2 Lettered Regulations of the Board of System

Transcription

2 Lettered Regulations of the Board of
Governors of the Federal Reserve
System
FIS Regulatory Advisory Services
Equal Credit Opportunity
Regulation B
That part (or even all) of the
applicant‘s income is from public
assistance programs (such as Aid to
Families with Dependent Children,
Social Security, and non-cash benefits
such as food stamps)
That the applicant has, in good faith,
exercised any rights under the Federal
Consumer Credit Protection Act (an
omnibus federal statute which includes
the ECOA itself, the Truth-in-Lending
Act, and other similar statutes)
Common name: Regulation B
Reference: 12 C.F.R. 202
Introduction
Regulation B is the regulation of the Board
of Governors of the Federal Reserve
System that implements the Equal Credit
Opportunity Act (ECOA). This regulation
applies to all federally regulated lenders and
to most lenders that are not federally
regulated. The purpose of the law and the
regulation is to prevent discrimination on a
prohibited basis in any aspect of a credit
transaction.
The Prohibited Bases
Most of the prohibited bases are selfexplanatory, but some aspects of them
require some additional information. ―Sex‖
means the applicant‘s physical attributes,
not sexual preference. While case law on
the rights of male and female homosexuals
is an evolving body of precedent, we are
unaware of any application of this particular
federal statute to protect people against
adverse credit decisions based on their
sexual preferences. A few state and local
laws have been enacted along these lines,
so double-check those sources if you are
about to deny credit to an applicant who
appears to qualify for the protection of those
state or local rules.
The initial version of the Equal Credit
Opportunity Act outlawed discrimination in
any aspect of a credit transaction on either
of two ―prohibited bases‖: sex and marital
status. The objective was to have women
with certain economic attributes, such as
income, assets, and credit history, treated
exactly the same as men with the same
economic attributes. At the time, some
lending institutions engaged in the practice
of discounting the income of young,
working, married women, allegedly based
on valid statistics.
Because the initial proponents of the law
believed divorced women were being
treated particularly unfairly by lenders, the
term ―divorced‖ was removed from the
permissible categories of marital status in
credit documents. The only permissible
marital statuses now are ―married,‖
―unmarried,‖ and ―separated.‖
Divorced
people must be classified as ―unmarried,‖
the same as people who have never been
married, widows, and widowers.
In 1977, Congress extended the ECOA to
prohibit discrimination on seven additional
prohibited bases. Now, the list of prohibited
bases a bank is forbidden to discriminate
upon in any aspect of a credit transaction
reads as follows:
Sex
Marital status
Race
Color
Religion
National origin
Age (if above the age of majority)
The inclusion of both race and color as
separate prohibited bases puzzles those
who are unable to conceive of any
distinction.
In the field of employment
discrimination, however, where the federal
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Regulation B
―seniors‖ programs that grant reduced loan
or credit card interest rates or similar credit
concessions to those above age 55, 60, 65,
or any age except 62, are blatant violations
of ECOA.
The various federal bank
regulators periodically remind the industry of
this fact, but many banks maintain such
programs nonetheless, usually citing
―competitive reasons.‖ A reverse mortgage
program that requires borrowers to be 62 or
older is permissible, and the bank may
consider a borrower‘s age to evaluate the
pertinent element of creditworthiness, such
as the amount of credit or monthly
payments that the borrower will receive or
the estimated repayment date.
statutes contain language similar to that in
ECOA, there have been cases fought over
alleged discrimination by light-skinned
African-Americans against dark-skinned
ones and vice versa. ECOA plainly outlaws
discrimination on either basis.
Discrimination in credit granting by banks on
the bases of religion and national origin
appears to have been quite rare even
before ECOA, but the rules ought to be kept
in mind as cautionary notes. A banker who
must turn down a loan request by a
borrower who is of a minority religion or
national origin must be certain that the
purely economic grounds for the turndown
are evident in the bank‘s file documents.
Name, mode of dress or speech, and
physical characteristics are the usual ways
a banker decides he or she is dealing with
such a protected borrower.
No credit
application or financial statement form we
are aware of explicitly asks for information
on the applicant‘s religion or national origin.
The fact that part, or even all, of the
applicant‘s income is from public assistance
programs cannot be used as a reason for
turndown. The fact that the income is
insufficient, or that the applicant soon will
lose eligibility (through children reaching the
age of majority or other factors) can be
considered. In fact, most public assistance
programs do not provide sufficient income
to allow their recipients to qualify for most
bank loan programs, but in those cases
where the applicant would qualify, full
weight must be given to the money received
from the programs.
Age discrimination can be tricky to avoid
even for the well-intentioned bank. Once an
applicant is over the age of majority (in most
states either 18 or 21 years of age, the age
at which an applicant may sign legally
binding contracts for things over and above
the necessities of life) a bank may not treat
that applicant less favorably than other
credit applicants because of how much
over the age of majority he or she may be.
A bank is allowed to turn down or impose
additional conditions on applications from
people under the age of majority, whatever
that age may be in the relevant state. The
law and regulation allow a bank to treat
applicants age 62 and older more favorably
than those age 61 and younger, but any
other age difference is illegal. Applicants
age 62 and over are ―elderly‖ under ECOA.
This breakpoint of age 62 is a nationwide
standard under federal law, regardless of
what age of majority or other age-related
legal events or statuses a state may have
enacted into its laws. Specifically, all the
The final prohibited basis is the fact that the
applicant has, in good faith, exercised any
rights under the Federal Consumer Credit
Protection Act. It is almost impossible for a
bank to show that the applicant‘s exercise of
those rights was not in good faith. We are
unaware of any such case in the history of
the Equal Credit Opportunity Act. What this
prohibited basis means in practice is that
the fact that an applicant has sued the bank
under one of the federal consumer credit
protection statutes covered by FCCPA
cannot be used against the applicant if he or
she applies for credit to that same bank.
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Regulation B
entities, such as partnerships and limited
partnerships.
Scope of the Law
The ECOA forbids discrimination on a
prohibited basis in ANY aspect of a credit
transaction. The bank‘s print and electronic
ads for credit must be neutral as to all nine
prohibited bases. No bank would use text in
its advertisements that is intentionally
discriminatory; unintentional discrimination
is the danger.
The ECOA rules for
advertising require using models and actors
of both sexes and all ages, races, and
national origins represented within the
bank‘s market territory. If all the people in
an advertisement are young, white, and
male, the bank may be deemed to be
sending a message that other kinds of
people need not apply. Similar cases have
come
down
under
the
housing
discrimination rules.
ECOA also protects members of a protected
class from ―disparate effect‖ discriminatory
practices of a bank, even though the
protected person has never dealt with the
bank and has no plans to do so.
Discrimination
The enforcers of the credit discrimination
rules have defined three forms of
discrimination.
They
are
―overt
discrimination,‖ ―disparate treatment,‖ and
―disparate impact.‖ Overt discrimination is
an action, statement, writing, or other event
that is discriminatory on its face. Disparate
treatment occurs when a protected
applicant is treated more harshly than a
nonprotected applicant with an equal or less
favorable credit profile. Disparate impact
occurs when a policy or practice that is
neutral on its face as to discrimination has a
harsher impact on a protected class in its
application.
At the ―back end‖ of the process, the bank‘s
collection staff may not impose tougher
collection practices or workout terms on
divorced women than they do on married
men, or vice versa.
Secondary Reach
Overt Discrimination
The ECOA protects not only the applicants
for credit, but also those who will ultimately
benefit from the use to which the loan
proceeds will be put. For example, if the
direct applicant for a loan is a 30-year-old
white Anglo-Saxon Protestant married male,
but the purpose of that applicant‘s loan
request is to enable him to build a home for
unwed mothers of whatever is the least
popular local minority, the banker must be
cognizant of the antidiscrimination rules.
Those intended beneficiaries of the
transaction are just as protected by ECOA‘s
rules as is the direct borrower.
Many actions constitute overt credit
discrimination. Regulation B deals in detail
with three aspects of a credit transaction
and defines actions that constitute overt
discrimination in relation to each. The three
aspects are the taking of a credit
application, evaluation of credit, and the
extension of the credit (primarily signature
requirements).
Applications for Credit. Entry into the
system cannot be limited on any
discriminatory basis. Just as a bank‘s
advertisements must be neutral as to all
nine prohibited bases so as not to
discourage applicants illegally,
bank
personnel must not say or write things that
would discourage someone from applying
for credit based on a forbidden
characteristic.
The
Commentary
to
Similarly, ECOA makes it illegal to refuse to
lend to a corporation because its president
is divorced, its directors Hispanic, its
shareholders black, or any similar reason.
The same rules apply to other business
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Regulation B written by the Federal Reserve
Board gives as an example a statement to
an applicant that ―you should not even
bother to apply,‖ after the applicant has said
he is retired. Discouraging applicants from
applying for loans based on where the
proposed real estate collateral is located
can be a Community Reinvestment Act
violation as well as a violation of ECOA.
Encourage applications and grant or deny
them based on legally permissible criteria
only.
Regulation B
The use of courtesy titles such as Ms. or Mr.
must be plainly identified as optional. And,
as a practical matter, whatever other
courtesy titles a bank offers as options, Ms.
must be one of the choices. Limiting female
applicants to only Miss or Mrs. would be
deemed to be an impermissible request for
marital status information. Section 202.5(c)
Bankers must not ask an applicant‘s marital
status unless the applicant resides in a
community property state, is relying on
property in such a state as a basis for
repayment, or the application is for joint
and/or secured credit. Even when the
inquiry is permitted, the bank may use only
the terms, married, unmarried, and
separated.
The category unmarried
includes persons who have never been
married, persons who have been divorced,
and widows and widowers.
To prevent the use of certain kinds of
information in a discriminatory way, banks
are not allowed to ask certain questions of a
credit applicant.
Questions requiring
information about any present or former
spouse are only permitted if:
The spouse will be allowed to use the
account;
Bankers are not allowed to inquire about an
applicant‘s birth control practices or
intentions, or the applicant‘s ability to have
children. Bankers are allowed to ask the
number and ages of the applicant‘s
dependents, so long as that question is
asked whether the applicant is male or
female, married or unmarried, and so on.
(Asking that question only of women would
be a violation of ECOA.) Section 202.5(d)(3)
The spouse will be contractually liable
on the account;
The applicant is relying on the
spouse‘s income as a basis for
repayment;
The applicant lives in a community
property state (Arizona, California,
Idaho, Louisiana, Nevada, New
Mexico, Texas, Washington, and
Wisconsin), or property on which the
applicant is relying as a basis for
repayment is in such a state; or
Alimony, child support, and separate
maintenance payments are a sensitive
subject. Banks are allowed to ask whether
an applicant is responsible for making such
payments. However, before a bank may
inquire about whether an applicant will be
relying on receipt of such payments to
repay the loan applied for, it must disclose
that the applicant need not reveal such
payments if he or she does not want the
bank to consider them in determining
whether the applicant qualifies for the loan.
This disclosure must be given before the
inquiry is made. In the context of a printed
application form, the disclosure of the right
not to tell about receipt of such payments
must appear above and/or to the left of the
The applicant relies on alimony, child
support, or separate maintenance
payments from a spouse or former
spouse as a basis for repaying the
credit requested. Section 202.5(c)
With some exceptions for housing-related
loans Section 202.13 the bank must not ask
the applicant‘s sex, race, color, religion, or
national origin, but inquiries about an
applicant‘s
permanent
resident
or
immigration status are permissible. Section
202.6(b)(7)
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inquiry about income, so that even an
applicant who fills in the application as he or
she reads through it will not inadvertently list
income from such a source before reading
the disclosure that it is not required. The
compliance officer should include this item
in his or her review of bank forms for ECOA
compliance. Section 202.5(d)(2)
Regulation B
open credit accounts in their own names.
An applicant is allowed to open a credit
account in his or her ―birth-given surname‖
(―maiden name‖ was discarded as archaic,
sexist, and otherwise unsuitable), a
combination of the applicant‘s birth-given
surname and the applicant‘s spouse‘s birthgiven surname, or just the applicant‘s
spouse‘s birth-given surname.
Thus, if
Mary Smith married John Jones, she would
be entitled to open loans as: Mary Smith,
Mary Smith-Jones, Mary Jones-Smith, or
Mary Jones. The bank is entitled to require
her to pick one of these names and use it in
all her dealings with the bank. Section
202.7(b)
Inquiries about particular types of income,
such as salary, wages, tips, or investment
income, need not be prefaced by the
disclosure of the right to withhold the
information.
Those types of income
typically are followed by a catchall inquiry
about ―other income‖, however, and that
inquiry must be prefaced.
Evaluating Credit Applications.
In
judging whether an applicant‘s income from
alimony, child support, or separate
maintenance (now properly listed only after
disclosure of the right to withhold
information about it) is sufficient, the banker
is entitled to consider the likelihood that the
payments will be made in the future. The
banker may ask whether the payments are
made pursuant to a formal or informal
agreement,
court
order,
or
other
arrangement, and about the enforcement
mechanisms for such an arrangement under
relevant law and practice. The banker must
not, however, pull a credit bureau report on
the person who is responsible for making
those payments to the applicant unless that
payor (not just the applicant) consents. This
restriction comes from the Fair Credit
Reporting Act. Section 202.6(b)(5)
Banks are allowed to inquire about
ownership of assets listed on an application
(are they jointly owned for example) and
about whether any debt listed on the
application is jointly owned. Most welldrafted application and financial statement
forms require such a breakout, but
customers often do not complete the forms
correctly. Bankers are allowed to confirm
that the forms have been filled in correctly.
The name under which a person opens a
loan relationship is also a subject of some
history under the ECOA, and ties into the
reporting of credit experience and the
development of credit history. Prior to the
enactment of ECOA, many married women
found that they were almost nonentities to
the lending industry because they had no
credit history separate from their husbands‘
credit histories. Both while married and
when they became divorced, they were
turned down for loans for that lack of credit
history, even though in some cases they
had been responsible for financial
management of the couple‘s borrowing
relationships, and thus largely responsible
for the couple‘s (combined) good credit
history.
The ECOA prohibits using statistics that
show that young, working, married women
are more likely than other members of the
work force to drop out of the work force, and
therefore suffer a loss of income. Any bank
that still uses such statistics is violating the
law. Section 202.6(b)(3)
A bank may consider whether there is a
telephone in the applicant‘s home, but must
not consider (or even inquire) whether there
is a telephone listing in the applicant‘s
The ECOA expressly requires lenders to
permit married women (and anyone else) to
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name. This distinction is a subtle one. The
telephone in a married couple‘s home often
was listed in only one name. To make
absence of a telephone listing a negative
factor would discriminate against the
married applicant. The compliance officer
should be certain the bank‘s forms are
phrased to ask for ―home telephone
number‖ or some similar permissible
language. Section 202.6(b)(4)
Regulation B
other prohibited bases. All the rules on
credit history stated above apply only ―to the
extent that a creditor considers credit history
in evaluating the creditworthiness of
similarly qualified applicants for a similar
type and amount of credit.‖ If a bank would
not consider credit history when the
applicant for a particular amount and type of
loan is a 35-year-old white Anglo-Saxon
Protestant married male, the bank will have
difficulty justifying an inquiry into credit
history when an applicant of different
characteristics applies for a similar loan.
ECOA requires banks to consider credit
history developed on accounts that may
have been nominally the husband‘s, but for
which both spouses where contractually
liable, and/or that each was permitted to
use. Furthermore, banks are required to
consider the history of any account in the
name of an applicant‘s spouse or former
spouse that the applicant can show actually
reflects
the
applicant‘s
own
creditworthiness. Canceled checks showing
that the applicant, not the spouse or exspouse, made all or most of the payments
on a well-handled credit account might be
one example of such proof. Others could
be developed in particular circumstances.
Retain copies of the proof provided by the
applicant in the loan file.
There are only two ages at which a bank
may treat credit applicants differently. The
first age is under the age of majority, usually
either 18 or 21, depending on the laws of
the particular state. The second age of
importance under ECOA is 62 and over.
The bank must not use any other ages
except these two in any of its credit
practices. The compliance officer should
review any ―seniors‖ program to ensure no
age other than 62 is used. Section
202.6(b)(2)
Under ECOA there are only two
classifications into which all methods of
evaluating
credit
applications
are
pigeonholed. The first is ―an empirically
derived, demonstrably and statistically
sound,
credit
scoring
system‖
(EDDSSCSS).
All other systems are
classified as ―judgmental systems of
evaluating creditworthiness.‖ To qualify as
an EDDSSCSS, the credit scoring system
must be:
The ECOA also requires banks to consider
any evidence an applicant might present
that shows that the history of a particular
account did not reflect the applicant‘s credit
practices and creditworthiness. Records
showing that the ex-spouse was the only
user of the account or the only owner of the
property (a car, for example) purchased with
the proceeds of the loan might qualify.
Again, keep evidence provided by the
applicant in the loan file in case of future
need. Section 202.6(b)(6)
Based on data derived from an
empirical comparison of sample
groups
for
the
population
of
creditworthy
and
noncreditworthy
applicants who applied for credit within
a reasonable preceding period of time
Bankers must not request credit history from
some applicants and not others for the
same type and amount of credit. That by
itself is a violation of ECOA if done on the
basis of sex, marital status, or any of the
Developed for the purpose of
evaluating the creditworthiness of
applicants with respect to the
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Regulation B
legitimate business interests of the
creditor using the system (including,
but not limited to, minimizing bad debt
losses and operating expenses in
accordance
with
the
creditor‘s
business judgment)
income expected by that applicant that can
be reasonably substantiated. Comments 16 Section 202.6(b)(2)
Developed and validated using
accepted statistical principles and
methodology
The Federal Reserve recognized that a
bank‘s files might wind up containing
information the bank is not allowed to
request.
