A bank holding company owns a member bank, a broker-dealer and an insurance company. Which of the group's internal transactions do Section 23A and Regulation W restrict?

Every loan between any two companies in the group, since a member bank sits at the centre of the group

Those between the member bank and any of its affiliates, not a loan the broker-dealer makes to the insurer

Only those between the holding company and its subsidiaries, the member bank being one of those subsidiaries

Only those in which an affiliate lends money to the member bank, the bank being the party the rules protect

Banks hold privileges that together make up the federal safety net. On the reasoning behind Regulation W, what are those privileges meant to serve?

The growth of the whole holding company group, including its securities and insurance businesses

A substitute for equity capital in funding the bank's own lending and investment

The stability of the payments system and the protection of the bank's depositors

Credit for households and small firms that the markets would otherwise decline to finance

A securities affiliate could raise funds in the market, but its sister member bank can raise the same funds more cheaply. Where does the bank's funding advantage come from?

Insured deposits cost less than uninsured market funding, and the discount window lends to it below market rates in stress

Interest it pays depositors is exempt from federal income tax, which lowers its after-tax cost of funds below the affiliate's

A federal cap on deposit interest rates holds what it pays its depositors below the rates the market would otherwise set

It is exempt from the capital rules that bind its affiliate, which leaves more of its funding free to lend out cheaply

Without Sections 23A and 23B, how would a member bank's unrestricted loans, asset purchases and guarantees for its non-bank affiliates misuse the federal safety net?

By concentrating the bank's lending in sectors that Regulation W forbids member banks to finance on any terms at all

By passing on the cheap funding the bank enjoys to companies that have no entitlement of their own to it

By breaching the bank's duty to its own shareholders, who would earn more from lending the same money to outside borrowers

By drawing the affiliates into federal deposit insurance, so that the fund comes to insure their own customers' accounts

A member bank has funded its insurance affiliate heavily, and the affiliate then suffers large losses. On the reasoning behind Sections 23A and 23B, where do those losses end up?

With the holding company parent, which by statute must absorb every affiliate's losses before the bank bears any

With the affiliate's own creditors and shareholders, the corporate structure keeping the losses well away from the bank

Back at the bank, and through it with the deposit insurance fund and the Federal Reserve's emergency lending

With the Treasury, which lends directly to any holding company affiliate that is unable to meet its own debts

An insured bank chartered by its state has never joined the Federal Reserve System. It plans a large loan to a company under common control with it. Do Sections 23A and 23B govern the loan?

They do not, as they bind member banks alone and a non-member bank follows only the limits its own state sets

They will, once its primary federal supervisor has adopted the two sections by a rule of its own for such banks

Only the market terms requirement does, the quantitative limits and the collateral rules binding member banks alone

They do, the Federal Deposit Insurance Act applying them to the bank as if it were a member bank

A national bank lends to its affiliate. On what footing does Regulation W reach the national bank?

Directly, as every national bank is a member bank of the Federal Reserve System

Only if the national bank has chosen to join the Federal Reserve System, membership being optional for it

Not at all, as national banks follow the Comptroller of the Currency's own affiliate rules instead

Indirectly, through the state where the bank has its head office adopting Regulation W into state law

Which of these companies is an affiliate of a member bank under the definition in Section 223.2 of Regulation W?

A pension fund that holds two percent of the shares of the bank's parent holding company

A mutual fund advised by the bank's sister adviser company, though neither owns any of the fund's shares

A clearing firm that settles the bank's securities trades under a long-term contract with the bank

A corporate borrower owing the bank a large loan, though the two share no owners or controlling persons

A member bank makes a loan to the holding company that owns it. How does Section 23A treat the loan?

As an insider loan under separate lending rules, the parent being the bank's shareholder and not its affiliate

As outside Section 23A, which reaches companies under common control but not the bank's own parent

As a covered transaction, a company that controls the member bank being one of its affiliates

As a covered transaction only if the parent owns other companies besides the bank itself

Regulation W treats a member bank's purchase of assets from an affiliate as a covered transaction. What danger is that treatment aimed at?

