financial
institutions
i Unconsolidated means ownership of
less than 80%
69
ii
Regulations distinguish between

significant and nonsignificant
interests in unconsolidated financial
institutions: significant is 10% or more
ownership interest
iii Both significant and non-significant
investments subject to 10% threshold
banks must deduct amount of
investment in excess of 10% of common
equity Tier 1 capital
iv Significant investments subject to 15%
threshold the amount not subject to
the 10% threshold is combined with
other deductions from capital, and to the
extent the total exceeds 15% of T1EC,
the excess must also be deducted from
capital
v Investments in financial subsidiaries
must be deducted from capital in full
this is required by statute (12 U.S.C.
24a)
vi Deductions from capital apply for
purposes of leverage ratio as well as the
risk-weighted ratio
18.Rules for securitizations
a. Under some securitizations, originator retains some risk
(subordinate position) to enhance the credit position of senior
tranches in the securitization.
b. Capital adequacy guidelines call these recourse positions if the
position is one retain by an originator, and direct credit
substitutes if they are acquired by another party or institution.
70

c. After a 4-year period of notice, comment, and dialogue with
affected communities, the four banking agencies in 1998
published final rules for dealing with these positions, rules that
depended heavily upon NSRO ratings of the position.
d. Long-term positions that are traded were subject to four risk
weights
i
lxxviii.
lxxix.
lxxx.
20% for the 2 highest investment grades

50% for the third highest investment grade
200% for one grade below investment grade
e. Short-term positions that are traded were subject to three risk

weights
i
lxxxi.
lxxxii.
f.
20% for the highest investment grades

50% for the second highest investment grade
Untraded positions were eligible for the same treatment, but

required to be rated by more than one NSRO
i
lxxxiii.
Ratings required to be based on same criteria as for traded positions,

and to be publicly available
If ratings are different, lowest rating is determinative of risk weight.
g. Positions that were not rated or traded but senior and preferred
in all respect to a traded position may use the risk weight
assigned to the traded position.
h. Positions not rated or rated below the lowest investment grade
could be accounted for under any of 3 defined methods, subject
to conditions imposed on each method.
i
lxxxiv.
lxxxv.
i.
Internal ratings method

Program ratings
Computer program
Special rules for a variety of types of securitization interests
i
lxxxvi.
lxxxvii.
lxxxviii.
Credit-enhancing interest-only (I/O) strips

Participation certificates retained in mortgage loan swaps
Residual interests
Low-level exposure rule
H. CONSEQUENCES OF ABROGATION
71
VIII.
PRUDENTIAL STANDARDS UNDER DODD-FRANK
72

A. STATUTORY BASIS
1. Section 115 lists prudential standards that FSOC may recommend that
the Board adopt for supervised NBFCs and large, interconnected
BHCs.
2. Section 165 lists essentially the same prudential standards which the
Board is directed or authorized to impose on supervised NBFCs and
$50b BHCs.
a. Statute lists 9 separate standards.
b. 5 standards are mandatory Board must impose them.
i
iii
iv
v
vi
Capital standards (leverage and risk-weighted)

Liquidity requirements
Resolution plans and credit exposure requirements (living wills)
Concentration limits
Risk committee requirements
c. 4 others are discretionary Board may but is not required to

impose them
i
ii
iii
iv
Contingent capital requirements

Short-term debt limits
Additional Public disclosures
Such other standards as Board deems appropriate.
d. Section 165(i) imposes a 10th requirement, for stress tests,

which has a unique status.
i
ii
iii
It is not listed in 125 or 165(b) as a prudential standard.

Part of the requirement ( 165(i)(2), for company-run stress tests
applies to financial companies even in the absence of designation.
Threshold, for both BHCs and financial companies, is $10 billion in
assets, not $50 billion.
e. Split in authority between Board and FSOC reflects continuing

congressional ambivalence about assigning bank regulatory
powers between politically responsive agencies (Treasury, OCC)
and independent regulatory body (the Board).
i
ii
iii
iv
Same ambivalence reflected in GLBA division of authority for FHCs