Such information might have
entered the bank‘s files before 1977, when
the law first forbade it, or it might be the
result of an applicant or a credit reporting
agency giving more information than the
bank requested. The federal government
requires banks to ask applicants for
otherwise prohibited information (race, sex,
etc.) to allow the government to be sure the
banks are not using that information to
discriminate in granting certain kinds of
loans.
Income from permanent part-time work
must be given the same weight as the same
amount of income from a full-time job.
Periodically revalidated by the use of
appropriate statistical principles and
methodology,
and
adjusted
as
necessary to maintain predictive
ability.
Note the ongoing compliance burden that
comes with an EDDSSCSS.
The law
permits the bank to obtain such a system
from another person or to develop its own.
If the bank develops its own, but is not able
to validate the system based on its own
credit experience during the development
period, it must do so as soon as sufficient
credit experience is available. Any system,
self-developed or obtained elsewhere, must
be revalidated periodically, and if it ever fails
revalidation, it must be adjusted as
necessary to reestablish its predictive ability
or no longer used as an EDDSSCSS.
Information obtained in these ways is
expressly allowed in the bank‘s files and,
the regulation says, will not be deemed a
violation of ECOA. The bank, however,
must always be able to prove that it did not
use that information in making its credit
decisions.
In an EDDSSCSS, a bank may use the
applicant‘s age as one of the predictive
variables, so long as the age of an applicant
who is 62 or older is not assigned a
negative factor or value. In a ―judgmental‖
system (that is, any method other than an
EDDSSCSS) the applicant‘s age may be
considered only in determining a pertinent
element of creditworthiness. Length of time
until retirement is the most common use of
age in such systems. The Official Comment
on this portion of the regulation has not
been revised since another federal law
eliminated most mandatory retirement ages,
so bankers need to exercise care in
determining the age of retirement for any
particular elderly applicant. They also must
be careful to give full weight to all retirement
Recommendations to Avoid
Overt Discrimination
Enlist the aid of top management to
make it plain to all staff that the bank
does not and will not discriminate on
any prohibited basis.
Review the bank‘s application forms
for the requirements identified in this
section.
Train all bank employees, not just
those in loan-related jobs, about the
nine prohibited bases and the major
rules. A receptionist or teller, for
example, might inadvertently say
something that would discourage
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someone from
prohibited basis.
applying
on
a
Regulation B
Assume that a person applies for an
unsecured loan. ECOA requires the bank to
evaluate that person‘s income, assets,
credit history, and/or other economic
attributes under the bank‘s established
credit standards for the particular type loan.
If the applicant meets those standards, the
analysis stops. The bank must grant the
credit and may require only the applicant‘s
signature on the promissory note, credit
agreement or other document evidencing
the credit extension. No other signatures
may be required by the bank. Specifically, if
the applicant is married, the bank must not
require that his or her spouse sign or cosign
any document. This also includes requiring
a guarantor‘s spouse to sign the guarantee.
Although a bank may require the personal
guarantee of partners, directors, officers, or
shareholders of a closely held corporation,
the requirement must be based on the
guarantor‘s business relationship and not on
any prohibited basis. Section 202.7
Train
those
who
take
credit
applications to be especially alert to
ECOA compliance issues in their
work. What would be merely polite
conversation in a non-lending situation
(―What a lovely wedding ring.‖) can be
turned into something illegal in the
eyes of an aggrieved or sensitive
customer.
Be sure the bank can track and report
each
customer‘s
credit
history
separate from his or her spouse‘s
credit history.
If your bank uses a credit scoring
system to decide who gets some type
of credit account (credit cards are
frequently granted or denied using
them, for example), be sure the
system was validated at inception and
have it revalidated periodically.
The bank‘s credit application or financial
statement forms should require the
applicant to break out assets and income in
his or her name alone versus those owned
jointly with another, such as a spouse. The
bank should then analyze the applicant‘s
creditworthiness in light of that breakout. In
the valuation of the applicant‘s interest in
jointly owned property, the bank may not
consider that separate property may be
transferred to joint property sometime after
consummation of the loan or that a couple
may later divorce. If the applicant lacks
sufficient income or assets (or any other
economic attribute) the bank is entitled to
tell the applicant that alone he or she does
not qualify for the credit requested, but that
the bank would reconsider if the applicant
obtained one or more ―creditworthy
cosigners.‖ The term in quotation marks is
critical. The bank must not require or
suggest that the applicant‘s spouse, or any
other particular person, such as a ―family
member,‖ be the cosigner.
With one
Keep records of all these actions to
prove to examiners (and judges and
juries, if necessary) that you did them.
At training sessions, take roll or have
sign-up sheets to prove who attended.
Tape the sessions, if possible.
Preserve copies of the outlines and
handouts. Keep the ―old‖ pages of the
compliance calendar we supply you,
showing your reviews. Retain your
work papers, or at least your final
report, on each review. Document,
document, document!
Extensions of Credit Signature Rules
The nondiscrimination rules apply to any
type of credit transaction, whether
commercial, industrial, or consumer in
nature. The rules on whose signature the
bank may require on which document are
complex, and often require banks to deviate
from long-established industry practices.
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exception, the law requires the bank to
leave open to the applicant‘s selection who
is a possible creditworthy cosigner. The
exception is that the bank may require that
the cosigner reside within the bank‘s normal
market area. Section 202.7(d)
Regulation B
estate, a CD, etc.) and how the property is
owned (in common, by the entirety, etc.).
In most states, a bank account or CD
captioned ―John Jones or Mary Smith‖ may
be withdrawn in full or pledged by either
owner on his or her sole signature. In most
states, no security interest at all can be
obtained in a residence owned by a married
couple unless both spouses sign the
mortgage, deed of trust, or similar
instrument. Property owned by several
unrelated people as tenants in common can
be partitioned by a court into parcels of
equal value when one or more of the
owners have signed an instrument pledging
his or her interest in the property as
collateral for a loan.
When a banker tells an applicant that the
bank would reconsider its decision if the
applicant obtained a ―creditworthy cosigner,‖
the banker may be met with a blank look.
Again, care must be taken not to restrict the
scope of the possible cosigners illegally.
We suggest giving the applicant an
explanation such as, ―Someone who would
help you pay this debt if you were unable
to.‖ The person‘s spouse may be the only
person who could be counted on to help in
that way, and the applicant then will
understand the range of options actually
open to him or her. If the applicant says
something
like,
―How
about
my
husband/wife?‖ the banker is legally
permitted to say, ―We‘d be happy to
consider that. Please have him/her come in
and fill out a form.‖
The bank must ―keep score.‖
If the
ownership interests and value of the
property are such that the applicant, with his
or her sole signature on the security
document, can give the bank an
enforceable security interest in collateral
that meets the required collateral-to-loan
value under the bank‘s formal credit
standards, then the bank must be content
with just the applicant‘s signature on the
note or other obligation document and on
the mortgage, security agreement, or other
collateral documentation.
The situation is more complex when the
loan is to be secured and the applicant is
only part owner of the proposed collateral.
For purposes of discussion, assume that the
applicant has sufficient income and other
economic attributes to qualify for the loan.
Here the banker must become (or consult) a
property lawyer. The terminology used in
discussing property concepts suggests the
age of the law: ―tenants in common,‖ ―joint
tenants‖ (with or without right of
survivorship) and most of all, ―tenants by the
entirety.‖
If the ownership interests and value of the
proposed collateral are such that a greater
interest in the collateral is needed to meet
the bank‘s standards, then the bank may
require other co-owners of the proposed
collateral to sign the mortgage, security
agreement, or similar document. But the
bank must not require these ―nonapplicant
co-owners‖ to sign the promissory note or
other obligation to repay.
The banker must analyze the legal
ownership of the proposed collateral and
determine how much, if any, of it the
applicant alone can give the bank the right
to obtain and resell to pay itself if the
applicant defaults. That portion can vary
from zero to 100% depending on state law,
the type of property involved (e.g., real
This distinction is as critical as the one
regarding when a bank may require coowners to pledge their interests in the
collateral.
The Federal Reserve has
expressly said that to require the
nonapplicant co-owners to sign the note or
2.9
04/01/06
other promise to repay is a violation of
ECOA.
Regulation B
unconnected with the businesses have
guaranteed the loans.
Banks need to
develop and preserve clear written evidence
that this very common pattern is not the
result of violations of ECOA‘s rules on
signatures.
Most banks have a policy that loans to
closely held corporations must be
guaranteed by some defined group of
related parties. So long as the language
used to define that group does not
discriminate on any prohibited basis, there
is no violation of ECOA. Many banks define
the group who must sign guarantees as all
directors, all officers, and/or all holders of
more than a stated percentage of the
company‘s stock.
Each of these
formulations, in fact, all of them together, is
perfectly legal. A few banks use the term
―principals,‖ which is not a legally defined
term, and which sometimes is stretched to
cover people the ECOA does not permit.
Commentary Section 202.7(d)(6)
Note: A small number of states still
have some form of community
property, generally as a holdover from
the days before the joint federal
income tax return was established.
Each of these states has different rules
that determine what the community
property laws actually mean to a
lender. The rules explained in this
section will be different in each of
those states, so consult bank counsel
about just how, if at all, these rules
apply there.
Problems arise when the bank, either as a
matter of policy or as a case-by-case
requirement in its board or loan-committee
approvals, requires guarantees from all
directors,
officers,
and
X
percent
shareholders, and their spouses. Such a
practice violates ECOA by discriminating on
the basis of marital status.
Joint Applicants
If there are joint applicants for a loan, the
bank receiving the application must
document the applicant‘s intent to become
jointly liable for a credit obligation. Evidence
of that intent must be provided at the time
of application. The fact that two parties
signed the promissory note is not evidence
of intent to be jointly liable at the time of
application. Mere submission of joint
financial information does not constitute
evidence of intent to apply for joint credit.
The fact that the applicant jointly owns
property and submits information about the
joint owner and the property to establish
creditworthiness does not necessarily mean
the joint owner intends to be co-applicant on
the loan. Signatures on a joint financial
statement affirming the veracity of
information are not sufficient to establish
intent to apply for joint credit. The intent to
jointly apply must be expressly documented.
Commentary Section 202.7(d)(1)
To avoid the problem, the bank should
obtain financial statements from the
proposed guarantors that show individuallyowned assets separately from jointly-owned
assets. If the bank‘s analysis shows that
the proposed guarantors do not sufficiently
support the credit based on their
individually-owned assets, it may decline
the loan and indicate that it would
reconsider if the parties could obtain
―additional creditworthy co-guarantors.‖
Again, the words in quotation marks are
critical. The bank must not require that the
co-guarantors be the spouses of the offered
guarantors. The bank should document its
policy of not requiring the spouses as
cosigners or co-guarantors, including the
quoted terminology. Examiners have begun
sampling guarantees of corporate loans and
questioning situations in which spouses
2.10
04/01/06
Creditors have the flexibility to determine
methods used to document intent to apply
for joint credit. Signatures or initials on a
credit application may be used to affirm
applicants‘ intent to apply for joint credit.
Regulation B
applicants are clearly unqualified. Those
applicants are denied credit regardless of
race. The problem is the 60% in the middle.
They have a flaw in their credit that requires
the discretion of a loan officer. It is at this
point the regulators have determined that
disparate treatment discrimination enters
into the loan application process.
The method used to establish intent must
be distinct from the means used by
individuals to affirm the accuracy of
information. Where there is no written
application, the applicants‘ intent to apply
for joint credit may be evidenced, for
example, by the presence in the file of a
written statement by the applicants that
expresses such intent. In Appendix B the
first four model forms clarify the guidance
on how to evidence the intent of applicants
to apply for joint credit.
The New Rules.
On March 5, 1993,
Stephen Steinbrink, the Acting Comptroller
of the Currency, speaking to the Federal
Financial Institutions Examination Council‘s
Emerging Issues Conference, said that
lending discrimination exists.
He went on to say that the OCC had
developed new examination techniques to
better enable examiners to detect instances
of discrimination. ―At banks with substantial
minority loan denials, examiners will review
selected loan files for minority denials and
nonminority approvals‖ he said. Examiners
will review nonminority loan approvals to
see what kinds of accommodations,
exceptions, and assistance are commonly
given by the bank. The examiners will then
review minority denials to see if there is any
instance where those commonly given
accommodations,
exceptions,
and
assistance were not given to a minority
applicant. It is anticipated that the FDIC
and the Federal Reserve will follow the
OCC‘s lead and make similar changes in
their examination practices.
Disparate Treatment
Discrimination by disparate treatment
occurs whenever a member of a protected
class is treated less favorably than a
member of a non-protected class who is
similarly situated.
The emphasis of
disparate treatment is focused on credit
approvals and denials, but it can occur
anywhere in the credit process, from the
credit application to the credit collection.
The Old Rules. Until now, the examination
techniques
used
to
detect
racial
discrimination have consisted primarily of a
self-assessment by banks and an audit of
that assessment by examiners. Bankers
and examiners reviewed minority loan
application denials to make sure that each
denial was based on a legitimate creditrelated reason. In almost every case the
denial was supported by an appropriate
credit-related failure of the applicant. The
examiners have determined that form of
examination was flawed.
Examiner Attitude.
Congress has
declared that discrimination exists in
residential lending and that the regulators
are doing a poor job in detecting it. The
regulators have declared that discrimination
exists and that they will find it.
This
translates to the individual examiner in the
field as a commission to find instances of
discrimination.
Approximately 20% of housing-related loan
applicants have impeccable credit. Virtually
100% of those applications are approved
regardless of the race of the applicant.
Approximately 20% of housing-related loan
In 1991, the examiners determined that all
commercial real estate loans were suspect,
and the ensuing examinations of real estate
loan portfolios were brutal. The examiners
2.11
04/01/06
will find what they will believe to be
evidence of some incident of discrimination
in every bank if they look hard enough. By
their standard, that evidence will constitute
proof that discrimination does exist. In their
minds, if they fail to find the evidence, it is
not because it doesn‘t exist, but because
they didn‘t look hard enough.
Regulation B
among others. This scenario can quickly
get out of hand and become ugly.
The result may be that bank customers will
be encouraged to move their business to
other banks. Government and quasi-public
depositors may be forced to move their
deposits.
Steps to Compliance. The following are
some actions a bank can take to reduce the
probability that it will engage in any acts the
regulators will find constitute disparate
treatment dissemination.
The Consequences. Any instance of
discrimination found by the examiners will
probably constitute a violation of both the
Equal Credit Opportunity Act and the Fair
Housing Act. Fair Housing Act violations
carry a civil penalty of up to $50,000 for a
first violation and $100,000 for subsequent
violations.
Under ECOA, an aggrieved
credit applicant may recover his or her
actual damages, attorney‘s fees, and up to
$10,000 in punitive damages. Additionally,
ECOA provides for a class action with a limit
on recovery of the lesser of $500,000 or one
percent of a bank‘s net worth, and
attorney‘s fees.
Continue all of the things you are
doing to ensure that the bank is free
from
―institutional‖
discrimination,
including picturing racial minorities in
your advertising and advertising in
media that reach all minorities, training
for all bank personnel who deal with
the public, and being constantly
vigilant that no employee of the bank
is treating racial minorities differently,
to their detriment, than nonminorities.
If a bank‘s examiners find instances of
discrimination, they must report them to the
Attorney
General
and
the
Justice
Department if a pattern of discrimination is
found, and to the Department of Housing
and Urban Development if only an isolated
instance is found. They must also notify the
rejected applicant that he or she has been
discriminated against and that remedies
may be available under the Fair Housing
Act. Recognize that every instance that the
examiners believe to be discrimination will
be reported to another government agency
and to the customer.
Understand what the examiners are
looking for.
Previously, examiners
have
looked
for
institutional
discrimination. They have also looked
at individual loan application rejections
to see if the rejection was appropriate
under the bank‘s credit standards.
Now the examiners are looking for
individual instances in which a minority
was treated adversely from a
nonminority. That becomes almost a
question of whether the one minority
person who was treated least
advantageously was given as much
accommodation
as
the
one
nonminority person who was given the
most accommodation.
In many cases, the civil liability for loan
discrimination
is
insignificant
when
compared to the public relations damages.
A rejected loan applicant receives a letter
from a bank regulator on official government
agency letterhead saying that he or she has
been discriminated against by the bank and
that he or she may have grounds for a
lawsuit. The customer takes the letter to a
lawyer who takes it to the local newspaper,
Watch your HMDA statistics. Pay
special attention to the ratio of minority
applications denied to nonminority
applications denied. This is the gauge
the regulators will use in determining
2.12
04/01/06
how closely to examine your bank. If
either the ratio of minority loan
applications to nonminority loan
applications is out of balance with the
population of your market area, or if
you are rejecting a substantially higher
percentage of applications from
minorities than nonminorities, you will
come under regulatory scrutiny.
Examine your HMDA data and ratios
monthly and take whatever steps are
necessary to keep the ratios in line.
Regulation B
the approved nonminority applications
is to catalogue accommodations that
are being granted and the frequency
with which they are granted. The
purpose for reviewing the minority
rejections is to make sure that the
rejection came only after all commonly
given
accommodations
were
considered.
Document fully all minority residential
loan application rejections. Document
that
all
commonly
given
accommodations were considered.
Keep accurate records of any credit
accommodations that are made to
nonminority
loan
applicants.
Determine which accommodations are
made ―customarily‖ and make sure
that all customary accommodations
are granted to all minority applicants.
The difficulty is determining what is
customary and anticipating what will
be customary when the examiners do
their review. What was not customary
today, when a loan application is
rejected, may be customary six
months from now when the examiners
come.
Apply the same standards to loan
collections as to loan approvals.
Establish procedures to make sure
that
accommodations
commonly
granted to nonminority delinquent
borrowers are granted to all minority
delinquent borrowers.
Make sure that everyone in the
lending process understands what the
examiners will be looking for.
The fact that one loan applicant did not
receive an accommodation that is either
seldom or commonly given to other
applicants is not necessarily discrimination.