The bank paying for the assets with insured deposits, which may not lawfully be used to buy securities

The bank building a concentration in a single asset class that its capital rules would not allow

The affiliate parting with assets it needs, which weakens its ability to support the bank in a crisis

The affiliate unloading assets of questionable quality onto the bank for cash, drawing value out of the bank

A member bank buys Treasury notes from its broker-dealer affiliate, and the affiliate agrees to buy them back in a week at a slightly higher price. How does Regulation W regard the arrangement?

As a covered transaction that is in substance a loan to the affiliate, secured by the notes it sold

As a covered transaction that is in substance a deposit by the affiliate, placed with the bank for a week

As a covered transaction that is in substance a guarantee, the bank standing behind the affiliate's notes

As a covered transaction that is in substance an investment in securities the affiliate itself issued

A member bank accepts, as collateral for a loan it makes, bonds issued by one of its own affiliates. Why is accepting that collateral treated as a covered transaction?

The pledge passes the bonds to the bank outright, which turns the loan into a purchase of affiliate bonds

The affiliate's own securities end up supporting credit, a circular support that can rest on inflated values

Bonds issued by an affiliate often have no market price, so the bank cannot value them for its capital ratios

The bank's borrower becomes an affiliate of the bank by pledging the affiliate's bonds to it as security

A member bank issues a standby letter of credit backing its affiliate's commercial paper, and no cash leaves the bank. Why has the Federal Reserve regarded guarantees of this kind as particularly concerning?

They commit the Federal Reserve to honour the paper should the bank itself fail to pay under the letter

They may let the affiliate sell its paper without disclosing its own financial condition to the paper's buyers

They pass the bank's creditworthiness to the affiliate while their full exposure may not show on the balance sheet

They put the holders of the affiliate's paper ahead of the bank's depositors if the bank is liquidated

A member bank has Tier 1 capital of $700 million, Tier 2 capital of $250 million and total assets of $9 billion. Under the ten percent limit, what is the most it may have in covered transactions with any single affiliate?

$70 million, ten percent of its Tier 1 capital, the Tier 2 capital being left out

$25 million, ten percent of its Tier 2 capital, the Tier 1 capital being left out

$190 million, twenty percent of its Tier 1 and Tier 2 capital taken together

$95 million, ten percent of its Tier 1 and Tier 2 capital taken together

A member bank has capital stock and surplus of $3 billion and three affiliates. Its covered transactions with the first affiliate come to $280 million and with the second to $260 million. Under limits of ten percent for any one affiliate and twenty percent for all combined, how much more may it extend to the third?

$60 million, the combined limit for all affiliates binding first

$300 million, the full ten percent limit for that one affiliate

$600 million, the combined limit with nothing used against it yet

$40 million, the room the second affiliate has left under its own limit

A member bank with capital stock and surplus of $800 million makes twelve successive one-month loans of $45 million to one affiliate during a year, each repaid before the next is made. How does the ten percent single-affiliate limit apply?

It is met only if the Federal Reserve approves each loan after the first as a renewal of the original

It is met, as the limit applies to the amount outstanding at any time, which never exceeds $45 million

It is breached in each quarter, as three months of loans total $135 million against $80 million

It is breached, as the loans made over the year total $540 million against a limit of $80 million

A member bank with capital stock and surplus of $1.5 billion has one affiliate. With it, the bank has made an $85 million loan to it and issued a $55 million guarantee of its debt, both covered transactions. How much more may it lend to that affiliate?

$150 million, each kind of covered transaction carrying a ten percent limit of its own

$65 million, the guarantee counting against the twenty percent aggregate limit alone

$10 million, the loan and the guarantee counting together against one ten percent limit

$160 million, the room left under the twenty percent limit for all affiliates combined

An affiliate offers, as collateral for a loan from its sister member bank, a pool of commercial loans that examiners have classified as substandard. What collateral value does Regulation W give the pool?