(Board) and FinSubs (Comptroller).
GLBA gives final authority to the Board in determining designation of
additional activities as financial in nature under BHCA 4(k)(1).
Dodd-Frank, by contrast, gives final say to Treasury Secretary of
Treasury is Chair of FSOC, and has veto over its determinations.
Board is required to consult with FSOC members with primary
responsibility for supervising a subsidiary of a BHC or NBFC before
imposing requirements or sanctions on a regulated subsidiary.
3. Application of prudential standards

a. Prudential standards apply automatically to $50b BHCs i.e.,
they apply without FSOC determination of systemic
significance.
73

b. By contrast, standards apply to NBFCs only if they are
designated as systemically significant by the FSOC.
i
ii
iii
$50 billion threshold is irrelevant to designation FSOC may designate

an entity without regard to asset size.
At the present time, no institutions are designated.
Bloomberg News has reported that FSOC is on verge of designating two
institutions AIG and GE Capital.
4. Implementation of the proposed standards

a. Board issued proposed regulations in January 2012
implementing the 5 mandatory standards.
b. No proposed regulations have been issued with respect to the
discretionary standards, and no public indication has been
made that Board intends to do so in the near future.
c. Proposed regulations were part of a large project implementing
the early remediation provisions of section 166 of Dodd-Frank,
12 U.S.C. 5366.
i
ii
iii
iv
Early remediation provisions patterned on prompt corrective action

provisions of section 38 of the FDIA, 12 U.S.C. 1831o.
Idea is to provide authority in Board to take early action to prevent a
developing crisis with a systemically significant institution.
Understand that proposed regulations may be changed before final
regulations are issued.
Treacherous to teach proposed regulations, but there are at present no
other basis for elaborating the statutory rules.
B. CAPITAL STANDARDS
1. Statute requires risk-based and leverage limits ( 165(b)(1)(A)(i)).
2. Most requirements are to be based on requirements discussed above.
3. Section 165(j) authorizes Board to impose a 15-1 leverage limit
(6.25%, greater than the 3-4% limit imposed by current law) on $50b
BHC or supervised NBFC, upon a determination by the Council (FSOC)
that institutions poses a grave threat to the financial stability of US.
4. Section 165(k)(1) expressly requires that computation of capital for
purposes of meeting capital requirements . . . take into account any
off-balance-sheet activities of the company.
a. Appears to apply to leverage limits as well as risk-based capital
requirements, although no regulatory action on this point
appears to have been taken.
b. Statute authorizes Board to exempt a company or transaction
from the requirement.
74

c. Section 165(k)(3) defines off-balance sheet item and gives a
laundry list of them.
d. You should understand, at least generally, what each item on the
list constitutes and how they work.
C. LIQUIDITY REQUIRMENTS
1. Statute does not amplify what is meant by liquidity requirements.
2. Proposed regulations apply to covered companies, as defined by the
regulations
a. Includes NBFCs supervised by Board
b. Includes $50 b BHCs, determined on the basis of average
consolidated assets as reported in four most recent quarterly
reports filed by the BHC
3. Covered companies required to stress test cash flow projections
monthly (Prop. 12 C.F.R. 252.56(a).
a. Stress testing based on scenarios usually baseline, stressed,
and extremely stressed
b. For liquidity, must account for market stress, idiosyncratic
stress, and combined market and idiosyncratic stress
c. Most incorporate different time horizons, including overnight, 30
days, 90 days, and one year (Prop. 12 C.F.R. 252.56(b)(1))
d. Specifications for control and management functions and
processes (Prop. 12 C.F.R. 252.56(c))
4. Company establishes a liquidity buffer based on results of stress
tests (Prop. 12 C.F.R. 252.57(a))
a. Must be sufficient to meet projected net cash outflows and loss
or impairment of funding sources for 30 days
b. Consists ofhighly liquid assets that are unencumbered
c. Highly liquid assets include cash and Treasury obligations,
government agency or GSE obligations, or other assets, as
approved by Board, which are low-risk and actively traded, and
a type of asset that investors historically have purchased in
periods of financial market distress during which market liquidity
is impaired (Prop. 12 C.F.R. 252.51(g))
d. Covered company must establish a Contingency Funding Plan
(CFP) (Prop. 12 C.F.R. 252.58(a))
i
Must include a Quantitative Assessment, to identify stress events, the

impact on the company, and assets or funding sources available to the
company in such events
75

ii
iii
iv
\Must describe an Event Management Process

Procedures for monitoring emerging liquidity stress events
Periodic testing to determine reliability of CFP
5.October 2013 regulations implement

liquidity coverage ratio for BHCs and
supervised NBFCs
a.Institutions must through stress testing
measure a maximum net cash flow
requirement over a 30-day period
b.Institutions must then meet a
coverage ratio of 100 per cent of the
net cash flow so measured
c. Institutions must hold high quality
liquid assets (HQLA) in an amount
determined by this coverage ratio
i Three classifications or levels of
HQLA: Level 1; Level 2A; Level 2B
ii Level 1 assets include government
securities, and generally assets
qualifying for a zero risk weight
under RWCA rules
iii Level 2A includes things like
interbank deposits, or other liquid
assets
iv Level 2B includes things like
publicly traded stock and bonds
76
v Level 2A assets are subject to a