More probably it is the legitimate exercise of
discretion by a loan officer. In all likelihood,
no two loan officers exercise their discretion
identically. One may be more lenient and
grant
a
particular
accommodation
commonly; the other is more strict and does
not grant it at all. The Acting Comptroller of
the Currency has stated ―...if an examiner
finds one or two minority denials that appear
to be the equivalent of one or two white
approvals, that fact by itself will not
automatically
trigger
a
finding
of
discrimination. But it will trigger further
questioning to determine the cause of the
difference.‖
To pass an examination
conducted under these standards, a bank
must have a procedure to insure that all
commonly granted accommodations are
Take a new look at your credit policies
and underwriting
standards for
residential loans. If a bank‘s lending
policies
do
not
describe
the
accommodations that a loan officer
can make and the circumstances
under which they can be made,
consider adding that to the policy.
When changes to the lending policy
(or the accommodation policy) are
made, make sure that those changes
are in writing and dated so that loan
officers and examiners have a clear
time delineation for each change.
Form a senior loan-review committee
to review all minority residential loan
applications that are rejected and all
nonminority loan applications that are
approved. The purpose of reviewing
2.13
04/01/06
considered for all minority residential loan
applicants, and, if the accommodation is not
given, the reason for denying it must be
carefully documented. Racial discrimination
in lending has risen to the top of both the
Congressional and regulatory lists of
immediate concern. Banks must avoid not
just racial discrimination but also anything
that could give the appearance of racial
discrimination.
Regulation B
calculating income- to-debt-service ratios.
The statement says that this practice has a
disparate effect on the elderly and the
handicapped because they have a higher
percentage of nontaxable income and the
policy does not make allowance for the
income tax advantage that that form of
income provides.
Every creditworthiness standard in a bank
will have a disparate effect based on either
income or net worth. Most lending policies
and practices will have a similar result.
Those that are not justified by a ―business
necessity‖ and those that are so justified but
have a less discriminatory alternate are all
acts of illegal discrimination.
Disparate Impact
A disparate impact occurs when a lender
uniformly applies a policy or practice that on
its face has no inappropriate discriminatory
purpose or effect (and behind which there is
no discriminatory intent), but in practice it
does have a discriminatory effect on a
prohibited basis. Said differently, a
disparate
impact
occurs
when
a
discrimination-neutral policy is applied to all
applicants or potential applicants uniformly
and the policy has or would have a
disproportionately adverse impact on a
protected class. If a policy or practice is
found to have a disparate impact, the bank
must demonstrate that the policy or practice
is justified by a ―business necessity‖ and
that there is no less discriminatory
alternative that the bank could use to
accomplish the same purpose.
Note that in cases of disparate impact, there
is no requirement of evidence of any intent
to discriminate. Quite to the contrary, by
definition, in cases of disparate impact there
is no intent to discriminate. The only thing
that has to be demonstrated is that there is
an adverse effect on a greater percentage
of a protected class than on the population
as a whole. Also note that no particular
customer of the bank must have been
adversely affected. All that must be shown
is an adverse impact on a greater
percentage of a protected class of potential
applicants than on the public as a whole.
The policy statement contains two examples
of policies that have a disparate impact.
The first is a policy that a bank will not make
residential real estate loans for less than
$60,000. The statement assumes that a
disproportionately greater percentage of
racial minorities (and probably single
women) tend to have lower incomes and
live in lower-value housing than the average
person in the bank‘s market. Therefore the
$60,000 minimum loan amount has a
disproportionately adverse effect on them.
That is an effect of illegal discrimination.
The second example is a lender who uses a
borrower‘s gross income in making
underwriting decisions, for example in
Business Necessity. It is important to
understand that the term the regulators
chose to define the reason that a bank may
have for a policy which has a disparate
impact is ―business necessity.‖ It is equally
important to understand that they did not
choose a term such as ―valid business
purpose‖. A necessity is something defined
as absolutely essential or indispensable.
The contents of the interagency policy
statement were hotly debated among the
people responsible for writing it. It can be
reasonably assumed that none of the terms
that are used therein appeared by chance
or without the drafters understanding
precisely what they were saying.
2.14
04/01/06
The statement says that for a policy or
practice to be justified as a business
necessity, the justification ―must be manifest
and may not be hypothetical or speculative.‖
Return to the statement‘s example of a
$60,000 minimum real estate loan policy.
Most banks have a minimum loan
requirement for each of their credit
products. Typically those minimums are
based on someone‘s judgment that loans
below the minimum are not sufficiently
profitable for the bank to spend its
resources on them. That judgment, though
it may be accurate, is seldom supported by
statistics that were evaluated at the time the
judgment was made. Such a judgment is
typically someone‘s ―gut‖ reaction based on
experience; as such it is totally speculative.
It may prove to be accurate; nonetheless it
is speculative, and not what the examiners
will find acceptable.
Regulation B
return, say one percent, after consideration
of all expenses, bank overhead, and taxes.
Understand, this is for antidiscrimination
purposes; CRA may have a greater impact.
Business
Necessity
and
Creditworthiness.
The commentary to
Regulation B makes reference to the effects
test relative to the ―credit decision-making
process.‖ Rather than the term business
necessity, however, the commentary states
that the ―criterion [the policy or practice] is a
valid predictor of creditworthiness.‖ In the
statement there is a caution to lenders to
examine
widespread,
familiar
credit
standards to see if they have an
inappropriate disparate impact. In other
words, take a look at the creditworthiness
standards that your bank has used for so
long that they are ingrained in your credit
culture. Question whether there are valid
measures of creditworthiness or are they
used today only because they were used
yesterday, and is there a continued
justification for them. The statement issues
a particular caution about requirements that
are ―more stringent than customary‖ (i.e.,
harsher than industry standards).
The
statement advises lenders to stay informed
of developments in underwriting and
portfolio performance evaluation, that is, to
be familiar with current industry standards.
The statement requires that a bank analyze
a loan made at its lending minimum and
demonstrate from the analysis the business
necessity for the minimum. What does it
cost to put the loan on the books? What
fees are generated? What is the loan loss
reserve? What are the costs to service the
loan? Will/can the loan be sold in the
secondary market or held in portfolio?
Finally, from the above, calculate the return
on assets for the loan and determine that
the resulting answer justifies the policy.
The entire area of discrimination is in a
regulatory state of flux. Anyone‘s prediction
of what examiners will implement in actual
examinations is at best an educated
estimate. Our educated estimate is that
examiners will divide a bank‘s lending
policies and procedures into those that bear
on creditworthiness and those that do not.
For the creditworthiness standards, that is,
those that go to the ability or probability of
repayment, or to collateral adequacy, the
examiners will probably require that, as a
minimum, the standard be statistically valid
as a predictor of creditworthiness. If the
standard is in line with industry norms,
statistically valid standards probably will not
be challenged. If the standard is harsher
The statement says ―Factors that may be
relevant to the justification [of business
necessity] could include cost and profit.‖
There is no explanation of what that
statement means and the regulators will not
give a definitive answer to any question
about it. The obvious conclusion that you
can draw is that you do not have to offer a
credit at a loss. Less obvious is what level
of profitability is a business necessity? To
date, the regulators have refused to answer
that question. Our judgment is that a bank
may set loan minimums and adopt other
policies that provide a reasonable net
2.15
04/01/06
than industry norms, a bank may be
required to demonstrate that it is a valid
standard or that there is not an alternate
standard that will accomplish the same
purpose with a lesser disparate impact. In
actual practice, we believe that examiners
will seldom challenge a creditworthiness
standard. One of the regulators‘ goals is to
demonstrate that antidiscrimination and
CRA are not in juxtaposition with safety and
soundness. We believe it will be extremely
unusual for examiners to require a bank to
lower its credit standards for disparate
impact reasons.
Regulation B
Many banks compensate their residential
loan originators with a commission based
on the dollar volume of their loan
originations. The effect is that this form of
compensation causes the originators to
solicit more aggressively and work harder
on higher dollar loans. It therefore has a
disparate impact on minority applicants.
Adequate compensation of personnel is a
business necessity.
But is there an
alternate compensation method that would
create the same dollar volume of
originations at the same cost to the bank
with a lesser discriminatory effect? In any
particular case there may be or there may
not be. But as to every such policy a bank
should document that:
Lending policies and practices that do not
impact creditworthiness, however, are quite
another thing. Examiners have been told by
their
supervisors
that
banks
are
discriminating, and the examiners are to find
evidence of what is known to be there, but
the examiners find no evidence of overt
discrimination and no evidence of disparate
treatment.
In fact, we believe that
examiners find, in most cases, that banks
are trying to avoid discrimination so
desperately that the people who are
believed to be the target of discrimination
are held to a lesser standard than a bank‘s
customers as a whole.
That leaves
disparate impact as the last remaining
source of evidence of discrimination.
It realizes its policy or practice has a
disparate impact
The policy is a business necessity
The bank has explored alternate
policies and found none that have a
less
discriminatory
effect
and
accomplish the same purpose.
Suggestions for Compliance. List every
policy and practice that is related in any way
to your bank‘s lending function. The list
should not be limited to loan origination, but
should include loan administration and in
particular the handling of past-due loans.
Particular attention should be given to
practices that are not documented but are
consciously or subconsciously part of the
bank‘s credit or credit administration culture.
A bank should examine every lending policy
or practice that it has that is not directly
related to creditworthiness. If the policy or
practice has a disparate impact, the bank
should develop evidence supporting its
business necessity, and if the evidence is
not there, the policy or practice should be
changed.
Policies and practices found
supported by a business necessity should
be examined for any alternate policy that
would accomplish the same purpose with a
lesser disparate impact.
After the list is completed, divide it into
creditworthiness issues and issues that do
not involve creditworthiness.
The
creditworthiness
issues
should
be
compared to customary credit standards.
Any that are significantly more stringent
than the norm should be either justified or
rewritten to meet the norm.
A Less Discriminatory Alternative. The
final hurdle for a policy or practice that has a
disparate impact of discrimination, but is
supported by a business necessity, is that
there is no less discriminatory alternative.
Non-creditworthiness policies and practices
should first be analyzed to determine if they
have a disparate effect of illegal
2.16
04/01/06
discrimination. For each that does, there
should be an analysis of its business
necessity and any alternate policy or
practice that would accomplish the purpose
with a lesser discriminatory effect. In all
cases, the bank‘s analysis of its policies and
practices should be well documented.
Examiners are less likely to challenge a
policy or practice that has been thoroughly
analyzed and the analysis documented than
one where no analysis has been done. If
there is no documentation of the analysis,
from an examiner‘s standpoint, no analysis
was made.
Regulation B
the application is denied or a counteroffer is
made, the rules to follow are more technical
and compliance is more difficult. Section
202.9
Notices -- Favorable Action -- Consumer
Credit. When the bank has approved the
applicant‘s request as it was originally
made, this requirement is almost trivial. In
this situation, the notice of action taken may
be given formally or informally, orally or in
writing. Even in this best case, a record
ought to be kept in the bank‘s files so the
bank can show later that bank employee
Smith telephoned loan applicant Brown and
told her that her loan had been approved. If
the applicant comes in and signs the
documents for the credit, those documents
will suffice as records of notice. But if the
applicant forgets or borrows elsewhere, the
bank may need some proof it approved the
application and notified the customer of that
approval.
Conclusion.
Equality in lending is
potentially the single most dangerous issue
facing any bank today. The fines and
penalties can be severe, but they can be
insignificant compared to the public
relations cost, the burden on management
and the disruption of a bank‘s business plan
that a discrimination claim can bring. The
disparate impact or effects test type of
discrimination can be the most difficult for a
bank to recognize and cure because it
arises from a neutral policy, there is no
intent of discrimination, and no customer
needs to have been adversely affected by it.
Notices -- Adverse Action -- Consumer
Credit. The real potential for compliance
problems arises when the bank‘s credit
decision is less than 100% favorable. There
are two subcategories here: counteroffers
(sometimes called ―conditioned deals‖) and
turndowns (or ―declines‖). In the case of a
counteroffer, the bank is saying, in essence,
―We cannot lend to you on exactly the terms
you applied for, but we could lend to you if
X.‖ That X may mean a reduced principal
amount,
increased
down
payment,
additional cosigners and/or collateral, or
other credit enhancing factors.
It is our judgment that if a bank makes a
reasoned, well-documented analysis of its
credit policies and practices, examiners will
be far more cautious with any criticism than
if no analysis is apparent. We also believe
that if a bank makes a thorough analysis
and reasoned judgment about its policies
and practices examiners will be reluctant to
challenge the bank‘s logic. On the other
hand, where an analysis has not been
made, the examiners have free license.
Where consumer credit is concerned, the
law requires the bank to give a formal
written notice to the consumer. Under the
statute, the notice is called an ―Adverse
Action Notice.‖ Similarly, a formal written
adverse action notice is required when the
bank turns down a consumer‘s request for
credit, either because the application is
incomplete, or because the applicant does
Notices of Action Taken
Regulation B requires that a creditor advise
a credit applicant whether an application
was approved or denied.
When the
application is approved, compliance with the
rules is simple and straightforward. When
2.17
04/01/06
not qualify under that bank‘s standards for
the credit he or she requested. If the
creditor does not offer the type of credit
requested by the consumer, then the bank‘s
refusal of the customer‘s request is not
considered adverse action, and no notice is
required. However, if the creditor does not
offer the term of credit requested by the
applicant, that does constitute adverse
action and a notice must be sent to the
consumer.
For example, say that a
customer requests a home mortgage loan
from the bank. If the bank does not make
home mortgage loans, then refusal of the
request is not adverse action. But if the
customer requests a 30-year home
mortgage loan, and the bank only makes
15-year home mortgage loans, then the
refusal is adverse action, and a notice is
required to be sent.
Regulation B
Forms. The Federal Reserve Board has
drafted and published model forms to guide
banks in advising applicants of adverse
action taken by banks on their credit
applications. (Refer to the sample forms in
Appendix C.) If a bank makes proper use of
one of these forms, using exactly the
language shown, it will be deemed to have
complied with the appropriate parts of the
law and regulation. For this reason, the
forms are often referred to in compliance
circles as safe harbor forms. We must
emphasize that the Federal Reserve Board
forms are the ONLY safe harbor adverse
action notices in existence. That is, any
change, no matter how slight, in the
language of those forms by a lender may be
enough to allow a court to award significant
damages to an aggrieved customer.
We want to highlight the fact that if a lender
makes even seemingly harmless changes in
one of the Federal Reserve Board‘s
standards forms, it loses the legal protection
it otherwise would have. A federal court of
appeals has held that a change from
―insufficient credit references‖ to ―credit
references are insufficient‖ was a violation
of Regulation B. The decision to give up
that protection for some perceived
improvement in the adverse action notice‘s
language is a decision that ought to be
made only after considered review of the
possible consequences and approval by
senior management.
An adverse action notice may be one of two
types. The first gives a statement of the
specific reasons for the bank‘s action, while
the second merely discloses the applicant‘s
right to request such a statement of specific
reasons. Very few banks use the latter
option in consumer lending. In the case of a
counteroffer, the specific terms of that
counteroffer must be included in the notice.
The adverse action notice must contain the
―ECOA Notice,‖ as well. This text tells the
consumer about the nine prohibited bases
and gives the name and address of the
federal bank regulatory agency (OCC, FRB,
FDIC) that enforces compliance against that
particular bank.
The Federal Reserve has revised its form
C-1 to break the old ―insufficient credit
references‖ reason into two separate
reasons:
―insufficient number of credit
references provided‖ and ―unacceptable
type of credit references provided.‖ Note
that the lead-in text to the form refers to
―insufficient credit references,‖ a reason that
no longer appears anywhere on the form.
Purpose. The purpose of the adverse
action notice is twofold: first to inform the
applicant of the adverse action and the
specific reasons for it, and secondly to
serve as a piece of evidence in any dispute
between the applicant and the lending
institution in the future. It is designed to
serve as ―Plaintiff‘s Exhibit A‖ in any lawsuit
alleging that the bank discriminated illegally
against the applicant.
The forms in Appendix C are intended to
cover most of the common adverse action
notice requirements of lending institutions.
Form C-1 is the broad form, while C-2 is a
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04/01/06
slightly different version. C-3 is designed
for use with credit scoring systems. C-4
allows for counteroffers. C-5 is for use in
situations in which the bank wishes to force
the consumer to request a statement of the
reasons for adverse action in writing before
it supplies them.
C-6 is to handle
incomplete applications, and C-7 and C-8
are for use in business credit situations.
You will note that some of the forms contain
optional language that indicates that the
bank‘s decision was influenced by
information obtained from a credit reporting
agency, and states that the consumer has
the right to obtain that information directly
from the credit reporting agency. That
provision is mandated by the Fair Credit
Reporting Act, so these forms serve to
assure compliance with two laws rather than
just one. Note that merely disclosing that
the adverse action was based on
information obtained from a particular credit
bureau does not completely satisfy ECOA‘s
requirements. The specific reasons for the
credit denial still must be given. Usually this
means checking the box beside the reason,
―Delinquent past or present credit
obligations with others‖ on form C-1.
Regulation B
bank now, in a second turndown letter, list
those other reasons when it did not do so in
the first letter? We believe not, or at least
not without making it obvious that the bank
has violated the Equal Credit Opportunity
Act. The Federal Reserve Board, in its
comments on this situation, has indicated
that four reasons would not be excessive.
Comment 1 Section 202.9(b)(2)
Our
opinion is that if more than four reasons for
a decline exist, and each is a legitimate,
defensible ground for denial, every one of
them should be indicated on the form.
Do not be concerned about privacy issues
when you are giving the primary applicant
information about reasons for adverse
action that may relate to a co-applicant or
guarantor. The Federal Reserve Board
says that the co-applicant or guarantor
should have an expectation that such
information will be shared.