None, as assets classified substandard, doubtful or loss cannot count toward the requirement

Its full face amount, as classification affects loss provisioning but not use as collateral

Its market value, once an independent appraisal confirms the price the pool would fetch

Half its face amount, the standard reduction applied to any classified asset that is pledged

Why does Regulation W require a larger margin of collateral for a covered transaction secured by equity securities than for one secured by United States Treasury securities?

Treasury securities are guaranteed by the Federal Reserve, so they need no cushion at all beyond their face amount

Riskier, less liquid collateral can lose more value, so a wider cushion above the amount protects the bank

Equities are usually carried at book value rather than market value, so the extra margin offsets stale valuations

Dividends on pledged shares are paid to the affiliate, so the extra margin makes up the income the bank forgoes

A holding company owns ninety percent of the voting shares of each of two member banks, and one of the banks lends to the other. How do Section 23A's quantitative limits and collateral requirements apply to the loan?

Both apply in full, as a bank under common control with the lender is an affiliate like any other company in the group

The limits apply but the collateral rules do not, as a loan made to another insured bank needs no security behind it

Neither applies, though the loan must still be made on terms that are consistent with safe and sound banking practices

Neither applies, and the loan is free of any further restriction, the two banks being treated as one single institution

A member bank lends $230 million to an affiliate. Treasury securities worth $140 million secure part of the loan and corporate bonds worth $170 million secure the rest. The Treasury securities later fall in value to $105 million. Under Regulation W's exemption for credit secured by obligations of the United States, what is the covered transaction now?

$90 million, the part of the loan that the Treasury securities did not cover at the time it was made

$230 million, the whole loan, the exemption being lost once the Treasuries cover less than all of it

$0, the loan still being fully secured once the corporate bonds are counted alongside the Treasuries

$125 million, the part of the loan that the Treasury securities no longer cover at their current value

A member bank's loan to its affiliate is within the ten percent limit and secured by the required collateral, but its interest rate is below what the bank charges comparable unaffiliated borrowers. How does the loan stand?

It breaches Section 23B, as meeting Section 23A's limits and collateral does not cure below-market pricing

It complies, as a loan within Section 23A's limits and fully secured is treated as being on market terms

It complies, as the affiliate's board approved the rate and the bank disclosed it to its own examiners

It breaches Section 23A, as a loan below market rates counts at double its amount against the limit

How does the range of transactions between a member bank and its affiliates that Section 23B reaches compare with the range that Section 23A reaches?

Section 23A's is wider, Section 23B reaching only loans and extensions of credit among covered transactions

Section 23B's is wider, reaching covered transactions and also some transactions that are not covered ones

The two are identical, the sections differing in what each of them requires of the same covered transactions

Section 23B's is narrower, reaching only those covered transactions that exceed the ten percent limit

A member bank made a five-year fixed-rate loan to its affiliate on terms that met Section 23B when the loan was made. Two years later, market rates have risen well above the loan's rate. Does the loan now breach Section 23B?

Yes, unless the affiliate repays the loan within a year of the rise in market interest rates

Yes; it breaches from the day market rates passed its rate, and the bank must reprice the loan

No; Section 23B compares the terms with those prevailing when the transaction was entered into

No, because once made, a fixed-rate loan to an affiliate is exempt from Section 23B altogether

A member bank's trust department wants to buy bonds from the bank's broker-dealer affiliate for a trust that the bank manages as trustee. Under Regulation W, what allows the bank to make that purchase as fiduciary?

The bank's trust committee finding the bonds suitable for the trust and recording its reasons in writing beforehand

Each of the trust's beneficiaries being told of the affiliation in writing beforehand and none of them objecting to it

The affiliate selling the bonds at or below their current market quotation as published in the financial press

The trust instrument, an order of a court, or the law governing the trust relationship permitting the purchase

Since the Dodd-Frank amendments to Section 23A took effect, a member bank has entered into an interest rate swap with its affiliate. The swap's notional amount is $400 million, and the most the bank would lose if the affiliate defaulted on it is $12 million. What counts toward the bank's covered transactions?