15% haircut; and (together with
Level 2B assets) may not constitute
more than 40% of the coverage
requirement
vi Level 2B assets are subject to a
50% haircut; and may not
constitute more than 15% of the
coverage requirement
vii For instance suppose requirement
is $3 b; Level 2B limit would be
$900 m (which after 50% haircut
would count as $450 m, which is
15% of $3b); and additional $882.4
m. in Level 2A assets could be held
((which after 15% haircut would
count as $750 m, which is 25% of
$3b); total of Level 2 assets
counted is $1.2b, 40% of $3 b
d.Rule applies to institutions with over
$250 b in assets, which includes only
about 8 U.S.-based institutions at
present; and any of the depository
institution subsidiaries of such
companies with more than $10 billion
in assets
e.More relaxed rule proposed by Board to
apply to BHCs with $50b-$250 b in
assets (BHCs subject to DF 165)
77
Modified minimum LCR is 70 per

cent
ii Test period is 21 days, rather than
30 days
6.Second conception of Basel III is net
stable funding ratio
a.Not required to be implemented until
2018
b.Requires measurement of liquidity
needs over longer period (one year),
and maintenance of funding sources
(not static assets) over such period.
D. CREDIT EXPOSURE LIMITS
1. Section 165(e)(2) prescribes limit of 25% of capital and surplus for
exposure to any other company.
2. Section 165(e)(3) defines credit exposure; you should understand, at
least generally, what all the transactions on this list are.
3. Proposed regulations give complex rules specifying computation of
gross credit exposure and net credit exposure (Prop. 12 C.F.R.
252.93-.95)
4. Proposed regulations impose special rule that limits exposure of one
major covered company to any major counterparty
a. Major means, in both cases, more than $500 billion in assets
b. For foreign organizations, $500 billion relates to worldwide
assets different from most measures under DFA, which refer
generally to assets connected with U.S. as measured either
annually or quarterly, depending on filing status of company
78

5. Requirements are phased in: first effective July 21, 2013 (third
anniversary date of DFA), with authority in Board to extend effective
date up to 2 years ( 165(e)(7))
E. RESOLUTION PLANS (Living Wills)
1. Section 8(d) requires submission of resolution plans and credit
exposure reports annually, to three agencies: Board, FDIC, FSOC.
2. Proposed regulations jointly issued by Board and FDIC November 1,
2011, implement requirement.
a. Separate from proposed early remediation regulations
described above.
b. Unlike those regulations, these have FDIC input.\
c. Point of plans is to give agencies (esp. FDIC) roadmap of what to
do if company needs to be liquidated under Title II of DFA.
3. Phased-in requirements
a. For BHCs with assets in excess of $250 billion, first required July
1, 2012.
b. For BHCs with assets $100-250 billion, first required July 1, 2013.
c. For other covered companies, first required December 31, 2013.
d. Required annually on anniversary date thereafter.
e. For company newly subject to the prudential standards, required
on the first July 1 that is at least 270 days from the date
company becomes subject to the requirements.
f.
Agencies have authority to require interim updates, and

companies are required to provide notice of material events.
4. Required content
a. Information about corporate structures within company,
subsidiaries, etc.
b. Information about management information systems
c. Information about interconnections and interdependencies
among different corporations in the structure, including any
cross-guarantees or cross-collateral and cross-default provisions
d. Information about supervisory and regulatory authorities
responsible for safety and soundness of institutions
e. Strategic analysis
f.
Executive summary
79

5. Acceptance or rejection of plan
a. Agencies review plan, and may determine it to be deficient
b. If so determined, company required to correct deficiencies
c. If company fails to correct deficiencies satisfactorily, agencies
may impose prudential standards additional to or more stringent
than those imposed by the statute or regulations.
d. If after 2 years from the date such strictures are imposed, the
company still fails to correct deficiencies, agencies may order
divestiture of businesses or assets of the company.
6. Public disclosure and confidentiality
a. Submitting company is to designate public and nonpublic
(confidential) portions of plans.
b. Submission of plans last July watched by financial markets
c. Some criticism, both of partial publication of plans and of the
requirement itself
i
ii
Some believe plans are used to whitewash problems within the banks
Others question whether the information collected by the agencies is
worth what is a high cost to institutions of complying with the plan
F. RISK COMMITTEE (MANAGEMENT) REQUIREMENTS

1. Statute requires establishment of risk committee of the Board of
Directors of covered company, with responsibility for oversight of
enterprise-wide risk management practices.
2. Committee must include independent directors, and at least one risk
management expert.
3. Application of requirement
a. Must be established by supervised NBFC within 1 year that
supervision starts
b. Applies to all BHCs which are publicly traded and have at least
$10 billion in assets not $50 billion, as is true for other
prudential standards.
c. Board has authority to apply requirement to any publicly traded
BHC, regardless of size
4. Proposed regulations require appointment of a chief risk officer by each
covered company (Prop. 12 C.F.R. 252.126(d))
G. STRESS TESTS
80

1. Stress testing is a requirement that is not listed among the
prudential standards in either DFA 165(b) or 125(b)
a. Requirement is stated in 165(i).
b. It is, however, unique and different from the other 165
requirements in certain respects.
i
ii
iii
iv
Applies to NBFCs without designation.