If there are joint applicants for a loan or if
there is a proposed guarantor you must
specify the person or persons to whom each
specific reason for denial applies. For
example, a lender evaluates both the
primary and co-applicant‘s consumer report
in making the credit decision. The loan is
denied based on the co- applicant‘s length
of employment, income insufficient for the
amount of credit requested and limited
credit experience. There is no violation of
privacy by sending one copy of the adverse
action notice to each applicant disclosing
the reason for denial relating to one of the
applicant‘s poor credit history, in this case
the co-applicant. Similarly, if the consumer
report of a guarantor contributed to the
credit decision on a commercial loan
application and the loan was denied the
notice should be sent to the business
indicating the reason for denial as ―credit
history of the guarantor‖.
Form C-1 is the most commonly used form
in consumer credit operations. It probably
will be used, in one variation or another, by
any bank that uses a ―judgmental‖ system of
reaching credit decisions, as opposed to a
credit scoring system that has been
qualified as an EDDSSCSS.
Completing the Form. Even though there
may be several valid reasons for the
turndown, the person completing the
adverse action notice form may check only
one or two of them. The hazard lies in the
fact that the customer may remedy the one
or two defects that were marked. For
example, perhaps the bad credit history was
a mistake in reporting by another creditor or
the bureau. Would the bank now like to
make that loan? Certainly not. The other
(unchecked) reasons still exist. But can the
Time Frames. Within 30 days after a bank
receives a completed application for credit,
it must notify the applicant whether the loan
was approved, denied, or the bank has a
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04/01/06
counteroffer. If the loan is approved or
denied, the bank should give the
appropriate notice as described in this
chapter. If there is a counteroffer, a bank
may either make the counteroffer alone, or
make it in combination with an adverse
action notice, showing why the original
application was not approved. If the bank
combines the adverse action notice with the
notice of the counteroffer, it need not send
another adverse action notice if the
applicant rejects or ignores the counteroffer.
Federal Reserve Sample form C-4 is an
example of such a combined notice. On the
other hand, if the bank merely sends a
counteroffer, without the adverse action
notice, the bank must send the adverse
action notice sometime within 90 days after
it has notified the applicant of the
counteroffer, unless the applicant expressly
accepts (or uses) the counter offered credit.
Few banks are willing to undertake this
additional monitoring and mailing, so most
use a combined notice of adverse action
and counteroffer.
Regulation B
receive the entire adverse action notice and
each applicant must receive the FCRA
portion of it.) FTC Staff Opinion Letter
In the situation where an application is
submitted to the bank through a broker, the
adverse action notice may be provided
either by the bank or by the broker. If a
broker submits an application to multiple
creditors, and no creditor approves the
application, the adverse action notice
provided by the broker must contain the
names of each creditor on whose behalf the
notice is given. If the bank is unsure of
whether the broker will fulfill its duties, the
better practice is for the bank to provide an
adverse action notice to the customer
directly. If an application is submitted to
multiple creditors and the consumer
expressly accepts or uses credit made by
one of the creditors, adverse action notices
are not required from the creditors who did
not offer the consumer credit. Again, if a
creditor does not know whether the
consumer has accepted someone else‘s
offer, the better practice is to provide an
adverse action notice to the customer if the
creditor denies the application.
If an application submitted by more than
one applicant is denied, the bank needs to
send an adverse action notice to only one of
the co-applicants. If a primary applicant is
readily apparent, the adverse action notice
should be sent to that person. However, if a
primary applicant is not readily apparent,
the bank may choose to send the adverse
action notice to any one of the applicants.
(Note of caution: The Fair Credit Reporting
Act [FCRA], whose adverse action language
is incorporated into the Regulation B model
forms, does not limit the adverse action
notice requirements to only one of multiple
applicants.
The FCRA requires that if
consumer report information of any
applicant contributed to an adverse
decision, an FCRA adverse action notice
must be provided to that applicant. There is
no provision in the FCRA for sending only
one notice when both joint applicants‘ bad
credit reports contribute to the denial. When
that is the case, at least one applicant must
Incomplete Applications. Occasionally,
an applicant will fail to fill in all the
information the bank needs to reach a credit
decision. The bank then has two options
under ECOA: it can simply turn down the
application, indicating that the reason for the
adverse action is ―credit application
incomplete;‖ or it can notify the applicant of
the ―incompleteness‖ of the information. In
the latter case, the regulation requires the
bank to:
Specify the information that is needed
to complete the application
Designate a reasonable period of time
for the applicant to provide the
information
Inform the applicant that failure to
provide this information within this
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time will result in the bank giving no
further
consideration
to
the
application.
Regulation B
their own. In addition, the Federal Reserve
Board recognized that the possible reasons
for adverse action in a business credit
context are much more numerous and cover
a much broader range than those commonly
encountered in consumer credit turndowns.
For this reason, a somewhat looser, more
adaptable procedure for adverse action
notices was imposed in the context of
business credit.
If the bank‘s notice complies with these
requirements, it need not send any further
notices if the applicant fails to respond
within the ―reasonable time‖ designated in
the notice. Section 202.9(a)(3)
Warning.
ECOA violations, even
―technical‖ ones, such as not properly
completing adverse action notices, can
come back to haunt the bank in other
compliance areas. They weigh heavily in
CRA compliance, for example.
Businesses
with
Annual
Gross
Revenues of $1 Million or Less. The
Women‘s
Business
Ownership
Act
amended the ECOA with regard to business
loan adverse action notices.
This
amendment requires a bank to follow a
different procedure when it takes adverse
action on a credit request from a business
that had gross revenues of $1 million or less
in the business‘s preceding fiscal year.
(The procedure is not applicable when the
bank takes adverse action on certain limited
types of credit to these ―small businesses.‖
These types of credit are extensions of
trade credit, credit incident to a factoring
arrangement, and similar types of credit.
These types of credit are not often granted
by commercial banks.)
Notices -- Adverse Action -- Business
with Annual Gross Revenues of More
Than $1 Million.
Although the ECOA
allows the Federal Reserve Board to
exempt business credit completely from the
coverage of the ECOA and Regulation B,
the Federal Reserve Board has never
chosen to exercise that discretion.
Therefore, the ECOA‘s implementation of
Regulation B contained a provision that
requires banks to notify business credit
applicants of adverse action. This notice
may be formal or informal, oral or written. A
telephone call will suffice. The time limits
involved from the bank‘s standpoint are: the
notice has to be given within a ―reasonable
time‖ after the adverse action was taken,
and a written statement of the reasons for
the adverse action is required only if the
applicant makes a written request for such a
statement within 60 days after the initial
(possibly oral) notice of adverse action from
the bank.
The procedure requires the bank to comply
with the full consumer credit adverse action
notification
requirements,
including
supplying the statement of reasons for
adverse action and the ECOA notice. The
latter notice is the one that gives the name
and address of the federal bank regulatory
agency that enforces compliance against
the bank in question. The only exceptions
are the following:
This abbreviated procedure was justified by
the repeatedly documented fact that most
business loan applicants who are turned
down by one bank simply wish to get their
financial statements back from that bank
and apply at another bank. Most business
loan applicants do not want a formal
statement of the reasons for turndown or
condition in either the first bank‘s files or
The statement of action taken may be
given orally or in writing
The bank may tell the applicant of the
applicant‘s right to request a
statement of reasons at the time the
business loan application is taken,
rather than on notice of adverse
action, provided the disclosure of the
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04/01/06
right is given in a form that the
applicant may retain, and contains the
following information:
Regulation B
Congress mandates, under penalty of law,
that in certain types of loans the banker
must ask the applicant about his or her
race, national origin, sex, marital status, and
age. And if, as is often the case, the
applicant refuses to answer, the banker
then must make his or her own best guess
as to the applicant‘s race or national origin
and sex, ―on the basis of visual observation
or surname.‖
Consider loan applicant
―Maria Hernandez,‖ who is blond and fairskinned with pale blue eyes.
Is she
Hispanic? What if she is Swedish, but
married to a Cuban? Applicants ―Pat and
Lee Jones‖ are both brown-skinned, with
shoulder-length black hair.
Are they
husband and wife, brother and sister,
unrelated people of the same (or different)
sex with the same last name? Are they
members of some protected group, or just
deeply-tanned Caucasians?
The time periods within which the
applicant and the bank must act
(60 days after notice of adverse
action for the applicant to ask for a
statement of reasons and 30 days
from that request for the bank to
supply it)
The name, address, and telephone
number of the person or office
from whom or which the statement
of reasons can be obtained
If the creditor chooses to provide
the statement of reasons for
adverse action orally, then a
disclosure of the applicant‘s right
to have those reasons confirmed
in writing within 30 days after a
written request from the applicant
for the same.
Completely aside from being required to
guess at information the applicant refuses to
volunteer, there is a legal requirement that,
when the information is recorded, the
banker must then forget it. It cannot enter
his or her mind again while deciding
whether to grant the loan. The required
monitoring information must be requested,
guessed at, recorded, retained, and
forgotten whenever the application is for
credit primarily for the purchase or
refinancing of a dwelling that will be
occupied as a principal residence, and
secured by the dwelling. A refinancing
takes place when an existing obligation is
satisfied and replaced by a new obligation
of the same borrower. In an application to
refinance
applicant‘s
dwelling,
the
monitoring information may be requested
but is not required if obtained in the earlier
transaction. Comment 6 §202.13
Few banks avail themselves of these
exceptions. For adverse action notices on
loans to businesses with more than $1
million in gross revenues in the most recent
fiscal year (as well as for factoring, trade
credit, and similar forms of lending even to
other businesses) the ―old‖ rules with their
simpler, more flexible notice requirements
remain in effect. Section 202.9(a)(3)
Monitoring Information
The ECOA also requires that banks collect
(or in some situations even guess at)
―monitoring information.‖ The purpose of
this law is to prevent bankers from making
loan decisions while considering any of
certain ―prohibited bases,‖ including the
applicant‘s race, national origin, or sex. To
help determine whether banks are indeed
ignoring those factors, a bank is required to
record these very characteristics and retain
the records. Section 202.13
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04/01/06
If the applicant applies by electronic means
(e.g., Internet or fax) without video
capability, the applicant should be treated
as received by telephone or mail. If taken
by any means where the bank can see the
applicant, the monitoring information must
be noted by visual observation or surname if
the applicant chooses not to provide the
information.
Regulation B
owned or rented land also securitizes the
loan. There is no evidence indicating that
the definition covers a houseboat or a travel
trailer; however, under a strict construction
of the language, such ―structures‖ would be
covered. Similar structures are considered
to be dwellings for the purpose of rescission
under Regulation Z.
The rule applies to both consumer and
business loans of any amount, regardless of
whether the security interest will be a first or
junior lien. Section 202.14
If a lender is subject to the reporting
requirements of Regulation C, the
monitoring information must be taken for all
loan applications that are required to be put
on the Loan Application Register.
Inadvertent
collection
of
monitoring
information on a dwelling related transaction
when not required is not a violation of
Regulation B; however, it is a violation to
gather the monitoring information for nondwelling related loans or on every
application.
Appraisal Report. An appraisal is an
estimate of value. An appraisal report is the
document or documents in which the
appraiser sets out an estimate of value and
the facts on which that value was based. If
a bank uses a third-party appraiser to
evaluate the collateral for a particular loan
and the bank accepts the value, then the
third-party appraiser report is the appraisal
report. If, however, a bank uses a valuation
that is different than that of the third-party
appraiser, then the appraisal report is the
third-party‘s report together with all other
documents that reflect the bank‘s valuation
of the collateral. If a bank does not use a
third-party appraiser, but instead uses a
bank employee to prepare an estimate of
value, the appraisal report is the written
report of that bank employee.
Providing Appraisals to Credit
Applicants
When an appraisal has been conducted
during the underwriting process for a loan to
be secured by a lien on a one- to fourfamily
unit
residential
structure,
Regulation B requires the bank to either
routinely (always), or upon written request,
provide a copy of the appraisal report. If a
bank elects to supply the appraisal report
upon written request, an appraisal notice
explaining an applicant‘s right to a copy of
the appraisal report must be provided. The
notice only needs to be provided to “an”
applicant, not every applicant. Therefore,
when multiple applicants submit an
application for a covered loan transaction,
the bank only needs to provide the notice to
one applicant, preferably the primary
applicant where one is readily apparent.
Banks that use employees to prepare
estimates of value should be extremely
cautious because the audience for the
employee‘s estimates of value may no
longer be just the bank‘s loan officer and
loan committee. In any given instance the
audience may be the public at large,
including the Justice Department, HUD, and
a judge and jury. In every instance, a bank
employee must be prepared to successfully
defend the estimate of value that he or she
reached. Additionally, each written report
setting out an employee‘s estimate of value
should
be
sufficiently
formal
and
grammatically correct that neither the
The definition of a residential structure
includes individual condominiums and
cooperative units, as well as mobile or other
manufactured homes whether or not the
2.23
04/01/06
employee nor the bank will be embarrassed
by its publication.
Regulation B
The Federal Reserve Board has provided a
model form for the notice that we
recommend all banks use verbatim:
―You have the right to a copy of the
appraisal report used in connection with
your application for credit. If you wish a
copy, please write to us at the mailing
address we have provided. We must hear
from you no later than 90 days after we
notify you about the action taken on your
credit application or you withdraw your
application.
The real estate secured loan-limit threshold
above which a certified or licensed thirdparty appraisal is required was raised from
$100,000 to $250,000 to lower the effective
cost of credit to borrowers. However, this
regulation blunts that effort. Many banks,
particularly community banks that do not
have employees with formal appraisal
training, will rely more rather than less on
independent third-party appraisals to avoid
discrimination claims. At the same time,
loan underwriters will be less inclined to
challenge the value estimates of third-party
appraisers because of the requirement of
documenting the difference of opinion and
the threat of having to sustain their position
in court.
[In your letter
information:]‖
give
us
the
following
The sentence in brackets is optional. Most
banks say, ―In your letter give us your name
as it appears on your loan application and
the address you want the report mailed to.‖
A bank may charge an applicant for the cost
of copying and mailing the report. The cost
charged need not be the exact cost for a
specific report, but may be a ―generic‖ cost
for an average report. If a bank elects to
charge applicants this cost then the
following sentences should be added to the
notice: ―The cost for copying and mailing
the appraisal report to you is $__________.
Please enclose that amount with your
written request for the appraisal report.‖
Commentary Section 202.14
Notice Requirements. If a bank routinely
(always) provides a copy of the appraisal
report to all loan applicants regardless of
whether the loan application was approved,
rejected, or withdrawn, then the bank is not
required to notify loan applicants that a copy
of the appraisal report is available to them.
If a bank does not routinely provide
applicants with appraisal reports, then the
bank must comply with the regulation‘s
notice requirements. In that case, a bank
must give residential real estate loan
applicants written notice of their right to
receive a copy of the appraisal report.
If the applicant has not previously paid for
the appraisal, that cost may be imposed if a
copy of the report is requested. Because
the cost of appraisals may vary widely, the
exact cost for the specific appraisal, and not
a generic average cost, should be charged.
If a charge for the cost of the appraisal is
to be imposed, we suggest the following
language be added to the notice: ―If we
receive a written request from you for the
appraisal report, we will advise you in
writing of the cost of the report. Upon
receipt of that amount we will provide a
copy of the report to you promptly.‖
The notice may be given at any time during
the application process, but not later than
when notice is given to the applicant of the
action taken on the application. The notice
must state:
That the applicant‘s request for the
appraisal report must be in writing
The bank‘s mailing address
That the request for the appraisal
report must be made not more than 90
days after the bank notifies the
applicant of the action taken on the
application or the applicant withdraws
the application.
How and When to Give the Notice. As
stated above, the notice on any particular
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04/01/06
loan may be given at any time from the time
when the application is taken, up to and
including the time the applicant is advised of
the action taken. Because most notices of
action taken are oral, it is not practical to
await that point in the credit process to give
notice. It would create excessive mailing
costs. Logically, the applicants‘ copy of the
loan application would be a good place to
put the notice, but many banks do not have
formal commercial real estate loan
applications, and those that do might not
want to give the disclosure to nonresidential
real estate loan applicants. Accordingly, we
suggest that the appraisal disclosure be
placed on the RESPA disclosure and on the
Regulation Z disclosures.
This will
accommodate all first mortgage applications
and all consumer junior mortgage
applications. (Some applicants will get the
disclosure twice, but that is permissible.)
Strangely enough, if it is the bank‘s policy to
provide the notice rather than routinely
supply a copy of the appraisal, it must
provide the notice even if the application
was denied before an appraisal was
ordered. There is no provision in the rule
excepting the notice if no appraisal was
ordered. The only affected applicants that
will not receive one of these disclosures are
applicants for a commercial purpose loan
secured by a junior mortgage on residential
real estate, some mobile home loans, and
those applicants turned down before
receiving a good faith estimate and
Regulation Z disclosures. For those loans a
separate disclosure should be prepared and
procedures provided to the loan officers to
insure that the disclosures are given
whenever appropriate.
Regulation B
receipt of the appraisal report or receipt of
reimbursement of costs from the applicant.
Promptly, for this purpose, is defined as
generally within 30 days.
Suggestions for Compliance. If a loan
applicant makes a proper written request for
an appraisal report, the bank to which the
loan application was made must honor the
request. All the new regulation does is
more specifically define what an appraisal
report is and what constitutes residential
real property, and it formalizes the notice
requirement and process.
The regulation, passed in December, 1993,
specifically defines what an appraisal report
is and what constitutes residential real
property, and it formalizes the notice
requirement and process.
The following are some suggestions for
compliance:
Determine the cost of copying and
mailing a typical appraisal report.
Prepare the language of the
disclosure, adding the requirement
that the applicant reimburse the
copying and mailing cost and the
language for reimbursing the cost of
the appraisal if the bank has loan
programs where the applicant does
not pay for the appraisal.
Put the disclosure on a separate
piece of paper and provide it to
every affected applicant who makes
an oral or written request for an
appraisal report.