The $12 million of credit exposure that the bank has to the affiliate under the swap

The $400 million notional amount, being the size of the contract the bank entered into

The net interest payments the bank expects to receive from the affiliate over the swap's life

The swap's value to the affiliate, being what the affiliate would gain if it were ended now

A Federal Reserve examination finds that a member bank's covered transactions with one affiliate are above the applicable limit. Which responses are open to the Federal Reserve?

Termination of the bank's deposit insurance, which is the one remedy the statute provides for any breach of the limits

A referral to FINRA, which fines the affiliate and bars its registered staff from working in the securities industry

A cease and desist order, civil money penalties, and requiring the bank to unwind or correct the excess

None beyond a finding, the excess being cured on its own as the bank's existing transactions with the affiliate mature

When Federal Reserve examiners review a member bank for Regulation W compliance, which materials does that review cover?

The holding company's securities filings, its proxy statements and the pay of its senior executives

The affiliates' customer complaint files, their suitability records and the sales scripts their registered staff use

The bank's consumer loan disclosures, its fair lending data and its community reinvestment records

Covered transaction records, collateral documents and the bank's own policies for monitoring affiliate exposures

Regulation W | Financial Regulation Courses

SERIES 7 PREP | FINANCIAL REGULATION COURSES

Regulation W — codified at 12 CFR Part 223 and effective April 1, 2003 — is the Federal Reserve Board regulation implementing Sections 23A and 23B of the Federal Reserve Act, which establish quantitative limits, collateral requirements, and market terms standards for transactions between a member bank and its affiliates. Issued under the authority of Sections 23A(f) and 23B(e) of the Federal Reserve Act at 12 U.S.C. 371c and 371c-1, and subsequently amended by Sections 608 and 609 of the Dodd-Frank Wall Street Reform and Consumer Protection Act effective July 21, 2012, Regulation W serves as the primary prudential safeguard preventing banks from using their access to federally insured deposits and the Federal Reserve's discount window — the government-backed safety net — to subsidise or prop up non-bank affiliates, thereby concentrating the financial system's risks inside the insured depository institution where they are ultimately backstopped by the taxpayer.

The Policy Rationale — Protecting the Federal Safety Net

The conceptual foundation of Regulation W is straightforward and directly stated in the Federal Reserve's own regulatory framework. Banks occupy a privileged position in the financial system — they have access to federally insured deposits that cost less to obtain than uninsured market funding, and they can borrow from the Federal Reserve's discount window in times of stress at below-market rates. These privileges — the federal safety net — exist to ensure the stability of the payments system and to protect depositors. They were not created to be used as a funding subsidy for the securities affiliates, insurance affiliates, real estate subsidiaries, and other non-bank entities that may be part of the same financial holding company structure.

Without restrictions on affiliate transactions, a bank could channel cheap federally subsidised funding to its affiliates in the form of loans, asset purchases, or guarantees — effectively transferring the safety net subsidy to non-bank entities that have no independent entitlement to it. In the event those affiliates suffer losses, the problems would flow back to the bank and ultimately to the deposit insurance fund and the Federal Reserve's emergency lending facilities. Sections 23A and 23B were enacted to prevent this subsidy transfer and to maintain a genuine firewall between the insured bank and its non-bank affiliates.

The Scope — Member Banks and Their Affiliates

Regulation W applies to member banks — national banks and state-chartered banks that are members of the Federal Reserve System. The Federal Deposit Insurance Act at 12 U.S.C. 1828(j) extends the requirements of Sections 23A and 23B to insured state non-member banks in the same manner as if they were member banks, effectively making the affiliate transaction restrictions applicable to virtually all federally insured depository institutions. The Home Owners' Loan Act extends the same restrictions to insured savings associations.