Applies to depository institutions themselves (section 165(i)(2) (as
discussed below), not just bank holding companies.
Section 165(i)(2) has different (lower) asset threshold -- /$10 billion, as
opposed to $50 billion.
Section 165(i)(2) threshold applies to NBFCs as well as banks only
asset level threshold to apply to NBFCs.
2. Section 165(i)(1) requires Board to conduct annual stress tests of $50

billion BHCs and supervised NBFCs.
a. Conducted in coordination with primary Federal regulators and
the FIO.
b. Requires 3 different scenarios baseline, adverse, severely
adverse ( 165(i)(1)(B)(i)).
c. Summary of results are to be published.
d. Effective date of requirement (Prop. Reg. 252,131)
i
ii
iii
For BHCs, first reporting date is first September 30 to occur more than
90 days after company becomes a $50 billion BHC.
For supervised NBFCs, first reporting date is first September 30 to
occur more than 18990 days after company is designated.
BHC that is covered on effective date of proposed regulations must
immediately comply.
e. Information required (Prop. Reg. 252,134)

i
ii
iii
Information related to companys on- and off-balance sheet edposures

Information to assist Board in estimating the sensitivity of the covered
companys revenues and expenses to changes in economic and
financial conditions
Information to assist Board in estimating the likely evolution of the
covered companys balance sheet (such as the composition of its loan
and securities portfolios) and allowance for loan losses, in response to
changes in economic and financial conditions
3. Section 165(i) establishes two different sets of requirements for

company-run stress tests, the scope of one of which is distinctly
unclear.
a. First sentence requires semiannual stress tests by $50b BHCs
and supervised NBFCs this requirement is clear.
b. Second sentence requires annual stress tests by financial
companies that have total consolidated assets of more than
[$10 billion] and are regulated by a primary Federal financial
regulatory agency.
81

c. These Federal financial regulatory agencies are given
regulatory authority with respect to the entities under their
jurisdiction, which they are to exercise in coordination with the
Board and the Federal Insurance Office.
4. Problems with the second sentence
a. Section 165(i)(2) refers to financial companies, and primary
Federal financial regulatory agencies, but neither term is
defined in Title I.
b. Section 102(a)(4) defines for purposes of Title I the terms
United States nonbank financial company, and foreign
nonbank financial company, but never defines the term
financial company.
i
ii
iii
iv
Each term is defined by where the company is organized, plus whether

the company is predominantly engaged in financial (Section 4(k))
activities.
Also, definition excludes any BHC and certain entities dealing with
swaps, most of which are entities newly defined and recognized by
Title VII of DFA.
The definition, however, does not exclude banks or other DIs in terms.
Presumably, banks and DIs would mostly meet the predominantly
engaged standard, because lending money and holding securities, the
source of most bank revenue and focus of most bank assets, are listed
in BHCA 4(k)(4)(A).
But Title I is not thought to be about banks, it is about BHCs; query
whether FSOC could oust a primary bank supervisor (OCC or FDIC)
from jurisdiction over a bank, moving such jurisdiction to the Board
under Title I.
c. Similarly, DFA 2(12) defines the term primary financial

regulatory agency for all purposes of the DFA, but does not
define primary Federal financial regulatory agency.
i
ii
Section 2(12)(D) identifies the state insurance regulator as the PFRA

for insurance companies, which dont have Federal regulation.
Section 2(12)(C) defines the CFTC as the primary regulator for a range
of commodities firms, despite questions whether those firms would be
predominantly engaged, because of questions whether commodities
activities constitute financial activities under BHCA 4(k).
5. Questions about application of the annual company-run stress test

requirements
a. For banks, despite questions whether and how they constitute
financial companies, agencies clearly subject them to the
requirement.
i
ii
Extensive guidelines for the stress testing issued by 3 bank regulatory

agencies.
Agencies issued regulations jointly.
b. For swap-related entities excluded from the definition of

nonbank financial company by 102(a)(4), no clear indication
whether they should also be excluded from the term financial
company for purposes of 165(i)(2).
82

c. For other (non-swap-related) commodities firms, no clear
indication whether they may be considered financial
companies under 165(i)(2), without regard to the
predominantly engaged definition of 102(a)(6) and its
incorporation of BHCA 4(k)(1).
d. For insurance companies, not clear whether they are excluded
from the requirement on grounds that they do not have a
primary Federal financial regulatory agency.
i
ii
iii
In absence of the definition of the term PFFRA, it may be that the

