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Banking Interpretations

Superintendent's Regulations Part 11 and Part 321

November 10, 2005

To: John Ryan/exams/NYSBD

From: Alan Weinberg/legal/NYSBD

cc: Kevin Kaczorowski/exmnr/NYSBD, Manuel Kursky/thrift/NYSBD, Steven Barras/legal/NYSBD, Sara

Subject: [ ] -- insider loan policy questions


This e-mail is a follow up to our phone conversation of November 2, 2005 and to the questions in your e-mail of October 12, 2005 below with respect to [ ] Bank’s recently revised insider loan policy. I am also providing the attached copies of the federal regulations related to insider lending, which you requested, and would like you to note that loans by a bank to its affiliate are also subject to Section 23A and 23B of the Federal Reserve Act.

As we discussed [ ] has adopted a single insider loan policy that is designed to facilitate its compliance with various regulations, both on the state and federal levels, pertaining to insider loans. As you indicated, a single set of rules on this subject is intended to ease [ ] administration and compliance efforts even if in some situations it may restrict what might otherwise be permitted by the regulations in this area.

As I understand it [ ] Bank is a state- -chartered, federally-insured, non-member bank. Thus, on the federal level, [ ] Is subject to the FDIC safety and soundness regulation, as it relates to limits on extensions of credit to insiders of non-member banks. See 12CFR337.3, which is attached. This FDIC regulation, with minor variations, largely incorporates and tracks the FRB's Regulation O, 12 CFR215. Thus, Regulation O, which is also attached and which pertains to member banks, applies in large measure to [ ] Bank and other non-member banks, too.

On the state level, the applicable regulations, as you know, are Part 11 and 321 of the Superintendent's Regulations.

Each question you presented needs to be considered both from a federal and state regulatory perspective. We will try to answer each in turn and to provide some additional information that may prove helpful to you when dealing with related issues in the future.

Question #1 -- Does the Part 11 definition of an insider apply to Regulation O transactions?

Answer #1-- No. You are correct in your belief that the definition included in Part 11 pertains solely to Part 11. Regulation O and Part 11 are separate regulatory schemes dealing with the same subject matter. The regulations use different terminology and are structured differently.

However, with respect to the concepts of insiders, related persons or interests and immediate family, Regulation O has less broad coverage than Part 11. Therefore, if [ ] essentially adopts this definitional coverage from Part 11 and incorporates it into its insider lending policy, that should be sufficient to cover what is required by Regulation O.

This is illustrated in the example you referenced. A "person related to an insider" as defined in Part 11.1(e), in the case of a natural person, is "(i) the insider's spouse, (ii) any relative of the insider or the insider's spouse, if such relative has the same home as the insider and (iii) an insider's parent, stepparent, child or step child regardless of age or residency."

Regulation O, in Section 215.2(g), defines "immediate family" as

"the spouse of an individual, the individual's minor children, and any of the individual's children (including adults) residing in the individual's home."

This Regulation O definition, therefore, is less inclusive of relatives than the definition under part 11. As a result, the person to whom you referred, the 30 year old son of a director not living at home, would not come under the definitions in Regulation O, but would under Part 11.

Question #2 -- Does Part 321.7 limit borrowings of a director of a bank holding company to $100 thousand?

Answer #2 -- No. We believe that, although the provision in question is not entirely free from ambiguity, you are correct that directors of a bank holding company are not restricted to the $100 thousand borrowing limit imposed upon executive officers of a (bank or) bank holding company.

You indicated that [ ] management's interpretation, as reflected in their insider loan policy, is to limit borrowings of a director of the bank holding company to $100 thousand. Their interpretation is based on Part 321.7, which provides as follows:

§ § 321.7 Loans to executive officers and directors of bank holding companies.

(a) The provisions of sections 321.1(b), 321.2, 321.3 and 321.4 of this Part shall apply to any loan made by a bank subsidiary of a bank holding company to an executive officer or director of the bank holding company.

(b) The provisions of section 321.6 of this Part shall apply to any director of a bank holding company who becomes obligated on any loan or extension of credit to any banking subsidiary of a bank holding company. Emphasis Added.

[ ] management believes that Part 321.4 applies to loans to executive officers and directors of a bank holding company because of the language to that effect, highlighted above, in Part 321.7(a), which we think is perhaps too literal a reading. [ ] approach is acceptable, but in our view unnecessary, under the Superintendent's regulations. If this result were intended by the regulations, which we think are ambiguous on this point, Part 321.7(a) could have used the word "and" rather than the word "or." This is not the most persuasive reason, however, why we think that Part 321.7 makes Part 321.4 apply to loans to executive officers only, but not directors, of a bank holding company.