An affiliate is defined broadly in Section 223.2 of Regulation W to include any company that controls the member bank, any company under common control with the member bank, any company whose securities are held primarily for the benefit of the bank or its affiliates, and any investment fund advised by the bank or one of its affiliates. Companies that the member bank itself controls are generally not its affiliates — Section 223.2(b) excludes the bank's own subsidiaries from the definition unless the subsidiary is a depository institution or a financial subsidiary, is directly controlled by an affiliate of the bank other than a depository institution or by the shareholders who control the bank, is an employee stock option plan or similar trust for the benefit of the shareholders, partners, members or employees of the bank or its affiliates, or has been determined to be an affiliate by the Board or the bank's appropriate federal banking agency. The breadth of the affiliate definition is deliberately expansive — Congress and the Federal Reserve have consistently interpreted affiliation relationships broadly to prevent circumvention through complex corporate structures designed to place risk-taking entities just outside the technical definition of affiliate.

Covered Transactions — What Regulation W Restricts

Regulation W applies only to covered transactions — a defined category of transactions between a member bank and its affiliates that pose the most significant risks of subsidy transfer and potential harm to the bank. Section 23A of the Federal Reserve Act and Section 223.3 of Regulation W define covered transactions to include six categories.

Loans and extensions of credit to an affiliate — any loan, advance, line of credit, or other extension of credit made by the member bank to an affiliate — are the most obvious form of affiliate funding and the primary target of the original Section 23A restrictions.

Purchases of assets from an affiliate — any purchase of securities, loans, real estate, or other assets from an affiliate — allow the affiliate to transfer assets of questionable quality to the bank in exchange for cash, potentially stripping value from the bank to benefit the affiliate.

Purchases of assets subject to an agreement to repurchase — repo transactions in which the affiliate sells assets to the bank and agrees to repurchase them — are economically equivalent to loans secured by the sold assets and are treated as covered transactions accordingly.

Acceptance of securities issued by an affiliate as collateral for a loan — using an affiliate's own securities as collateral for a bank loan — is a form of circular credit support that could allow an affiliate to borrow against inflated valuations of its own equity or debt instruments.

Issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate — having the bank backstop the obligations of its affiliate — transfers the bank's creditworthiness and its safety net access to the affiliate without a direct cash disbursement. The Federal Reserve has treated guarantees as particularly concerning because their full economic exposure may not appear on the bank's balance sheet during normal operations.

Transactions that involve the bank investing in securities issued by an affiliate — certain investments in affiliate securities — are also covered when they create credit exposure to the affiliate.

The Quantitative Limits — Ten Percent and Twenty Percent

Section 23A establishes two quantitative limits on covered transactions that are among the most examination-relevant specific numbers in Regulation W.

The ten percent limit restricts the aggregate amount of covered transactions between a member bank and any single affiliate to no more than ten percent of the member bank's capital stock and surplus. Capital stock and surplus for this purpose equals the sum of the bank's Tier 1 and Tier 2 capital under applicable risk-based capital guidelines. A bank with one billion dollars of capital stock and surplus may have no more than one hundred million dollars in aggregate covered transactions with any single affiliate.

The twenty percent aggregate limit restricts the total amount of all covered transactions between a member bank and all of its affiliates combined to no more than twenty percent of the member bank's capital stock and surplus. The aggregate limit applies across all affiliates collectively — if a bank has five affiliates each at the ten percent individual limit, the twenty percent aggregate limit is binding before any of the individual limits are reached.

These limits apply to the outstanding aggregate amount of covered transactions at any point in time — not to the amount of new transactions entered in a period. A bank must monitor its covered transaction exposures continuously to ensure neither limit is breached.

The Collateral Requirements

Section 23A imposes collateral requirements on certain covered transactions — primarily loans and extensions of credit to affiliates — to ensure that the bank retains security interests sufficient to recover the loaned amount if the affiliate defaults. The required collateral coverage depends on the type of collateral pledged.

Covered transactions secured by United States Treasury securities or obligations of a federal agency require collateral with a market value of at least one hundred percent of the outstanding covered transaction amount. Covered transactions secured by obligations of states or political subdivisions require one hundred and ten percent coverage. Covered transactions secured by other debt instruments require one hundred and twenty percent coverage. Covered transactions secured by equity securities require one hundred and thirty percent coverage. Low-quality assets — assets that are classified as substandard, doubtful, or loss under bank examination standards — have no collateral value under Regulation W and may not be used to satisfy the collateral requirements.