statute contemplates that the FIO is the companies PFFRA.
Else how to make sense of the reference to the FIO in 165(i)(2)(C).
Counterargument is that since PFRA is state body, insurance
companies do not have a PFFRA, and therefore are not subject to the
requirement.
6. What is clear is that $10b FCs are subject to the requirement without
FSOC designation of them as systemically significant.
a. However, if all of insurance companies, swap-related firms, and
non-swap-related commodities firms are not subject to the
requirement, then the requirement is a narrow one applicable to
securities firms and maybe some leasing, or capital firms,
which tend not to be that large.
b. No indication whether medium-size banks in any way intend to
resist the requirement.
c. Requirement is relatively burdensome for a bank with assets
between $10 billion and $50 billion.
d. The remedy for deficiencies in the stress tests includes
requirement of revisions to living wills: but banks in the $10b$50b range are not subject to the living will requirement, so
the stress test rule is potentially a basis for regulatory expansion
of the living will requirement (or the prudential standards
generally).
H. CAPITAL PLANS
1. Requirement of annual capital plans is not a prudential standard
under DFA; but it was included in January 2012 proposed regulations of
Board, and is applicable only to $50b BHCs.
a. Requirement does not apply to NBFCs, even if supervised
b. Apparently, in view of Board, constitutes exercise of Boards
general power to supervise BHCs
c. Proposed regulations are proposed as amendments to
Regulation Y (12 C.F.R. Part 225), not prudential standards
regulation (12 C.F.R. Part 252)
2. Plan to be submitted by January 5 each year
83

a. Must be resubmitted within 30 days in the event of material
changes in risk profile, financial condition, or corporate structure
b. Must be resubmitted within 30 days if Board objects to plan or
directs revision of the plan for specified reasons
c. 30-day period may be extended to 60 days
3. Contents of plan
a. Projected revenues, losses, reserve, capital levels over planning
horizon (nine quarters, beginning with quarter preceding
submission of plan)
b. Tier 1 common ratio and how BHC plans to maintain tier 1
common ratio of 5% or more during stressed scenarios
c. BHCs process for assessing capital adequacy
d. BHCs capital policy, meaning BHCs written assessment of
the principles and guidelines use for capital planning, capital
issuance, usage and distributions, including internal capital
goals
4. Board may object to plan; BHC may request reconsideration or hearing
5. Required prior approval of capital distributions i.e., dividend
distributions and stock buybacks
a. If distribution would reduce tier 1 common ratio below 5% or
would exceed amount described in capital plan
b. Exception for well-capitalized banks in specified circumstances
for distributions exceeding the amount described in capital plan
c. Application for approval made to Reserve Bank
d. Board discretion whether to hold hearing on denial of application
PART IV.
IX.
EXPANSION AND DIVERSIFICATION OF BANK-RELATED ENTITIES

BANK ACQUISITIONS AND ANTITRUST
84

A. CONCEPT OF CONTROL
1. Approval Requirement
a. Most bank acquisitions must be approved under BHCA 3(a).
i
ii
iii
iv
v
vi
vii
If stock of bank acquired by non-BHC company, company becomes

a BHC, and bank becomes a subsidiary of a BHC
If stock of bank acquired by an existing BHC, bank becomes a
subsidiary of a BHC.
If assets of a BHC are acquired, it is equivalent of acquisition of stock of
bank.
If assets of a bank are acquired by BHC, fourth prong of 3(a) applies.
If BHCs are merged, fifth prong of 3(a) applies.
Major exceptions: mergers of banks, or acquisition of assets by bank of
another bank.
All approval requirements implicate control definition
b. Bank acquisition of assets of another bank and mergers of banks

i
ii
iii
Governed by Bank Merger Act, FDIA 18(c) (12 U.S.C. 1828(c)).

Requires approval of AFBA of resulting or surviving (merger) or
acquiring (asset acquisition) institution.
Same substantive standards as in BHCA
c. BHCA applies where acquiring party is a company, and Bank

Merger Act applies where acquiring party is a bank.
i
ii
iii
Although BHCA definition of company is broad, it does not

encompass all possible acquirers or groups of acquirers.
Major exceptions are where acquiring parties are individuals or groups
of individuals who do not legally constitute any kind of partnership.
In mid-1970s, led to abuses, the Texas Rent-a-bank Scheme
d. Gap filled by FIRIRCA (1978) adopted of Change in Bank Control

Act and Change in Savings and Loan Control Act, now codified at
FDIA 7(j), 12 U.S.C. 1817(j)
i
ii
iii
Applies where persons acting in concert complex definition