If a bank uses bank employees to do
evaluations where licensed or
certified appraisals are not required,
that process should be examined.
Look at the last several reports
prepared in-house and determine:
To be entitled to a copy of the appraisal
report, an applicant must provide a bank a
written request for the report within 90 days
after receiving notice of action on the
application from the bank or withdrawing the
application. After receiving a request, the
bank must provide the report promptly after
the last to occur of: receipt of the request,
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04/01/06
Regulation B
which the normal price is $20,000. The
bank refuses to lend to him because of a
prohibited basis.
Before he can find
alternate financing, the sale ends and he
has to pay the full pre-sale price. The
$5,000 difference constitutes ―actual
damages‖ he can recover from the bank.
Is the report in a form that would
be appropriate to give to an
applicant?
Can the preparer of the report
adequately
substantiate
the
opinion of value?
Is there anything in the report
that discriminates or could have
the effect (or even the potential)
of discriminating?
The exception to the definition of ―actual
damages‖ arises when a business applies
to finance a transaction, is turned down on
an illegal basis, and the planned transaction
does not occur. Then the term ―actual
damages‖ will be deemed to include the
projected profits the business would have
made if the transaction had occurred as
originally intended. Expert testimony from
accountants and others can be used to
develop the figure. The courts have ruled
that precision is not necessary; any
reasonable estimate of the damages will
suffice. Great danger lurks in these cases
because of the flexibility allowed in
calculating the amount the bank will pay.
Based on the answers to those
questions, consider whether the
bank wants to continue using
employees to do appraisals. If so,
determine what, if any, changes
need to be made to the in-house
appraisal and appraisal report
preparation process.
Put the notice disclosure on the
bank‘s RESPA good faith estimate
form and on the bank‘s Regulation Z
disclosure form for real estate
secured loans. Prepare a procedure
for loan officers to provide a copy of
the notice disclosure to affected
applicants who do not receive either
the RESPA or Regulation Z
disclosures.
Punitive Damages. As the words suggest,
these damages are for punishment, not
compensation, and they need have no
relationship to the actual damages suffered
by the plaintiff. The statute lists a number of
factors a court may consider in assessing
punitive damages:
Civil Liability
The amount of the actual damages
In addition to the problems with regulators
that a bank can incur from violations of
ECOA (examination criticisms, cease and
desist orders, and the devastating effect of
ECOA violations on a bank‘s Community
Reinvestment Act performance rating) the
ECOA provides for four types of civil liability
in two types of lawsuit by an aggrieved
applicant. Section 202.16
The frequency and persistence of the
compliance failures of the bank
Actual Damages. With one exception,
―actual damages‖ generally means: the
financial loss proximately caused by the
bank‘s violation. Suppose an applicant
wants to borrow $15,000 to purchase a boat
that is on sale for a limited period, and for
Thus, punitive damages can occur in many
areas. The fifth item plainly suggests that
punitive damages may be assessed even
for unintentional violations of the Act.
The bank‘s resources
The number of persons affected
The extent to which the bank‘s failure
of compliance was intentional
Any ―other relevant factors.‖
2.26
04/01/06
Congress apparently recognized the folly of
granting completely unfettered discretion to
assess punitive damages against financial
institutions under this statute, so it did place
some limits on them. In an individual
lawsuit, the maximum assessable is
$10,000. In a class action, that is, a lawsuit
brought by one person on behalf of himself
or herself and ―all others similarly situated,‖
the ceiling on punitive damages is one
percent of the net worth of the bank or
$500,000, whichever is less.
Regulation B
the amount of the check the bank must write
at the conclusion of the lawsuit. And keep
in mind that the bank will have its own
attorneys working on the case as well, and
their fees are unlikely to be less than the
plaintiff‘s attorney fee. By the very nature of
such cases, defense usually is more costly
than offense.
Recommendations
Understanding.
Understand the
consumer credit adverse action notice
requirements of the ECOA in detail.
Equitable and Declaratory Relief. The
court also may enter injunctions or similar
orders requiring the bank to do and/or not to
do certain things. These orders may remain
in effect for a limited time or forever. The
most likely remedies are changes in the
bank‘s loan approval process, reeducation
of staff, and similar internal improvement
programs. Costs to the bank in time and
money are not listed in the law as things to
be considered in crafting the order.
Management Involvement.
The
board of directors and senior
management must ―buy in‖ to ECOA
compliance. Without such a buy-in, all
the efforts of compliance officers and
others will be for naught, because the
people who must comply with the law
will not believe they really need to.
Training and Education. Be sure all
the bank‘s personnel who have any
part in the credit process understand
the provisions of ECOA that affect
their work. Be sure that even nonlending personnel know not to
discourage potential applicants on any
prohibited basis.
While the injunctive relief portion of ECOA
does not sound terribly threatening to the
individual banker, it can become so. If a
court issues an injunction in January of year
one, the people in the bank then very
probably will become familiar with it and
comply with it in their daily work. However,
by November of year three, many (perhaps
all) of these people will not be in their
original jobs. People who were not in those
jobs at the time the injunction was issued
may not know about the injunction. If the
new personnel slip up and violate the terms
of the injunction, they, their supervisors, and
the bank will be in contempt of court. All
can then be fined (separately) and the
people can be jailed.
Procedures. Document how credits
are approved and declined, and the
objective standards used. Prepare
policies and procedures to assure
compliance with the textual and time
frame requirements of the notice rules.
Monitoring. Be sure bank personnel
actually follow those procedures.
Take corrective action when the
inevitable human failures show up.
Attorney Fees. Finally, the court may grant
the aggrieved applicant a reasonable
attorney fee. In an individual action, such a
fee is unlikely to exceed the total of the
actual and punitive damages. In a class
action, it is likely to run into six figures. In
either type of case, it can virtually double
Documentation.
The only way
examiners, judges and juries will even
begin to believe your bank tried to
2.27
04/01/06
comply with this law is if you can show
them
documentation
of
your
management‘s
involvement,
your
bank‘s
training
programs,
its
Regulation B
procedures and credit standards, and
your monitoring efforts. You must
preserve and even showcase the hard
evidence of your efforts.
This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the
understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If legal advice or other expert
assistance is required, the services of a competent professional should be sought.
2.28
04/01/06
PAGES 2.29 – 2.33 INTENTIONALLY LEFT BLANK
Home Mortgage Disclosure Act
Regulation C
Institutions Covered by HMDA
Home Mortgage
Disclosure Act
A bank, savings association or credit union
is exempt from HMDA, if on December 31 of
the preceding year:
Common name: Regulation C
It had neither a home office nor a
branch office in a Metropolitan Area (it
used to be called Metropolitan
Statistical Area), or
Introduction
The Home Mortgage Disclosure Act
(HMDA) was composed and adopted by
Congress in 1975. In its original form, it
merely required covered lenders to publish
annual reports on certain housing-related
loans those lenders had made or purchased
during the year. The number of such loans
and their geographic distribution were
essentially all the data those reports
contained. The stated purpose of the law
was to assist the federal bank regulatory
agencies
and
community-activist
organizations to spot so-called ―redlining,‖
which was defined as denial of loans to
minority
and
other
low-income
neighborhoods.
It had total assets of less than $40
million. The asset exemption level
may change annually based on
changes in the Consumer Price Index.
FAQ #7 and Comment 2 Section
203.2(2)(e)
If an exempt institution loses its exemption,
it must begin reporting for the calendar year
following the calendar year in which it lost
its exemption. Thus, if an institution had
assets of $20 million on December 31 of
year one, it would not report data in year
two. On December 31 of year two, if it had
assets of $45 million, it would not report for
year two but it would begin reporting for
year three, after its assets were above the
threshold. Comment 1 Section 203.2(e)
Congress amended HMDA in 1989 as part
of the Financial Institutions Reform,
Recovery and Enforcement Act (―FIRREA).
The FIRREA amendments to HMDA
significantly expanded the data sets
required to be generated by covered
lenders. Applications for home-mortgage
and improvement loans, not just loans
made, were required to be reported. In
addition the reporting was expanded to the
sex, race and gross income of the applicant
and the disposition of the application.
When two institutions merge, coverage
depends on the status of the surviving
institution:
If two exempt institutions merge during
the year, no data collection is required
for the year of the merger (even if the
resulting institution is covered), but
data collection is required for the
following calendar year if the resulting
institution is a covered institution as of
December 31 of the year of the
merger.
In February 2002, the Federal Reserve
made a significant expansion of the types of
loan applications reported on the Loan
Application Registration (HMDA LAR) and
on the information that is included for
reportable applications.
These changes
were effective on January 1, 2004. The
most recent amendment to Regulation C
came in 2008, when the Federal Reserve
System revised the rules for price
information on higher-priced mortgage
loans.
If a covered institution merges with an
exempt institution, and the covered
institution is the surviving institution,
data collection is required in the year
of merger only for offices of the
covered institution. Data collection is
optional for applications handled in
offices of the previously exempt
institution.
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6/15/11
Regulation C
severe compliance problems. For every
regulation, make sure that you have a clear
understanding of the defined terms.
If an exempt institution merges with a
covered institution, and the exempt
institution is the surviving institution,
data collection is required only for
transactions of the covered institution
that took place before the merger.
Data collection is optional for
transactions that take place after the
merger.
Dwelling. Regulation C revolves around
dwelling purpose or dwelling secured loans,
so the understanding of what is or is not a
dwelling is critical for Regulation C
compliance. The regulation defines a
dwelling as ―a residential structure (whether
or not it is attached to real property) located
in a state of the United States of America,
the
District
of
Columbia,
or
the
Commonwealth of Puerto Rico. The term
includes an individual condominium unit,
cooperative unit, or mobile or manufactured
home.‖ The definition seems relatively
straightforward, however the devil is in the
details. Section 203.2(d)
If two covered institutions merge, data
collection is required throughout the
entire year for each. The new or
surviving institution may file either a
consolidated report or separate
submissions for the year of the
merger. Comment 3 Section 203.2(e)
Note that HMDA reporting is based solely
on the asset size and location of the
reporting institution. There is no additional
requirement based on the asset size of the
holding company by which it is owned. If an
exempt institution is acquired by a holding
company that owns several covered
institutions,
the
acquired
institution,
provided that it is not merged into a covered
institution, retains its exempt status.
First, some of the easy parts. If you are
financing a dwelling for a customer and the
dwelling is located in Canada, Mexico,
Bermuda or anywhere out of the United
States, other than Puerto Rico, the dwelling
is not a dwelling for HMDA purposes and
the loan is not reportable.
Second, a
residential structure is not limited to a oneto four-family structure. A single family
home is a dwelling. A 1000 unit apartment
complex is a dwelling. The number of
individual dwelling units within a residential
structure is not a consideration.
All
residential
structures
are
included.
Commentary Section 203.2(d)
Definitions
One of the most important things to do in
trying to understand any regulation is to
understand the definitions in the regulation.
On the one hand, the Federal Reserve does
not always define terms in the same
nomenclature that the banking industry, in
general, uses the term. On the other hand,
sometimes the same term is defined
differently in different regulations.
Just
because you understand the definition of a
term for one regulation does not mean that
same definition carries over to other
regulations. For example, the definition of a
business day is one thing for Regulation
CC. It is something entirely different for
Regulation Z. As a matter of fact for
Regulation Z there are two definitions of
business day.
If an institution applied
Regulation CC‘s business day definition to
Regulation Z, or vice versa, it would have
A mobile home or a manufactured home is
a dwelling.
For the purpose of the
regulation,
a mobile home or
a
manufactured home is any residential
structure as defined under regulations of
HUD establishing manufactured home
construction
safety
and
soundness
standards which are found at 24 CFR
3280.2. Recreational vehicles, boats or
other types of mobile structures that a
person may be using as his or her
residence, even though they may be
permanently located, are not dwellings for
HMDA purposes.
Comment 2 Section
203.2(d)
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6/15/11
Regulation C
Home Improvement Loan.
A home
improvement loan is a loan where any
portion of the proceeds is used for a home
improvement
purpose.
A
home
improvement purpose is to either improve a
dwelling or the land on which the dwelling is
located. Comment 2 Section 203.2(g) If a
person borrows $5000 to recarpet his or her
home, that is a home improvement loan.
Likewise if a person borrows $25,000 to put
a swimming pool on the property on which
the home is located that is a home
improvement loan. If any portion of a loan
will be used for home improvement, the loan
is a home improvement loan. Comment 5
Section 203.2(g) Accordingly, if a person
borrows $100,000 and will use $5000 of the
loan proceeds for home improvement and
$95,000 for another purpose, the entire loan
is a home improvement loan. Also, unlike
dwelling
purchase
loans,
a
home
improvement loan does not have to be
secured by a dwelling.
Next, the residence contemplated by the
regulation is one of a permanent nature.
Accordingly,
facilities
for
temporary
residence such as rooming houses,
dormitories and other types of notpermanent or transitory residence facilities
are not dwellings. A ―timeshare‖ is not a
dwelling. Also nursing homes and other
types of extended care facilities are not
dwellings. The regulators have taken the
position that the greater purpose of these
type facilities is to provide nursing, extended
care and meals as opposed to a bed in
which the resident sleeps or a room in
which a resident resides.
Finally, there is what is sometimes referred
to as the 50% rule. It applies when there is
a mixed-use property that is, a portion of the
property is a dwelling and a portion is not.
Assume that a loan applicant applies for a
loan to purchase a building that has
commercial space on the ground floor and
residential space on the upper floor or
floors. Is it a dwelling for HMDA purposes?
It is a dwelling if 50% or more of the value of
the building is attributable to the residential
space. You can determine value either by
square footage of the residential versus the
nonresidential space, or by their relative
income streams, or by the respective values
given the different parts of the building by
an appraiser. Assume that a loan applicant
applies for a loan to purchase a farm. The
farm has a value of $1 million dollars. On
the farm is a dwelling. The dwelling and the
land attributable to it have a value of
$50,000. The property is not a dwelling
because the greater part of the value is in
the farmland. On the other hand, if the
property is an estate-type farm and the
house and the land attributable to it is worth
$800,000 it would be a dwelling. You will
run into other situations of either temporary
residence
or
mixed-use
properties.
Comment 2 Section 203.2(h) Use the same
logic described here to determine whether
or not the property is a dwelling.
Refinancing.
A refinancing is a loan
secured by a dwelling where all or part of
the proceeds of the loan will be used to pay
off an existing loan by the same borrower
secured by a dwelling. Section 203.2(k) All
loans that fall within the refinancing
definition are refinancings, regardless of the
purpose of the loan being paid off or the use
of any new money from the new loan. See
FAQ, loan purpose.
Assume that a sole proprietor applies for a
$50,000 loan for inventory for his business
and will secure the loan with a second
mortgage on his home. That loan is not
HMDA reportable. Assume further that he
is successful and the next year he applies
for a $100,000 loan, again to be secured by
a second mortgage on his home. $50,000
of the loan will be used to repay the
existing loan and the other $50,000 will be
used for additional inventory. The second
loan is a refinancing. Assume that a
borrower has a $50,000 home improvement
loan secured by a certificate of deposit. The
borrower now applies for a $50,000 loan to
2.36
6/15/11
be secured by the dwelling that was
improved to pay off the initial loan. In this
case the second loan is not a refinancing
because the loan being paid off is not
secured by a dwelling.
Regulation C
wants to set it, provided it is not over two
years. Additionally the term ―temporary
financing‖ contemplates that the loan that is
being made is temporary, that is the
borrower will use the funds on a temporary
basis until permanent or longer term
financing is arranged, by the same
borrower, to pay off the temporary loan.
The classic example of temporary financing
is a home construction loan. The borrower
is using the money on a temporary basis, to
build the home, and then will pay the
temporary construction loan off with a
longer term financing. The FDIC has opined
that a short term loan to purchase and
rehabilitate a dwelling that the borrower
plans to resell is not temporary on the basis
that it is the only loan that borrower is going
to have on that dwelling. The loan will be
paid as a result of the sale of the property
and not by a refinancing by the same
borrower. This interpretation came from the
Kansas City office of the FDIC. This view
has now been supported in FAQs issued in
November 2005 for HMDA. If a person
borrows $5000 to recarpet his or her home,
and will pay the loan off in six equal monthly
installments, that is not a temporary
financing. It is the only financing that the
borrower will obtain for the carpet. It is not
anticipated that it will be paid off with
another financing. For a loan to be a
temporary financing it must have a term of
not more than two years, or such lesser
term as may be set by an institution, and it
must be anticipated, at the time the loan is
made, that it will be repaid with another
financing by the same borrower.
In determining what is and is not a
refinancing, recognize that both the old and
the new loan must be secured by a
dwelling. Assume that an institution makes
a loan to a corporation and the corporation‘s
principal stockholder guarantees the loan.
As collateral for the guarantee the principal
stockholder pledges his or her home.
Subsequently the loan is refinanced with the
same guarantee and guarantee collateral.
That is not a refinance. The dwelling was
collateral for the guarantee, not the loan.
The loan itself was not dwelling secured.
A refinancing for HMDA purposes is the
satisfaction and replacement of an existing
obligation by a new obligation of the same
borrower where both obligations are
secured by a dwelling. Accordingly, loan
modifications and loan extensions if
accomplished by a document titled ―Loan
Modification Agreement‖ or something
similar, are not refinancings. The existing
obligation was not satisfied. The existing
obligation remains in place with the terms
amended.
Even
though
the
loan
modification may attain the exact legal
effect that a new note would, if the effect is
reached through a modification agreement,
the transaction is not a refinancing. The
only exception is if in the modification new
money is advanced. That is always a new
extension of credit and is treated as a
refinance.
Application. An application is an oral or
written request for a dwelling purchase loan,
a dwelling improvement loan or a refinance
that is made in accordance with the
procedures of the institution for the type of
credit
requested.