These tiered collateral requirements reflect the relative liquidity and credit quality of different collateral types — the less liquid or more credit-risky the collateral, the greater the margin required above the loan amount to protect the bank against collateral value deterioration.

Exempt Transactions — Relief from the Limits, Not from Sound Banking

Section 23A(d) and Sections 223.41 and 223.42 of Regulation W exempt certain covered transactions from the quantitative limits and the collateral requirements, but every exempt transaction with an affiliate must still be on terms consistent with safe and sound banking practices. The most significant exemption concerns depository institutions under eighty percent common control — where the member bank controls eighty percent or more of the voting securities of the other institution, the other institution controls eighty percent or more of the member bank's, or one company controls eighty percent or more of both. These sister-bank transactions escape the limits and the collateral requirements, yet Congress deliberately left them subject to the separate prohibition on a member bank's purchase of a low-quality asset from an affiliate.

Section 23A also exempts credit to an affiliate fully secured by obligations of the United States or its agencies, obligations fully guaranteed by them, or a segregated, earmarked deposit account with the bank, and Regulation W extends the exemption to any credit transaction to the extent that it is and remains so secured. The exemption thus covers only the secured portion and moves with the collateral's value — in the regulation's own example, a one hundred dollar loan secured by Treasury securities worth fifty dollars and real estate worth seventy-five dollars is a covered transaction of fifty dollars, and if the Treasury securities fall to forty-five dollars the covered transaction rises to fifty-five dollars.

A third exemption turns on price: a member bank's purchase from an affiliate of an asset with a readily identifiable and publicly available market quotation, bought at or below its current market quotation, is exempt from the low-quality asset prohibition as well as from the limits and collateral rules. The asset qualifies only if its price is quoted routinely in a widely disseminated publication available to the general public — a test which, the Federal Reserve has explained, generally admits only exchange-traded assets, so that a qualifying asset has a true market quotation and examiners can verify the price paid.

Section 23B — The Market Terms Requirement

While Section 23A imposes quantitative limits on covered transactions, Section 23B of the Federal Reserve Act and Subpart F of Regulation W impose a market terms requirement — covered transactions and certain other transactions between a member bank and its affiliates must be conducted on terms and conditions that are at least as favourable to the bank as those prevailing at the time the transaction is entered into for comparable transactions with non-affiliated companies.

This arm's-length market terms standard prevents the bank from providing below-market funding to its affiliates — it must charge interest rates, fees, and prices that reflect genuine market rates rather than artificially subsidised terms that effectively transfer value from the bank to the affiliate. Section 23B applies to a broader range of transactions than Section 23A — including transactions that may not qualify as covered transactions but that could still involve non-market pricing between the bank and its affiliates.

Section 23B — Fiduciary Purchases, Affiliate Underwritings and Advertising

Alongside the market terms requirement, Section 23B of the Federal Reserve Act and Sections 223.53 and 223.54 of Regulation W impose three further restrictions. The first concerns the bank's fiduciary business — a member bank may not purchase as fiduciary any security or other asset from an affiliate unless the purchase is permitted under the instrument creating the fiduciary relationship, by court order, or by the law of the jurisdiction governing the fiduciary relationship.

The second applies while an affiliate is distributing securities. A member bank, whether acting as principal or as fiduciary, may not knowingly purchase or otherwise acquire, during the existence of any underwriting or selling syndicate, a security of which an affiliate is a principal underwriter — unless, before the security is initially offered for sale to the public, a majority of the bank's directors has approved the purchase on a determination that it is a sound investment for the bank, or for the person on whose behalf the bank acts as fiduciary, irrespective of the affiliate's role. The directors need not approve each purchase separately: they may instead approve standards for such acquisitions, provided each acquisition meets the standards and a majority of the directors periodically reviews both the acquisitions and the standards.