Requires approval of AFBA of bank control of which is acquired
More extensive application in context of thrifts than banks
2. Control definition
a. Primarily derived from BHCA
b. De facto control Oberstar decision
i
ii
iii
iv
v
Controlling shareholder of bank was in jail for bank fraud, and was
under prohibition order not to participate in affairs of an IDI.
Oberstar sought to buy the bank, but FDIC refused approval.
Banks chairman decided they needed a shareholders meeting;
controlling SH gave Oberstar proxy to vote shares of SH.
FDIC decided proxy violated 7(j), as control . . . through a purchase,
assignhment, transfer, pledge, or other disposition of voting stock,
and entered a prohibition order.
Eighth Circuit found both that the transaction did not involve change in
control, and that required culpability was missing.
B. ANTITRUST REVIEW
1. Complicated law that is of limited importance today.
85

a. Prior to financial crisis, law was of limited importance because it
was leniently enforced
i
ii
iii
iv
Period 1980-2007 was period of rapid consolidation: number of banks

shrank froim around 20,000 to less than 7000
Board and Justice Department were very lenient in administration of
laws, as noted below.
Since financial crisis, Board has let industry know it is not interested at
all in further consolidation.
Thus, very few bank acquisitions in current environment.
2. Statutory basis
a. Sherman Act 1-2: (1890) prohibit restraints of trade, and
efforts to monopolize
b. Clayton Act 7 (1914) prohibits any combination that tends to
create a monopoly in any line of commerce in any section of
the country
c. Bank Merger Act (1960) clarified application of statute to banks
i
ii
Clarified that regulatory (Board) approval of transaction did not

preclude antitrust enforcement (by Justice Department)
Provided for Board consideration of competitive effects
d. Amendments to Bank Merger Act further clarified application of

antitrust laws to banks
i
ii
iii
Enacted public benefits limitation

Established procedures for Justice Department consideration in
connection with regulatory approval
Limited Justice Department power to block transactions
e. Hart-Scott-Rodino Act (1974) changed antitrust enforcement

procedures
i
ii
iii
f.
Concentrated enforcement in pre-closing review and clearance

HSR does not apply to bank acquisitions
Limited judicial involvement in development of the law
Justice Department Guidelines (1982, 1984, 1992) further

concentrated enforcement in pre-clearance process
i
ii
1982 and 1984 Reagan Administration proposals greatly relaxed

standards
Tightened somewhat by kinder, gentler Bush 41 Administration 1992
revisions but Board of Governors never accepted 1992 Guidelines
3. Judicial background
a. Philadelphia National Bank decision landmark decision
applying Clayton Act to banks
i
ii
iii
iv
v
Affirmed that mergers subject to Clayton Act

Affirmed Clayton Act applies to bank mergers
Adopted 3-step analysis: analyze geographic market; analyze product
market; then antitrust numerology of market concentration indices
Decided geographic market for banking was local area
Decided product market was mix of products generally associated
with commercial banking
b. Frequent subsequent decisions in 1970s

86

c. Connecticut National Bank and Marine Bancorporation decisions
(1974)
i
ii
iii
iii
iv
New antitrust majority four Nixon-appointed Justices, plus Potter

Stewart, cut back on strict standards evolved from earlier Warren Court
decisions
Connecticut National Bank refused to relax geographic market
standards (from local to extended or statewide)
Connecticut National Bank refused to relax product market standards
(no inclusion of savings banks of Connecticu)
Marine Midland Bancorporation limited application of potential
competition doctrine
Last Supreme Court decisions involving bank antitrust
4. Guideline law
a. Reaffirms 3-step approach
b. Third step is Hirschmann-Herfindahl Index (HHI)
i
ii
iii
iv
v
vi
Sum of the squares of market shares of market participants\

Market share measured by share of deposits
Original thresholds for banks was concentration index of 1800 and
increase of 100
Clearly relaxed by late 1990s, to index of 2200 and increase of 200
In practice far more relaxed than that Board tolerated index of 4000
and increases of 500, even 800
Most extreme tolerance NationsBank acquisition of Barnett Banks
(1998) in Florida numerous markets with high tolerances
c. After 1992 (Clinton Administration) some tensions between

Board and Justice Department
i
ii
iii
iv
Most important was product market Justice began analyzing

separately market for small business commercial loans
Also on product market, some flexibility (inconsistency?) on inclusion of
thrift deposits.
Transactions disapproved by Justice subject to consent decrees in Court
no actual litigation, no decisions
Concentration limits often met by required branch divestitures
usually negotiated by Justice, and usually involving existing branches
of acquiring institutions
5. Riegle-Neal and DFA concentration limits

a. Riegle-Neal prohibits acquisitions resulting in concentrations of
30% in any state or 10% nationally
i
ii
iii
Applies only to acquisitions can exceed limits by internal growth