Section
203.2(b)
Regulation B requires that applications for
loans to purchase a principal residence or to
refinance a principal residence be on the
long form residential real estate loan
application. If that is your institution‘s policy
Temporary Financing. The first rule is that
any loan with a period of over two years is
not a temporary financing. The HMDA
Getting It Right booklet says that each
institution must make its own determination
of what length of time is temporary, however
it cannot set a time frame of more than two
years. So an institution can set a time
frame for temporary financings of one-year,
18 months, two years or wherever else it
2.37
6/15/11
then, for those loans you have received an
application when the applicant has filled out
the form and provided it to you. Many
institutions take some loan applications over
the telephone or orally without a formal
application. If that is the policy of your
institution then you have received an
application when the conversation is over.
The general rule is that to have an
application you must have (1) the identity of
the borrower, (2) the amount of loan
requested, (3) a description of the collateral
and (4) an affirmative request for credit. If
you have received these four elements in
accordance with your institution‘s policy for
receiving applications, you have an
application.
Regulation C
program meets these standards, then
requests that it receives under the program
are applications for preapproval. If the
program does not meet these standards, for
example if it does not issue written
commitments, or if the commitment is
subject to further credit underwriting, then
applications under the program are not
applications for preapproval. Note that only
applications for preapproval for home
purchase loans come under the definition.
Applications for preapproval for home
improvement loans or for refinancings do
not. See FAQ on preapprovals.
Applications to be Reported
Reportable applications fall into three
categories. See HMDA Guide to Getting it
Right. First is an application for a loan to
purchase a dwelling (including an
application for preapproval) provided that
the loan will be secured by a dwelling. The
dwelling being purchased does not
necessarily have to be the dwelling that is
being used as security. If a borrower uses
his or her personal residence as collateral
for a loan to purchase a rent house, that is a
reportable application. If the application is
for dwelling purchase preapproval, an
institution is only required to report the
preapproval application if the result was
either a denial or a loan. If the preapproval
application was approved but it did not
result in a loan then the reporting is at the
institution‘s option. Whether an institution
elects to report or not report those
preapproval applications, it must be
consistent.
That is it must report all
preapproval applications that are approved
and do not result in a loan or it must report
none of them.
One exception to the above rules is an
application for a preapproval for a home
purchase loan. If an institution has a formal
preapproval program for prospective home
buyers where the creditworthiness of the
applicant is checked and a commitment is
issued, then the applications under that
program are for preapproval. The formal
definition states as follows: ―A request for
preapproval for a home purchase loan is an
application...if the request is reviewed under
a program in which the financial institution,
after a comprehensive analysis of the
creditworthiness of the applicant, issues a
written commitment to the applicant valid for
a designated period of time to extend a
home purchase loan up to a specified
amount. Comment 2 Section 203.2(b) The
written commitment may not be subject to
conditions other than: (i) conditions that
require the identification of a suitable
property; (ii) conditions that require that no
material change has occurred in the
applicant‘s
financial
condition
or
creditworthiness prior to closing; and (iii)
limiting conditions that are not related to the
financial condition or creditworthiness of the
applicant that the lender ordinarily attaches
to a traditional home mortgage application
(such as a certification of a clear termite
inspection).‖ If an institution‘s preapproval
It is not a requirement of a dwelling
purchase loan application that the loan be a
first mortgage. Regardless of the priority of
the lien that will secure the loan, if the
proceeds will be used for dwelling purchase,
it is a dwelling purchase loan application.
Some institutions have a program for high
2.38
6/15/11
loan-to-value dwelling purchase applications
of making two simultaneous loans. In that
case, both loans are dwelling purchase
loans and each would be reported. For
example, a person applies to an institution
for a 90% loan-to-value loan to purchase a
residence. The institution makes the person
an 80% first mortgage and a 10% second
mortgage. Both loans are dwelling purchase
loans and each would be reported.
Alternatively one institution may be making
the first mortgage and another the second
mortgage. Again, each is a dwelling
purchase loan and is reportable.
Regulation C
institution must be consistent in either
classifying
those
loans
as
home
improvement or not so classifying them.
See HMDA Guide to Getting it Right.
The third category of reportable applications
is applications for a refinance. Again for
what is and is not a refinance, use the
definition above. As with a purchase loan, a
refinance does not have to be secured by
the property that secures the loan. As long
as both the new loan and the loan being
refinanced are secured by dwellings, albeit
different dwellings, the loan application is
reportable. See FAQs. If the application is
for a loan to be secured by a dwelling and
all or a portion of the proceeds are to repay
a loan secured by a dwelling, it is
reportable. Section 203.2(k) Also, as with
dwelling purchase loans, the lien status of
either the loan that is being made or the
loan that is being paid off is of no
consequence relative to whether the
refinancing is or is not reportable. It does
not matter whether the new loan or the old
loan is a first or junior mortgage. As long as
each is secured by a dwelling the
refinancing is reportable.
An application to assume an existing loan
secured by a dwelling is a dwelling
purchase loan application. When a
prospective purchaser of a dwelling applies
to an institution to assume a loan that the
institution has secured by the dwelling that
is an application for a dwelling purchase
loan. It is to be reported in the amount of
the outstanding principal balance. Comment
9 Section 203.1(c)
The second category of reportable
applications is home improvement loans.
Under the definition stated previously, a
loan is for home improvement if any portion
of the loan proceeds will be used to improve
a dwelling or the land that the dwelling is
situated on. Comment 2, Section 203.2(g)
Different rules apply for the reporting of
home improvement loans depending on
how the home improvement loan is secured.
If the application is for a home improvement
loan to be secured by a dwelling, it must be
reported. If the home improvement loan is
not to be secured by a dwelling then it is to
be reported if the lending institution
classifies the loan on its books as a home
improvement loan. Relative to classification
as a home improvement loan, an institution
must be consistent. Comment 1 Section
203.2(g)
An institution must report applications that it
receives for a covered purpose and loans
that it purchases that were for a covered
purpose. On the reporting of purchased
loans do not report the purchase of
participations in loans; report only whole
loans purchased.
Exclusions from Reporting
Were it not for the exclusions and the
exceptions and the exceptions to the
exceptions contained in the regulations,
those of us responsible for the writing of this
manual would probably not have a job
because people could just read the
regulation and understand what it requires.
We thank goodness for the exceptions. It
just depends on whose ox is being gored.
On non-dwelling secured loan applications,
where the applicant tells the institution that
some or all of the proceeds of the loan will
be used for home improvement, the
For HMDA reporting the first exception is
what is called the ―broker rule.‖ The broker
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6/15/11
rule provides that a financial institution shall
only report a loan application on which it
made a credit decision. Under that rule, if
an institution accepts an application for a
reportable loan and submits the application
to a secondary market buyer and the
secondary market buyer makes an
affirmative decision on the loan, the
institution that received the application does
not report it. The institution that received
the application did not make a credit
decision. The same rule applies regardless
of whether the loan closes in the name of
the secondary market buyer with the buyer‘s
funding, in the name of the institution with
the buyer‘s funding, or in the name of the
institution with the funding by the institution
if the loan is subsequently sold to the
secondary market buyer.
In all three
circumstances the credit decision was made
by the secondary market buyer, not by the
institution that received the covered
application. The secondary market buyer
will report the loan as an origination.
Comment 2 Section 203.1
Regulation C
report it. On the other hand assume that all
four secondary market buyers denied the
loan. In that event, all four, as well as the
institution that received the application,
would report it as a loan denied.
Another example. A person applies to an
institution for a HMDA covered loan and the
institution approves the application. After
the approval the institution submits the
application to a secondary market buyer
and the secondary market buyer agrees to
purchase the loan.
In that case, the
institution to which the application was
made would report the application because
it made a credit decision. An institution may
know what the credit standards of a
secondary market buyer are, and may
approve the application based on those
credit standards. It would still report the
application because it made a credit
decision, albeit based on a third party‘s
credit standard.
If the institution that
receives an application makes a credit
decision before it receives a credit decision
from a prospective purchaser of the loan, it
made a credit decision and should report
the application. Comment 4 Section 203.1
If the decision of the secondary market
buyer is negative and the institution that
received the application denies it because it
could not sell the loan in the secondary
market, then the institution will report the
loan as a denial. In this instance the
institution made a credit decision to deny
the loan, although the credit decision was
based upon the credit decision of someone
else. Comment 2 and 4 Section 203.1 Both
the institution that received the application
and the secondary market buyer would
report the loan as a denial. Assume that an
institution receives a covered application
and submits it to four secondary market
buyers. Two deny it, two approve it, and it
closes with one of the buyers who approved
it. The two that denied it would report it as a
denial. The one who approved it but did not
close would report it as an application
approved but not accepted and the one who
closed it would report it as an origination.
Comment 3 Section 203.1 The institution
that received the application would not
Now, let‘s assume that an institution is on
the other end of the application process. A
broker or another financial institution
submits to it applications for covered loans.
The institution that receives the loan
application from the broker will report it.
Alternatively, if a loan is offered for
purchase after the loan is closed, if the
institution purchases the loan it reports it as
a loan purchased. If it declines to purchase
the loan, it does not report it.
The second exception is home equity lines
of credit. For this purpose a loan is a home
equity line of credit if it is subject to the
home equity line of credit rules under
Regulation Z; that is, it is a revolving credit,
for a consumer purpose, secured by a
residence of the borrower. Section 203.1(f)
At its option an institution may report home
equity lines of credit if the purpose of the
credit line is for home purchase or home
2.40
6/15/11
improvement. See p8 HMDA Guide to
Getting it Right The Federal Reserve
omitted home equity line refinances. In
conversation with the Federal Reserve, it
said what it wrote is not what it intended.
The intent was to make the reporting of all
purpose covered home equity lines of credit
optional, including refinances. HELOCs that
are refinances are not required to be
reported.
Regulation C
the requirements and elects to renew the
loan, that is not a reportable refinancing.
Collecting the Government
Monitoring Information
If an institution receives an application for a
HMDA covered loan, then the institution
must request what is generally referred to
as the government monitoring information
from the loan applicant and any coapplicants.
The first rule is that the
requirement for government monitoring
information applies only to individuals, that
is, real live human beings. A juridical entity,
that is a corporation, partnership, trust,
limited liability company or other such
organization does not have a race, sex or
ethnicity. You do not look through the entity
to the race, sex, or ethnicity of its owners or
management. If the applicant is not an
individual do not ask for or take the
government monitoring information for the
loan. Appendix A ID4b
Whichever option an institution selects, that
is to report or not report HMDA purpose
home equity lines of credit, it must be
consistent. Either report all purpose covered
HELOCs or report none of them. If an
institution does elect to report them, then for
the loan amount it should report only the
amount of the line that is initially drawn for
the covered purpose, not the entire amount
of the credit line.
Additionally, realize that if an institution
receives an application for a dwellingsecured revolving credit line and it does not
fall under Regulation Z, it does not fall within
the exemption and if it is for a HMDA
covered purpose, it is reportable. The
reporting option extends only to Regulation
Z covered home equity lines of credit.
The government monitoring information is
the applicant‘s race, sex and ethnicity.
Where there are multiple individuals that are
applicants for a covered loan, you must
obtain
the
government
monitoring
information for every applicant, however
there is only room to report the information
on two applicants.
The third exception is temporary financings.
If an application is for a HMDA covered
purpose, but it is a temporary financing as
defined earlier, it is not reportable.
Temporary financings for a covered purpose
are not HMDA reportable.
There are five choices for race that an
individual may select. They are (1)
American Indian or Alaska Native, (2) Asian,
(3) Black or African American, (4) Native
Hawaiian or Other Pacific Islander and (5)
White.
Those are the only allowable
selections. There is no ―other‖ category. If
an individual wishes to do so, he or she may
select more than one category, and all
categories selected are reported. Appendix
A ID4a
The final exception is a refinancing where
the lender was obligated to refinance the
loan or the conditions for the refinance were
entirely in the borrower‘s control.
For
example, assume that an institution made a
home purchase loan with a 30 year
amortization schedule and a three year
term. The loan documents provide that at
the end of the three years, if the borrower
has had a good payment record the
institution is obligated to renew the loan for
an additional three years at the then-current
rate for similar loans. If the borrower meets
There are only two categories for sex, male
and female. So far, the political correctness
of the government does not allow the
selection of both categories nor does it give
a choice in between.
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Ethnicity means that the individual is or is
not Hispanic or Latino. The regulators do
not say what, if any, differences there are
between Hispanic and Latino and the two
constitute a single group for HMDA
reporting.
Regulation C
script that the loan officer must read
advising the person that providing the
information is not mandatory. Again, if the
person declines to provide the information
the loan officer should note on the datacollection form that the application was
taken over the telephone and that the
applicant
declined
to
provide
the
information. The loan officer does not
guess at race, sex or ethnicity based on the
person‘s voice. Also, as with mailed or
internet applications, if the loan officer
should subsequently see the applicant he or
she should not enter the government
monitoring information based upon the
visual observation.
If a HMDA covered application is taken by
an institution employee in person, the
applicant and any co-applicant for the loan
must be provided the government
monitoring information data-collection form
either as a part of the loan application or on
a separate sheet of paper. It states that the
government is soliciting the information and
the applicant is encouraged but not required
to provide it. If the applicant fills the
information out, report the information
exactly as the applicant provided it. If the
most masculine appearing person in the
world indicates sex of female, report the sex
as female. Don‘t second guess the
information provided.
If the applicant
declines to provide the information, the loan
officer must complete the information based
upon visual observation and note it on the
form. Appendix B IID
It is not infrequent that an institution will
receive
the
government
monitoring
information on loans that are not HMDA
covered loans and accordingly it should not
have received it. HMDA draws a very bright
line. For covered loans requesting the
information is mandatory and for noncovered loans requesting the information is
a violation of Regulation B. Sometimes a
loan officer may believe that the loan is
covered and obtain the information.
Sometimes an applicant will be provided an
application for a non-covered loan that has
the data-collection form on it and the
applicant will fill it out even though he or she
was instructed not to do so. In any event, if
the government monitoring information is
obtained on a loan where it should not have
been obtained, our advice is for the loan
officer to take an indelible marker and black
out the information. The loan officer should
then write on the form ―This information was
obtained inadvertently and deleted from the
file on‖ and then date it and initial or sign it.
No harm, no foul.
If an institution provides the application for a
covered loan over the internet or by mail the
application or a separate sheet of paper
with the application must contain the datacollection form. Again the applicant may
decline to provide the information. If the
applicant does decline, then on the form
note that it was received by mail or over the
internet. Assume that the internet applicant
declined to provide the information and the
loan officer sees the applicant at the
closing. Must or should the loan officer at
that time note the government monitoring
information based upon visual observation?
The answer is no. After the application is
received, nothing more must or should be
done relative to the data collection.
Appendix B IIE
Completing the Loan
Application Register
Appendix A
If a loan officer takes a covered application
over the telephone he or she must orally
request
the
government
monitoring
information from the customer and there is a
There are 26 elements of information to be
recorded on the LAR for every HMDA
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covered loan application and for every
covered loan that the institution purchased
during the year. For purchased loans,
report only whole loans purchased. Do not
treat the purchase of a participation in a
loan as the purchase of a loan.
Regulation C
refinancing where the person will use a
portion of the loan for home improvement.
In those cases, if a portion of the loan is for
home purchase, report the entire loan as
home purchase. If none of the loan is for
home purchase, but a portion is for home
improvement, report the entire loan as
home improvement. In essence, in the
pecking order, purchase trumps home
improvement,
trumps
refinance.
Commentary, Section 203.2(g) and Section
203.2(h)
In the first column of the Loan Application
Register, enter a number not exceeding 25
characters to identify the loan application or
the loan purchased. Most institutions use
the number assigned to the loan application
or to the loan.
In the sixth column enter the appropriate
code for the owner occupancy of the
property. If the property will be occupied by
the owner as his or her principal residence,
enter Code 1. If the property will be a
second home, vacation home or rental,
enter Code 2. If the property is a multifamily
dwelling, or it is not located in a
metropolitan area, or is located in a
metropolitan area in which the institution
does not have an office, enter Code 3.
Alternatively to Code 3, at the institution‘s
option, it may report the actual occupancy
status, using Code 1 or Code 2 as
applicable. For example, a loan secured by
a single-family home located outside a
metropolitan area that is the borrower‘s
principal residence, may be either Code 1 or
Code 3. Appendix A I A 6
In the second column enter the date that the
loan application was received. Enter NA for
loans that were purchased. If you file your
Loan Application Register on paper the date
format is MM/DD/CCYY. If you file
electronically
the
date
format
is
CCYY/MM/DD.
In the third column, enter the type of loan
that is being applied for or purchased. For
conventional loans, which are all loans other
than FHA, VA, Farm Service Agency or
Rural Housing Service loans, use Code 1.
Use Code 2 for FHA insured loans, Code 3
for VA loans and Code 4 for FSA or RHS
loans.
In the fourth column enter the code for the
property type. Code 1 is for a 1- to 4-family
dwelling other than a manufactured home.
Code 2 is for a manufactured home and
Code 3 is for a multi-family dwelling, that is
a property that exceeds four units. Use
Code 1 for individual condominium or cooperative units even though they may be in
a building that contains more than four
units. Appendix A I A 4(a)
In the seventh column enter the loan
amount rounded to the nearest thousand
dollars. Do not report loans of less than
$500 and round $500 up to the next $1000.
For closed end home purchase loans, home
improvement loans and refinancings, enter
the entire amount of the loan.
If an
institution elects to report covered homeequity lines of credit for home purchase and
home improvement, report only the amount
that was used for the home purchase or
home improvement purpose. For a loan
that is purchased, report the loan balance at
the time of purchase. For a loan application
that was denied or withdrawn, enter the
amount applied for. Appendix A I A 7
In the fifth column enter the code for the
purpose of the loan application or the
purchased loan.