The third is the advertising restriction. A member bank and its affiliates may not publish any advertisement or enter into any agreement stating or suggesting that the bank will in any way be responsible for the obligations of its affiliates. Read literally, that language would bar the bank from guaranteeing an affiliate's obligations at all, so Regulation W reads it alongside Section 23A — it does not prohibit a guarantee, acceptance or letter of credit issued on behalf of an affiliate to the extent the transaction satisfies the quantitative limits and the collateral requirements, nor a reference to such an instrument where the law otherwise requires one.

The Dodd-Frank Amendments — Strengthening the Firewall

Sections 608 and 609 of the Dodd-Frank Wall Street Reform and Consumer Protection Act amended Sections 23A and 23B effective July 21, 2012, in several significant respects that reflected the lessons of the 2008 financial crisis.

The amendments extended the covered transaction definition to include credit exposure arising from derivative transactions and securities lending transactions between a member bank and its affiliates — two transaction types that had created substantial but largely unrecognised inter-affiliate exposures during the financial crisis and that the original Sections 23A and 23B did not specifically address. These off-balance-sheet exposures had enabled significant subsidy transfer to affiliates without appearing as conventional covered transactions subject to the ten and twenty percent limits. The amendments further required that each loan or extension of credit to an affiliate, each guarantee, acceptance or letter of credit issued on its behalf, and any credit exposure to it arising from a derivative or securities lending transaction be secured by the required collateral at all times, where Section 23A had previously required the collateral only at the time of the transaction, and they extended the affiliate definition to any investment fund for which the member bank or one of its affiliates is an investment adviser.

Examination and Enforcement

The Federal Reserve conducts examinations of member banks for Regulation W compliance as part of its ongoing supervisory programme. Examiners review covered transaction records, collateral documentation, market terms analyses for Section 23B transactions, and the bank's internal policies and procedures for monitoring and controlling affiliate transaction exposures.

Violations of Sections 23A and 23B and Regulation W can result in cease and desist orders issued by the Federal Reserve, civil money penalties, and requirements to unwind non-compliant transactions. The Federal Reserve may also require a bank to take corrective action to bring outstanding covered transactions within the applicable limits when a violation is discovered during examination.

Examination Relevance and Key Takeaways

Regulation W is tested on the Series 7 examination in the context of banking regulation, the Federal Reserve's supervisory framework, and the restrictions governing transactions between banks and their non-bank affiliates.

The key points to retain are these.

Regulation W — 12 CFR Part 223, effective April 1, 2003 — implements Sections 23A and 23B of the Federal Reserve Act at 12 U.S.C. 371c and 371c-1, governing transactions between member banks and their affiliates. Its purpose is preventing banks from using their access to federally insured deposits and the Federal Reserve safety net to subsidise non-bank affiliates within the same holding company structure. Regulation W applies to member banks and — through the Federal Deposit Insurance Act at 12 U.S.C. 1828(j) — to all insured depository institutions. Affiliates are defined broadly to include all companies under common control and investment funds advised by the bank or its affiliates.

Covered transactions under Section 23A include loans to affiliates, asset purchases from affiliates, repo transactions with affiliates, acceptance of affiliate securities as collateral, and guarantees or letters of credit on behalf of affiliates. Section 23A limits covered transactions with any single affiliate to ten percent of the bank's capital stock and surplus and limits aggregate covered transactions with all affiliates combined to twenty percent of capital stock and surplus. Collateral requirements range from one hundred percent for Treasury security collateral to one hundred and thirty percent for equity collateral. Section 23B requires all covered transactions and related transactions to be conducted on terms at least as favourable to the bank as those available for comparable non-affiliate transactions — the arm's-length market terms standard. The Dodd-Frank Act amendments effective July 21, 2012 extended covered transaction coverage to derivative and securities lending transactions with affiliates, closing gaps that had allowed substantial off-balance-sheet inter-affiliate exposures to develop outside the Section 23A quantitative limits during the 2008 financial crisis.