In adopting the regulatory amendment creating Part 321.7, the Department indicated, in a letter dated April 21, 1986 "to the individual or institution addressed," that

"The amendments conform the regulation to statutory amendments of Banking Law Section142 (3)(b), which provide for substantially similar treatment of bank loans to bank holding company executive officers and directors as of bank loans to its insiders."

Thus, the Department previously expressed its intent that loans to directors of banks and bank holding companies ought to be treated the same. If Part 321.4 does not apply to directors of banks, it should not apply to directors of bank holding companies by virtue of Part 321.7. A proper reading of Part 321.7 should interpret it within the context of the other sections to which it refers. (See discussion of Part 321.4 below.)

The purpose of Part 321.7 is essentially to extend and broaden the application of sections 321.1(b), 321.2, 321.3 and 321.4, and 321.6 from banks to bank holding companies. Each of these sections covers executive officers or directors or both at banks, and none of these sections covers bank holding companies. Part 321.7, in a shorthand manner, extends these sections from banks to bank holding companies and this shorthand approach creates the ambiguity we are concerned about.

It is worthwhile to examine each of these sections:

Part 321.1(b) defines "executive officer" as essentially a policy-making officer for the bank, and excludes those acting solely as directors. To say that Part 321.7 makes the provisions of this definition apply to an executive officer of the bank holding company is one thing and an awkward one at that. Nevertheless one needs to do so to give meaning to Part 321.7. To say that Part 321.7 makes the provisions of this definition apply to a director of the bank holding company, however, is too much of a stretch when the definition does not include a director of the bank.

Part 321.2 contains the general provisions of what is considered to be a loan to an executive officer or a director of a bank. It seems reasonable to say that Part 321.7 makes these provisions apply to a director as well as an executive officer of the bank holding company.

Part 321.3 contains the requirements and restrictions on loans to an executive officer or a director of a bank. It seems reasonable to say that Part 321.7 makes these provisions, too, apply to a director as well as an executive officer of the bank holding company.

Part 321.4 , the section we are most concerned with, contains the additional restrictions on a loan to an executive officer, but not a director, of a bank. It seems reasonable to say that Part 321.7 makes these provisions apply an executive officer of the bank holding company, but not to a director of the bank holding company. To say otherwise would yield the anomalous result that Part 321.7 makes the additional restrictions on a loan apply to a director of the bank holding company, even though the same restrictions do not apply to a director of the bank. This would be an affront to common sense, as well as to the purpose of Part 321.7, as expressed in the Department's letter dated April 21, 1986 mentioned above.

Part 321.6 requires annual financial statements of every director of a bank. Part 321.7 clearly makes these provisions apply to a director, but not an executive officer, of the bank holding company.

Question #3 -- If an executive officer of the bank has only a 12.5% share in an LLC that borrows $250 thousand, is this a violation of Regulation O and/or Part 321.4, if the executive officer does not sign the note?

Answer #3 -- No, this is not necessarily a violation (and the result should not change regardless of whether the executive officer signs the note since it is the LLC that is the maker even if the note is signed by the individual). Your question is focused on the federal and state rules that at times limit extensions of credit to $100 thousand. This scenario needs to be looked at separately under Regulation O and Part 321. Also, please note that loans by a bank to its affiliate are subject to Section 23A and 23B of the Federal Reserve Act.

Under Regulation O, section 215.4 places requirements on the extension of credit to an "insider," which means "an executive officer, director, or principal shareholder, and includes any related interest of such a person. " In turn, each of these four terms is also defined. For purposes of you question, we can assume that the person to whom you refer is an executive officer and that the LLC is a related interest of the executive officer and hence an insider, although this latter point is potentially rebuttable.

Section 215.4 requires, in brief, that no preference be given to the insider, that prior approval from the banks board be sought under certain circumstances and that certain lending limits not be exceeded. For purposes of your question, we can assume that these requirements have been satisfied.

Section 215.5 restricts credit extensions by a bank to executive officers, but not to insiders. The 215.5 restrictions are in addition to the requirements of 215.4 that apply to insiders, including executive officers. One of the 215.5 restrictions, at times, limits extensions of credit to $100 thousand. However, this restriction is not applicable to credit to an insider, the LLC in our case, which is likely to be considered a related interest of the executive officer. Note that if the loan proceeds were to be considered for the tangible economic benefit of the executive officer the result would be different.

Under Part 321.2 there is a general provision that considers a transaction with a corporation or partnership to be one with the executive officer under certain circumstances. In our case, however, the transaction is with the LLC, which is neither a corporation nor a partnership. Therefore, under Part 321 the loan would not be considered to be to the executive officer and the limits on certain extensions of credit to $100 thousand would not be implicated. (Incidentally if the LLC were considered a corporation, the loan would still not be imputed to the officer since he owns less than a majority stake; whereas, if the LLC were considered a partnership, the loan would be imputed to him.)

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