Bank of America and JPMorgan Chase exceed national limits, and in
Florida Bank of America probably exceeds 30% limit (Wells Fargo might
also)
Measured by deposits and is applied to depository institutions
b. DFA 622 (BHCA 14, 12 U.S.C. 1852) prohibits concentrations

of financial companies, as defined for this statute only, in
excess of 10% nationally.
i
ii
Financial companies includes: BHCs, IDIs, SLHCs, supervised NBFCs

under Title I (not unsupervised NBFCs)
Concentration limit applies to liabilities, as defined not to deposits
87

iii
Liabilities is defined as the excess of risk-weighted assets over total

regulatory capital (for purposes of RW capital rules)
C. INTERSTATE ASPECTS
1. Like antitrust, complicated law that is of limited importance today
a. As in the case of antitrust, little consolidation activity in current
environment
b. Most restrictions on interstate activity have been eliminated
c. DFA provisions permitting de novo interstate branching without
regard to state law eliminated significance of restrictions on
acquisitions
d. So, mostly of historical significance
2. McFadden Act
a. Prior to 1907, Comptroller held NBA did not permit national
banks to branch.
b. Beginning 1907, Comptroller allowed intrastate branching to the
extent allowed by state law.
c. Supreme Court struck down NBA branching rights in First
National Bank in St. Louis v. Missouri (1924).
i
ii
Decisions represents strict interpretation by Supreme Court of NBA.

Affirms express powers reading of national bank powers.
d. McFadden Act (1926) allowed very limited branching within local

area of home office of national banks.
e. Banking Act of 1933 amended McFadden Act to provide broader
branching rights to the extent expressly allowed by state
statute law
3. Douglas Amendment
a. 3(d) of BHCA, 12 U.S.C. 1842(d)
b. Adopted in 1956 as part of original BHCA
c. Limited BHCs to acquiring banks in same state as principal bank
subsidiary of BHC prohibition of interstate banking, as
opposed to interstate branching
4. Initiatives prior to Riegle-Neal
a. New England interstate compact (1983) allowed banks in one
New England state to acquire banks in the others on a
regionality basis
b. Compact and an acquisition under it upheld in Supreme Courts
Northeast Bancorporation decision (1984) against attacks that
compact violated the compact and interstate commerce clauses
of the Constitution, and violated the Douglas Amendment
88

c. Proliferation of regionality and reciprocity state laws
throughout the 1980s
i
ii
iii
Led to emergence of superregional banks intermediate between

money center (New York) banks (e.g., Citibank, JPMorgan) and
community banks NationsBank, Banc One, First Union
Superregionals have now been either absorbed by money center
banks (JP Morgan Chase acquisition of Banc One) or become money
center banks themselves (NationsBank/Bank of America merger; Wells
Fargo acquisition of Wachovia).
Laws always excluded New York banks
d. Statutory changes in 1982 permitted limited

interstate/interindustry acquisitions of failing institutions, mostly
thrifts
i
ii
iii
Basis for Citibanks entry into Florida, Texas, and California

Acquisition was usually of thrifts that either were or became Federal
savings banks.
Authority expanded under FIRREA (1989) to permit BHC acquisitions of
any thrift, whether failing or healthy.
e. With limited exceptions, initiatives permitted interstate banking

(BHC control of banks in more than one state), but not interstate
branching (branches of the same bank in more than one state)
i
ii
iii
First Bush Administration in late 1991 (through OTS) permitted

interstate branching by thrifts, after failure of statutory initiative in
1991 (initiative that led to FDICIA).
Section 30 transactions, beginning circa 1989, allowed multistate BHCs
with banks in contiguous states to combine them in limited
circumstances.
Courts upheld section 30 transactions, but on very shaky, dubious
grounds.
5. Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994

(IBBEA)
a. Authorized interstate banking without regard to state law (BHCA
4(d), 12 U.S.C. 1842(d))
b. State age laws respected up to 5 years (had to acquire a bank
in existence at least a certain amount of time
c. 10%/30% deposit concentration caps
6. Authorized interstate branching without regard to state law on a
delayed basis with provision for state opt-out (FDIA 46, 12 U.S.C.
1831u)
a. State age laws respected up to 5 years (had to acquire a bank
in existence at least a certain amount of time
b. 10%/30% deposit concentration caps
c. Effective date delayed until July 1, 1997 (enactment date of
IBBEA September 28, 1994)
d. States permitted to opt out during phase-in period
89

e. Comptroller intimidated state opt-out right by ruling that once a
state opted out, it could not opt back in, ever
f.
Only Texas opted out, and it withdrew the opt-out after