Code 1 is for home
purchase, Code 2 is for home improvement
and Code 3 is for refinancing. Occasionally
an institution may receive an application for
a loan that falls into more than one
category. For example a person may apply
for a loan to purchase a home and to
refurbish it. Or a person may apply for a
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In the eighth column enter the appropriate
code to indicate whether the application was
a request for preapproval. Remember that
preapproval requests are reported only for
home purchase purpose loans. Enter Code
1 if the application was a request for a home
purchase loan preapproval. Enter Code 2 if
the application was for a home purchase
loan, but was not pursuant to a request for
preapproval. Enter code 3 for applications
for home improvement, refinancings and
purchased loans. Appendix A I A 8
Regulation C
originated and preapprovals that lead to a
loan origination, enter the settlement or
closing date. If the loan application was for
construction and permanent financing, an
institution may use either the date that the
construction loan closed or the date that it
converted to permanent financing, again
being consistent in the date that it chooses.
We believe that the easier method is to
use the date that the construction loan
closes. For loans purchased, use the
date of purchase. For applications and
preapprovals denied, applications and
preapprovals approved but not accepted by
the applicant, and files closed for
incompleteness enter the date that the
action was taken by the institution or the
date the notice was sent to the applicant.
For applications withdrawn, enter the date
the institution received the applicant‘s
express withdrawal, or enter the date shown
on the notification from the applicant.
Appendix A I B 2
In the ninth column enter the appropriate
code for the action that was taken on the
loan. Enter Code 1 for a loan originated.
Also use Code 1 if the institution made a
counter offer and the counter offer was
accepted and the loan closed. Enter code 2
for an application approved but not
accepted. Also use Code 2 for a loan that
was closed but subsequently rescinded by
the borrower. Enter Code 3 for an
application denied. Enter Code 4 for an
application withdrawn. For HMDA purposes,
an application can only be withdrawn if the
withdrawal occurs prior to a credit decision
being made. If a credit decision has been
made prior to the time that the applicant
withdraws the application, even if the
applicant has not been informed of the
credit decision, report the credit decision.
Enter Code 5 for a file closed for
incompleteness. Enter Code 6 for a loan
purchased. Enter Code 7 for a preapproval
request denied.
Enter code 8 for a
preapproval request approved but not
accepted. It is optional for an institution to
report preapproval requests approved but
not accepted. Whichever option the
institution chooses, it should be consistent
and either report all or report none.
Appendix A I B 1
In the eleventh, twelfth, thirteenth and
fourteenth columns enter the location data
for the property that includes the
metropolitan area code, the state code, the
county code and the census tract number.
For a home purchase loan secured by one
dwelling but for the purchase of another
dwelling, use the information for the
property in which the security interest is
being taken. If the home purchase loan is
secured by more than one property, report
the location of the property being
purchased. If the loan is to purchase
multiple properties and is secured by
multiple properties, the entire loan may be
reported using the location of one of the
properties or the loan may be allocated
among the properties being purchased and
reported using multiple entries on the Loan
Application Register.
If the loan is to
purchase a mobile or manufactured home
and the final location is not available, enter
not applicable. For a home improvement
loan, report the location of the property
being improved. If more than one property
is being improved the entire loan may be
In the tenth column, enter the date of action
taken on the loan. As with the date of
application, if an institution reports on paper
the proper date format is MM/DD/CCYY. If
an institution reports electronically the
proper format is CCYY/MM/DD. For loans
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reported using the location of one of the
properties or the loan may be allocated
among the properties being improved and
reported using multiple entries on the LAR.
Appendix A I C
Regulation C
In the fourteenth column enter the six-digit
number for the census tract in which the
property is located, using the census tract
information from the 2010 census. Enter
NA if the property is located in an area not
divided into census tracts or if the property
is located in a county with a population of
less than 30,000 according to the 2010
census.
If an institution is a large institution for CRA
purposes, then it must report the location
data for every loan application it receives
and every covered loan that it purchases. If
a property is not located in a metropolitan
area it must still report the state and county
codes and the census tract number for the
property. It must report the location data for
covered loans that it purchases, even if the
loan was purchased from a lender who was
not required to report the location
information. If an institution is not a large
institution for CRA purposes it is only
required to report the location information
for properties located in a metropolitan area
in which it has a home or branch office. A
small institution may report the location
information on properties located outside a
metropolitan area in which it does not have
a home or branch office or it may report the
location information for those loans as not
applicable.
If the request was for a preapproval that
was denied or approved but not accepted,
an institution may enter NA in all four
columns.
In the fifteenth through the twentieth
columns enter the information regarding the
ethnicity, race and sex of the applicant and
the first co-applicant, if any. Remember that
only a real live human being can have an
ethnicity, race or sex. Accordingly, if the
applicant or co-applicant is a juridical entity,
for example, a corporation, trust or
partnership, it has no ethnicity, race or sex
and enter the code for not applicable. You
need not collect or report this information for
loans purchased and if you choose not to do
so, enter the code for not applicable.
Appendix A I D
In the eleventh column enter the
metropolitan area (they used to be called
metropolitan statistical areas) number for
the location of the property to which the loan
relates. The Office of Management and
Budget
defines
metropolitan
area
boundaries. Use the boundaries that were
in effect on January 1 of the calendar year
for which you are reporting. You can obtain
a list of metropolitan areas from your
supervisory agency or from the FFIEC.
There is also a list in the back of the HMDA:
Getting It Right book. If the property is not
located in a metropolitan area, enter NA.
In the fifteenth and sixteenth columns enter
the appropriate codes for the ethnicity of the
applicant and the first co-applicant, if any.
For Hispanic or Latino enter Code 1. For
Not Hispanic or Latino enter Code 2. For
information not provided by applicant in
mail, internet, or telephone application enter
Code 3. For not applicable enter Code 4.
For no co-applicant enter Code 5. Appendix
AID3
In the seventeenth and eighteenth columns
enter the appropriate codes for the race of
the applicant and the first co-applicant, if
any. If the applicant has selected more than
one race, enter the code for each race that
the applicant has selected. Use Code 1 for
American Indian or Alaska Native. Use
Code 2 for Asian. Use Code 3 for Black or
African American. Use Code 4 for Native
Hawaiian or Other Pacific Islander. Use
In the twelfth and thirteenth columns enter
the two-digit numerical Federal Information
Processing Standard (FIPS) code for the
state and the three-digit numerical code for
the county in which the property is located.
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Code 5 for White.
Use Code 6 for
mail, internet or telephone application. Use
Code 7 for not applicable. Use Code 8 for
no co-applicant. Appendix A I D 4
Regulation C
the loan was
Appendix A I E
privately
securitized.
Use Code 6 if the buyer of the loan was a
commercial bank, savings bank or savings
association. Use Code 7 if the buyer of the
loan was a life insurance company, credit
union, mortgage bank, or finance company.
Use Code 8 if the loan was purchased by an
affiliate of your institution even if Code 6 or
7 would also be applicable. Use Code 9 if
another type purchaser purchased the loan.
In the nineteenth and twentieth columns
enter the sex of the applicant and the first
co-applicant, if any. Use Code 1 for male.
Use Code 2 for female. Use Code 3 for
mail, internet or telephone applications.
Use Code 4 for not applicable. Use Code 5
for no co-applicant. Appendix A I D 5
In the twenty-third column you may report
the reason for denial on loan applications or
prequalification requests that are denied.
The denial reason reporting is mandatory
for national banks. For other institutions the
reporting of the denial reason is optional.
An institution may report up to three
reasons that the loan was denied. If an
institution uses the model form for adverse
action notices contained in the Appendix to
Regulation B, use Code 1 for income
insufficient for amount of credit requested
and excessive obligations in relation to
income. Use Code 2 for temporary or
irregular employment and length of
employment. Use Code 3 for insufficient
number of credit references provided,
unacceptable type of credit references
provided, no credit file, limited credit
experience, poor credit performance with
us, delinquent past or present credit
obligations with others, garnishment,
attachment, foreclosure,
repossession,
collection action, judgment or bankruptcy. If
an institution does not use the Regulation B
model form, use Code 1 for an
unsatisfactory debt-to-income ratio. Use
Code 2 for an unsatisfactory employment
history. Use code 3 for an unsatisfactory
credit history. Use Code 4 for insufficient
collateral. Use Code 5 for an insufficient
down payment or insufficient cash to close.
Use Code 6 for unverifiable information.
Use Code 7 for an incomplete application.
Use Code 8 for private mortgage insurance
denied and code 9 for other. Appendix A I F
In the twenty-first column enter the gross
annual income that your institution relied
upon in making the credit decision. As with
the application amount, round all amounts
to the nearest $1000. Enter NA if the
applicant or the co-applicant is not a natural
person, for applications secured by loans on
multifamily dwellings or if no income
information is asked for or relied on in the
credit decision. An institution may also use
NA if the applicant or co-applicant is an
institution employee to maintain the
confidentiality of that information. Appendix
AID6
In the twenty-second column enter the
proper code for whether or not the loan was
sold, and if so the type institution to which it
was sold. Report only the sales of whole
loans. Do not report participation sold as a
sale. Enter Code 0 if the loan was not
originated or if originated was not sold in the
calendar year covered by the register.
Accordingly, use code 0 for applications that
were denied, withdrawn, approved but not
accepted by the applicant, or closed for
incompleteness. If a loan is originated in
one calendar year and sold in another, it is
never reported as sold. Do not put a loan
back on the register in the year that it is sold
to report it as sold. Use Code 1 if the buyer
of the loan is Fannie Mae. Use Code 2 if
the buyer of the loan is GNMA and Code 3 if
it is Freddie Mac. Use Code 4 if the buyer
of the loan is Farmer Mac. Use Code 5 if
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In the twenty-fourth column enter what is
referred to as the rate spread information if
the loan was a purchase loan, refinancing or
a dwelling secured home improvement loan
subject to Regulation Z. Do not report rate
spread information for loans that are
purchased, home improvement loans that
are not dwelling secured or loans that are
not subject to Regulation Z. The rate spread
is the difference between the annual
percentage rate (APR) on the loan and the
Treasury yield for a comparable term. To
obtain the comparable Treasury yield, an
institution must use the yields that are
published on the FFIEC‘s Web site, not the
Treasury H-15 release. Use the yield for
the fifteenth day of the month prior to the
date that the final rate is set for the loan.
If the rate is set on September 14, use the
comparable rate for August 15. If the rate is
set on September 15 through October 14,
use the comparable rate for September 15.
If the term of the loan falls immediately
between two Treasury terms, use the
lower of the two Treasury rates. For
example, if you have a 15-year loan, use
the lower of the 10 or 20 year Treasury rate.
The term of the loan is the term to maturity,
not the amortization period. A loan that
matures in three years that has payments
calculated on a 25-year amortization
schedule has a term of three years.
Recognize
that
the methodology
for
determining the appropriate Treasury rate is
different for this purpose than it is for
Section 32 of Regulation Z. The qualifying
spreads are different as well. Appendix A I
F1
Regulation C
truncate the digits that lie beyond the two
decimal places. If the rate spread is less
than 10%, enter a leading zero. Enter NA if
the rate spread is not reportable or if it is
less than the applicable 1.5 or 3%. Enter
the rate spread if it is equal to or greater
than the applicable 1.5 or 3%. Appendix A I
G1
The Federal Reserve amended Regulation
C to include the reporting of price
information for higher-priced mortgage
loans as of October 1, 2009.
Loan
applications taken on or after October 1,
2009 and any loans that closed on or after
January 1, 2010 had to have rate spread
information reported based upon the spread
between the loan‘s APR and a new index
which is used to determine if the loan
qualifies for treatment as a higher-priced
mortgage loan under both Regulations C
and Z.
For this rate spread reporting requirement,
institutions use the ―average prime offer
rate‖ instead of the yield on ―comparable‖
treasury securities.
Please see our
Regulation Z Chapter for additional
information on higher-priced mortgage
loans.
The FFIEC has updated its HMDA Web site
tools to provide a calculator for rate spread
reporting that is based on the average prime
offer rate. In addition to the tool which can
be used by HMDA reporting institutions to
determine the rate spread to report, the site
also provides two tables of rate information
– the ―Average Prime Offer Rates-Fixed‖
and ―Average Prime Offer Rates-Adjustable‖
tables. The tables are available in ASCII
comma delimited format to view, print and
download. Tables used for the rate spread
calculator are updated weekly to reflect
current market rates.
If the loan is secured by a first mortgage on
a property, the reportable rate spread is
1.5% or more. If the loan is secured by a
junior mortgage the reportable rate spread
is 3.5% or more. If the rate spread on the
loan equals or exceeds the applicable 1.5 or
3.5 percentage points, then enter the rate
spread to two decimal places. If the
difference between the APR and the
average prime rate is a figure with more
than two decimal places, round the figure or
Rates are updated every Friday and are
available for use the next Monday. You will
use the most recent average prime offer
rate that was in effect on the date the rate
was set for the loan. If there is a rate lock in
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effect, you use the rate lock date as the
benchmark date for doing the rate spread
calculation. If the loan was not closed
based on the initial rate lock, then you
should do the rate spread calculation as of
the date the final rate is set for the loan
before closing.
Regulation C
Loan Application Register
Maintenance and Reporting
Institutions must record their loan and
information data on the LAR within 30
calendar days after the end of the quarter in
which final action was taken. Institutions
regulated by the OCC or OTS also must
report the ―reason for denial‖ information.
Make sure that you do not use an average
prime offer rate that is not in effect. Since
the rates will be published weekly to apply
for the following week, you could
unintentionally use an average prime offer
rate with an effective date in the future.
Always make certain that a prime offer rate
is in effect before you use it.
All institutions that are required to file a LAR
must file two copies of it with their primary
regulator by March 1 of each year for the
preceding calendar year. Upon receipt of
each institution‘s LAR, the Federal Financial
Institutions Examination Council prepares a
―disclosure statement‖ from it and returns it
to the reporting institution. An institution
must make its disclosure statement
available to the public within three business
days after receipt at its home office and
within 10 business days at one branch office
in each other MSA in which the institution
has a branch. Alternative to making it
available at other than its home office, an
institution may post an address in its
branches to which written requests for the
disclosure statement may be sent. This
notice must appear in each branch of the
institution that is in a metropolitan area.
After filing its LAR an institution must modify
it by deleting (for each application) the
application date, the application number and
the date on which action was taken. The
modified LAR must be made available to the
public within 30 days of a request for it. For
requests made prior to March 1, it must be
made available on March 31.
Section
203.5(c)
In the twenty-fifth column, enter the loan‘s
HOEPA status, which is whether it is subject
to Section 32 of Regulation Z. For a loan
that is originated or purchased that is
subject to HOEPA because either the rate
spread or the points and fees exceed the
HOEPA triggers, enter Code 1. For all other
applications and loans, enter Code 2.
Appendix A I G 3
In the twenty-sixth column, enter the priority
of the lien securing the loan. Use Code 1 if
the loan is secured by a first lien on the
property. Use Code 2 if the loan is secured
by a junior lien on the property. Use Code 3
if the loan is unsecured. Use Code 4 for
loans that an institution purchases.
Appendix A I H
In the next column, enter the applicant‘s
DNA code and retinal scan. Alternatively,
enter the square root of the applicant‘s
height in centimeters divided by the
applicant‘s weight in stones. Just checking
to see if you are still awake. The regulators
asked for everything else about a loan.
They probably should not be given ideas
about what else they might ask. In any
event, for the moment the twenty-sixth
column, the lien status, is the last element
of information on the Loan Application
Register.
An institution must retain a copy of its
complete LAR for three years. The modified
LAR must be made available to anyone who
requests it for three years and the
disclosure statement for five years. Section
203.5(d)
Magnetic Media Reporting
An institution that reports more than 25 line
entries is required to report on magnetic
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media. The FFIEC supplies a HMDA LAR
software package at no charge. A number
of commercial firms offer packages with
more sophistication. Each institution needs
to judge its own requirements. Comment 1
Section 203.5 Whether an institution files
on magnetic media or paper, it is permitted
to submit separate LARs for different
branches or for different loan types. The
application or loan numbers reflected on the
register, however, must be unique (that is
no duplicates). Comment 4 Section 203.5
Regulation C
at least two
certification:
objectives
of
such
a
To ensure the correctness of the data
reported (simply for compliance
purposes and from the normal desire
not to submit incorrect information to
any government agency)
To afford an additional level of
protection both to the signing officer
and to the institution (the thought
being that having to sign certifications
will make the people actually
responsible for entering the data think
about their obligations and perhaps
bring out any potential mistakes early
enough in the process that correction
will be possible).
If the institution uses magnetic media, the
format must conform exactly to that
published by the regulatory agencies,
including the order of the column headings
and the date formats. Paper reports must
be formatted as the LAR is, but the
institution need not use the actual
government document. Typed or computerprinted forms are permissible. Finally, even
if the institution uses the government form
of LAR, it must type all of the entries.
Handwritten entries are not permissible.
Comment 2 Section 203.5
The preamble to the regulations published
in December 1994 said, ―Institutions are
expected to make a good-faith effort to
enter all data concerning transactions
completely and accurately.‖ It went on to
state that if an examiner finds some errors
despite such an effort, the errors would not
constitute a violation of Regulation C.
Officer’s Certification
Given the potential civil penalties (and the
regulators‘ new emphasis on them in a
HMDA context) it is thoroughly appropriate
for an institution officer and an institution to
require those who actually obtain the
information in the first instance to certify its
accuracy, even though the institution and
the signing officer are responsible for that
accuracy to the regulators and the public.