Comptrollers ruling
7. Prohibited de novo branching without state opt-in

a. Only about 10 states opted in
b. Limited expansion by banks in new states to acquiring an
existing institution
c. Placed great stress on definition of a branch permissive
rulings by Comptroller
d. Led to series of egregious rulings by Comptroller on nonbranch activities by out-of-state banks deposit production
offices, loan production offices, supermarket kiosks, etc.
8. DFA eliminated restrictions on de novo branching interstate.
a. Eliminates significance of many restrictions on interstate
acquisitions, e.g., state age limitations, even deposit caps.
b. Eliminates most state authority over branching.
9. Considerable difficulties under interstate branching and banking with
application of state laws, especially consumer protection laws, to
interstate banks.
X.
NONBANK FINANCIAL ACTIVITIES

A. DERIVATIVES
1. Nature of Derivatives
2. Credit Derivatives
B. PROPRIETARY TRADING, HEDGE FUNDS, PRIVATE EQUITY
C. INSURANCE
PART V. BAD BANKS AND BAD BANKING BEHAVIOR

XI.
EXAMINATION AND ENFORCEMENT
90

A. INSTITUTION-AFFILIATED PARTY
B. CEASE AND DESIST ORDERS
1. Unsafe and Unsound Practice
2. RESTITUTION AND AFFIRMATIVE ACTION
C. SUSPENSION AND PROHIBITION
1. Character as Punishment
2. Culpability
3. Hearing Rights
D. TEMPORARY CEASE AND DESIST ORDERS
E. COURT JURISDICTION AND JUDICIAL REVIEW
XII.
FAILED INSTITUTIONS
A. APPOINTMENT AND JUDICIAL REVIEW
B. CLAIMS PROCESS
C. REPUDIATION
D. ACTIONS AGAINST OFFICERS AND DIRECTORS
E. SIDE AGREEMENTS
F.
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2012 Stanley I.

12 U.S. Code 371c1 Restrictions on transactions with affiliates

HISTORICAL AND GENERAL BACKGROUND

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Bank had 20-year term; expired and not renewed in 1811

d. States freely chartered banks, by legislative act; practice led to

Chartered in 1816, for 20-year term

Andrew Jackson and the destruction of the Second Bank

Congress enacted renewal of charter in 1832, in anticipation of

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Jackson awarded Taney by appointing him Chief Justice of the Supreme

3. Free banking era

Sought to destroy state banks by taxing their notes, the obverse

g. Effort to drive out state banks failed because of the emergence

National Bank notes functioned as currency, which resulted in

Narrow interpretation of bank act was followed by the courts,

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National banks required to be members

6. Period between Federal Reserve Act and Great Depression

Federal Home Loan Bank Act (1932) established system of Federal

b. Banking Act of 1933

c. Bank Conservation Act (1933) established special form of

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e. In early 1960s, Comptroller Saxon, President Kennedys

Competitors challenged rulings in courts, in almost all cases

Congress responded with Bank Holding Company Amendments

Extended BHCA to one-bank holding companies.

g. Financial Institutions Supervisory Act of 1966 gave expanded

9. Crisis of the 1980s: Background

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Rising interest rates meant fall in the value of long-term, fixed-rate

e. Fluctuating interest rates led to widespread use of variable rate

Prevalence of variable rate contracts and fluctuating exchange

Derivatives are contracts where value of the property is determined

B. BRIEF HISTORY OF BANK REGULATION IN THE UNITED STATES:

Accounting measures (supervisory goodwill) masked capital position

e. Finally resolved by FIRREA (1989).

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Interest rate and currency swaps described above (see A-9-f).

Began in late 1960s with Ginnie Maes government effort to create a

3. Expansion of bank powers

Interest rate caps inherited from Banking Act of 1933.

b. First objective achieved by legislation in 1980.

Regionality: legislation or compact allowed banks from states in one

4. Legislation of the 1980s

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Expanded powers of Federal thrifts beginning of blurring of lines

b. Depository Institutions Deregulation and Monetary Control Act of

Eliminated caps on interest rates on checking accounts, except

c. Garn-St Germain Act of 1982

Extremely bad piece of legislation

d. Competitive Equality in Bank Act of 1987 (CEBA)

Began as effort to expand bank insurance and securities powers, but

e. Financial Institutions Reform Recovery and Enforcement Act of

Passed quickly after 1988 elections.

FDIC Improvement Act of 1991 (FDICIA)

Like CEBA, began as effort to revise powers of banks and to allow

5. Legislation of the 1990s

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Allowed interstate banking (through multiple bank subsidiaries of

c. Gramm-Leach-Bliley Act of 1999 (GLBA)

Passed after failure to adopt legislation in 104th and 105th Congress.

C. THE CURRENT PERIOD AND THE FINANCIAL CRISIS OF 2007-2009