The government-required transmittal form
for the HMDA LAR requires that an officer of
the reporting institution sign the following
statement: ―I certify to the accuracy of the
data contained in the register.‖ While the
certification is not expressly made under
oath or penalty of perjury, we strongly
recommend that the institution officer treat it
as though it were. To ―certify‖ to the federal
regulators the ―accuracy‖ of a year‘s worth
of data collected and recorded by a number
of institution employees over 12 months of
application gathering and lending ought not
to be undertaken lightly. An audit of a
significant sample of the data ought to be
done in order to confirm the correctness of
the register. In a larger institution, perhaps
some certification by the subordinates of the
signing officer would be an appropriate
basis in addition to the auditing. There are
In this connection, we do not recommend
that the compliance officer normally be the
officer who certifies the HMDA LAR. An
officer who actually participates in or
supervises the taking of applications for
covered loans is a much more appropriate
signer, because the collection of the data
will have been done by that officer or under
his or her supervision. If, for whatever
reasons, the institution requires the
compliance officer to be the one certifying
the accuracy of the register to the
government, then at the very least, he or
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she ought to be given backup certifications
by the people involved in collection and
supervising the collection of the information
in the first instance.
Regulation C
results and projections and take corrective
action, if necessary. An institution‘s HMDA
LAR contains a wealth of information about
an institution‘s lending patterns. An
institution should make that information as
valuable to itself as it is to its regulator.
Using the Information
Regulators use an institution‘s HMDA LAR
information as a primary tool to detect illegal
discrimination and predatory lending. It is
also a vital component of an institution‘s
CRA grade. Our recommendation is that an
institution monitors its HMDA LAR
information at least quarterly. An institution
should compare the data reported with the
institution‘s objectives for penetration of
targeted markets, such as low- and
moderate-income census tracts, minorities,
and the like. We also recommend that every
institution obtain the HMDA data from its
competitors to see how its lending patterns
stand up against those of its competitors.
Reports should be provided to institution
management so that it will know the results
in time to examine the situation, find the
reasons for any disparity between actual
Conclusion
Regulation C is a critical regulation, not just
from its own aspects, but also because of its
interplay with Regulation B, CRA and now
predatory lending. For every loan that an
institution puts on its loan application
register there are 26 opportunities for error.
Compliance is made even more difficult
because every loan officer in an institution
may generate a covered application.
Employee training and an effective audit
program are essentials of Regulation C
compliance. We recommend that an
institution update its HMDA LAR at least
once a month in order to detect any
information gathering weakness and to
provide current information on the
institution‘s lending patterns.
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Savings, Money Market,
and Time Deposits
Regulation D
Withdrawals initiated by telephone and
consummated by a check mailed to
the depositor
and Time Deposits
There is also no limit on the number of
deposits that can be made to a savings
deposit by any method.
Common name: Regulation D
Preauthorized transfers, on the other hand,
are limited to six per month, and include
transactions by check, draft, debit card, or
similar order made payable to third parties.
The types of transactions that fall within the
six-per-month limitation are also ACH
debits, transfers from a customer‘s savings
account pursuant to a preauthorized
agreement to cover overdrafts on a
transaction account, and a transfer from a
savings deposit at the telephoned request of
the customer made either directly to an
institution employee or indirectly through a
voice-response or internet banking system.
Prior to July 2, 2009, checks and debit card
transactions fell within a sublimit of three
transactions per month.
However, the
sublimit has been eliminated and such items
are now subject to the six-per-month limit.
Regulation D defines the types of deposit
accounts a regulated financial institution can
have, and identifies the characteristics of
each. A money market deposit account
(MMDA) is a type of savings deposit like a
savings account. Regulation D sets the
number and types of transfers that can be
made from a savings or money market
account during a month or cycle and still
retain its savings deposit status. Section
204.2(d) As a savings deposit, an account
is exempt from the transaction account
reserve requirements of Regulation D.
More importantly, an institution may pay
interest on the account under Regulation Q
since the account is not a demand deposit.
This article explains the types and number
of permissible transfers from a savings
deposit during an account cycle and
alternate ways an institution may deal with
transactions that exceed the permissible
number. This article also explains time
deposit penalties.
One of the problems frequently encountered
with checks is a check written in one
statement period and presented in another.
An institution may use, on a consistent
basis, either the date on the check, draft, or
POS item, or the date on which the item is
paid when determining if excessive
transactions exist. Transactions that exceed
the limit of permissible transactions are
excess transactions. Section 204.2(d)(2)
Permissible Transactions
The following types of transfers from a
savings deposit are permissible in
unlimited numbers: Section 204.2(d)(2)
Automatic (preauthorized) transfers for
the purpose of paying loans at the
same institution
Excess Transactions
Regulation D gives an institution two options
for dealing with excess transactions. Option
one is to return or dishonor any excess
transaction. The other is to monitor excess
transactions in any account; notify the
customer if the excess transactions become
more frequent than ―occasional‖; and if after
notice an additional excess transaction
occurs, either close the account, cease
paying interest on the account, or remove
Transfers or withdrawals made by
mail, messenger, automated teller
machine, or in person as:
Withdrawals or
Transfers to another account of
the depositor at the same
institution
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the account‘s transfer and draft capabilities.
Section 204.2(d)(2)
and Time Deposits
Regulation D
Willful Violations
MMDAs were created to provide financial
institutions a savings product with limited
draft capabilities. An occasional inadvertent
excess transaction may be allowed, but
either frequent or knowing violations of the
limits will cause an MMDA account to be
reclassified as a transaction account.
The regulators have not set finite limits of
when excess transactions become ―more
than occasional.‖ They have stated that a
―more than occasional‖ excess can occur
either by several excess transactions in a
single month or any excess transactions in
each of several months over a period of
time. For the latter, the Federal Reserve
has stated that excess transactions in each
of three months during a rolling 12-month
period are more than occasional. The
number of excess transactions in a single
month that constitutes more than occasional
has not been defined.
The Fed has
indicated that to some degree the
determination is based on the intent of the
transactions. Were the excess transactions
inadvertent or a deliberate attempt by the
customer (or the financial institution) to
violate or circumvent the rules? If an
excess transaction is deliberate, then a
single excess transaction probably is not
occasional. Federal Reserve staff opinions
to Regulation D state that if an excess
transaction is not inadvertent, the institution
must move more quickly to close the
account than if the transaction were the
result of an honest mistake. FRB Staff
Opinion February 15, 1990
Many institutions, to enhance customer
service, have tried to devise ways to utilize
an MMDA as a sweep account for corporate
customers. There is no problem sweeping
the funds from demand accounts to the
MMDA; the problem is the preauthorized
transfer of the funds back to the demand
account from the MMDA to prevent
overdrafts. Some financial institutions have
been fairly blatant in their attempts; others
have been more creative. In all cases
where the regulators have discovered the
charade, they have ordered the institution to
cease. Section 204.133
Some financial institutions have taken away
an account‘s transfer and draft facilities
when an excess transaction occurred and
then reinstated them at the beginning of the
next cycle. That also is not permissible.
Once an account loses its MMDA status, it
can never be returned to that status.
Early Withdrawal Penalties on
Time Deposits
A compliance program to monitor excess
transactions on an ex post basis must
measure both the excess transactions in a
given cycle and the frequency of excess
transactions in the prior eleven cycles.
A time deposit is an account that has a
maturity of at least seven days after the
date of deposit. Typical among these are
certificates of deposit and club accounts,
such as Christmas Club accounts, where
the depositor is not permitted to withdraw
funds until a certain number of deposits
have been made (although some institutions
have established their club accounts as
savings deposits, and this is permissible,
too). To be classified as a time deposit,
certain minimum penalties must be required
if a depositor withdraws funds prior to
maturity under certain conditions.
The
amount of the penalty depends on the
length of the maturity and the type of
account holder.
The minimum early
When a financial institution has determined
that the number or frequency of excess
transactions by a customer is more than
occasional, the institution must contact the
customer. If the customer continues to
violate the transaction limit rules, the
financial institution must close the account
or take away draft and transfer capabilities.
After the notice is sent, a financial institution
would be in compliance by thereafter
prohibiting any excess transactions.
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withdrawal penalty for all time deposits is
seven days‘ simple interest on funds
withdrawn within the first six days of
deposit. Seven days‘ simple interest on the
amount withdrawn must also be charged on
a withdrawal made within six days of an
earlier partial withdrawal or an additional
deposit to the account. Section 204.2(c)(1)
This is the only legally mandated early
withdrawal penalty for time deposits. A
financial institution is free to impose a larger
penalty if it wishes (in fact, it may even
prohibit withdrawals before maturity), but in
any event, it must impose at least the
minimum six day/seven days‘ simple
interest penalty.
The early withdrawal
penalty chosen by the institution must be
clearly stated in the deposit contract and
fully disclosed to the depositor in the initial
account disclosures. Other than the six
day/seven days‘ simple interest penalty, all
early withdrawal penalties on personal time
deposits are defined by the institution, and
can be waived for a customer at the
institution‘s discretion.
and Time Deposits
Regulation D
These exceptions include:
When an owner of the time deposit
dies;
When an owner of the time deposit is
declared legally incompetent;
When the owner of the time deposit
that is an IRA or Keogh account
attains the age of 59½ or becomes
disabled; and
When a depositor owns separate time
deposits
in
institutions
that
subsequently merge, the amount of
the deposits that exceeds FDIC
insurance coverage in the new
institution may be withdrawn without
penalty at any time within one year
after the merger; Where the time
deposit provides for automatic renewal
at the maturity date, the depositor may
withdraw the funds within 10 days
after the maturity date without penalty.
Section 204.2(c)(1)
If the legal minimum penalty is not imposed
on time deposits, then those deposits must
be reclassified as savings deposits, as they
will not meet the definition of a time deposit.
There are, however, certain situations in
which an institution may waive even the
mandated penalties.
Conclusion
The penalty for failing to comply with the
rules can be substantial.
A financial
institution can be fined for failing to meet its
reserve requirements, lose its income tax
deduction for interest improperly paid, and
most importantly, the institution‘s board of
directors can be held personally liable for
the improperly paid interest.
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Electronic Fund Transfers
Regulation E
Any transaction which does not debit or
credit a checking or savings or other
asset account established by a human
for personal, family, or household
purposes. (All non-personal accounts
and personal business accounts are
excluded.
Also, all transactions
affecting loan accounts are excluded
from Regulation E, but may be
governed by Regulation Z.)
All transactions initiated by a paper
instrument such as a check or draft.
Wire transfers.
Preauthorized transfers:
from one account to another
account of the same consumer with
the same institution.
into the consumer‘s account by the
institution.
from a consumer‘s account to the
institution, such as a loan payment.
from a consumer‘s account to the
account of a member of the
consumer‘s family with the same
institution.
Transactions that a consumer, who
does not have a written prearranged
telephone
transfer
or
bill-paying
agreement, initiates by a telephone call,
facsimile, or any other telephone
communication device. In this regard,
the
following
―agreements‖
by
themselves do not bring the telephone
transaction under Regulation E:
A hold-harmless agreement on a
signature card protecting the
institution if the consumer requests
a transfer.
A legend on a signature card,
periodic statement, or passbook
limiting the number of telephoneinitiated transfers the consumer can
make from a savings account under
Regulation D.
An agreement permitting the
consumer to approve by telephone
the rollover of an instrument‘s funds
at maturity.
Electronic Fund
Transfers
Common name: Regulation E
In 1978, Congress passed the Electronic
Fund Transfer Act to clarify the rights and
liabilities of users of electronic-fund-transfer
systems. The principal purpose of the act
was the protection of the consumer engaging
in electronic fund transfers. Regulation E
was issued to implement the provisions of the
act.
For the purpose of Regulation E, an
―electronic fund transfer‖ means any transfer
of funds, other than a transaction originated
by check, draft, or similar paper instrument
that is initiated through an electronic terminal,
telephone, computer or magnetic tape for the
purpose
of
ordering,
instructing,
or
authorizing a financial institution to debit or
credit a consumer deposit account.
Also under Regulation E, ―business day‖
means any day the institution is open for
substantially all business functions. Section
205.2(d) Note the Regulation E definition of
―business day‖ is not the same as that of
Regulation CC.
Regulation E also includes an opt-in
requirement for discretionary overdraft
protection programs so that a financial
institution may charge overdraft fees for ATM
and one-time debit card transactions. For
more information on the overdraft opt-in
required for ATM and one-time debit card
transactions see our Overdraft Protection
Products Chapter later in this Manual.
What Transactions Are
Covered by Regulation E?
To get an idea of what is covered by
Regulation E, it is easiest to begin by defining
what is not covered. The following
transactions are not covered:
Credit card transactions.
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However,
transactions
through
a
telephone response system or Internetbased system requiring an entry password
are covered by Regulation E because
issuance of a password constitutes the
kind of prearranged agreement covered by
Regulation E:
Transactions affecting trust accounts.
Preauthorized transactions where the
assets of the account-holding institution
are $100 million or less on the previous
December 31.
Transactions that are covered are those not
excluded above that are:
Transfers resulting from debit-card
transactions (even if no part of the
transaction is electronic).
Direct deposits and withdrawals.
Any transactions initiated through an
electronic terminal (ATM, telephone,
computer, magnetic tape, etc.) for the
purpose of debiting or crediting an
account.
Electronic check conversions (ECKs)
are covered as long as the consumer
has agreed to electronic presentment of
the check. This agreement can be
obtained by written consent, or by the
merchant posting a notice at the retail
location
where
the
transactions
originate indicating that checks are
presented electronically.
How the
institution would know whether or not
this has been done is not discussed.
For more information, see the
discussion
of
electronic
check
conversions later in this chapter.
Regulation E
of a bonus or expense reimbursement.
For more information, see the
discussion of payroll card accounts
later
in
this
chapter.
Section
205.2(b)(2).
Access Devices.
An access device is a
card, code, or other means of access to a
customer‘s account that may be used for the
purpose of initiating electronic fund transfers.
A financial institution may issue an access
device to a customer only (a) in response to
the customer‘s request, (b) as a substitution
or renewal of an existing validated access
device, or (c) if the device is not validated. In
the last case, the device must be
accompanied by an explanation that the
device is not validated, how to validate it, and
a complete disclosure of the customer‘s
rights and liabilities if the device is validated.
When a financial institution has activated an
access device to enable a customer to use it
to initiate an electronic transfer, the device is
considered ―validated‖ or an ―accepted‖
access device. Section 205.5
Initial Disclosures
Either at the time a consumer contracts for
Electronic Funds Transfer (―EFT‖) services or
before the first electronic funds transfer is
made, the financial institution must disclose
the following:
A summary of the consumer‘s liability
for
unauthorized
transfers
(see
―Customer‘s Liability for Unauthorized
Transfers‖).
The telephone number and address of
the person or office to be notified if the
customer believes that an unauthorized
transfer has been or may be made.
(Though the regulation does not
specifically require it, there is authority
that the telephone number should be
toll-free.)
Payroll card accounts are covered.
These accounts are established
through an employer to process reoccurring electronic fund transfers of
the consumer's wages, salary, or other
employee compensation (such as
commissions). These accounts do not
include a card that‘s strictly issued to
pay the consumer a one-time payment
The financial
days.
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The types of EFTs the consumer may
make, and any limitation on frequency
or dollar amount.
Any charges for EFT transactions or for
the right to make EFT transactions.
The fact that when the customer uses
an ATM not owned by this institution, a
fee may be charged for using that ATM
by the owner of the ATM and by any
national, regional, or local network used
to complete the transaction.
A summary of the consumer‘s right to
receive documentation of electronic
fund transfers (see ―Documentation of
Transfers‖).
A summary of the customer‘s right to
stop payment of a preauthorized fund
transfer, the procedure for initiating a
stop-payment order, and a summary of
the financial institution‘s liability if it fails
to honor an appropriate stop-payment
order.
The circumstances under which, in the
normal course of business, the financial
institution will disclose information to
third parties about the consumer‘s
account. Section 205.7(b)(9) Note that
this disclosure is different from those
required under Regulation P. Here the
―third parties‖ covered include the
institution‘s affiliates, and there is no
provision for a consumer to opt out.
The Federal Reserve has not
reconciled this disclosure with those
under Regulation P, so an institution
ought to give both: this one in its
electronic fund transfer disclosures, and
the Regulation P one as a separate,
stand-alone privacy disclosure.
A notice concerning error-resolution
procedures and the consumer‘s rights
under them (see ―Error Resolution‖).
If payroll card accounts are offered, a
special EFT disclosure must be
provided.
Regulation E
Effective August 6, 2007, the Federal
Reserve amended Regulation E to eliminate
the requirement for providing a receipt for a
transaction if the amount is $15 or less. The
primary purpose of this amendment was to
enable the use of debit cards to purchase
merchandise at vending machines and
similar facilities that do not have the capacity
to produce a receipt.
If the language in your Regulation E
disclosure regarding documentation states
that the customer may receive a receipt at an
electronic terminal, including a point of sale
(POS) terminal, or institution management
plans to re-program institution-owned ATMs
to eliminate receipts for transactions of $15
or less, then a disclosure change is required.
If a change to your disclosure is required, a
change in terms notice does not need to be
sent to existing customers.
If, after the disclosures have been made, the
financial institution wants to change, in a
manner adverse to the consumer, any term
or condition required to be disclosed, it must
give the consumer 21 days written notice
before the effective date of the change.
Section 205.8(a)(1) The error-resolution
procedure must be delivered to each
consumer annually or a modified version may
be delivered on or with each periodic
statement. Section 205.8(b)
Electronic Check Conversions. ECKs are
a one-time conversion of a check to an
electronic funds transfer from a consumer‘s
account. This conversion of the check may
take place at a merchant, lockbox facility or
elsewhere. The consumer, however, must
authorize the transfer and this is
accomplished by providing the consumer with
a notice that an electronic check conversion
will take place and the consumer proceeding
with the transaction having received the
notice. For POS transactions at a merchant
the notice must be posted in a clear and
conspicuous place and the consumer must
receive a copy of the notice, most likely on
the receipt for the transaction. For non-POS
conversions, such as a lockbox operations,
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this notice must also inform the consumer
that when a check is used to initiate an
electronic fund transfer, funds may be
debited from the consumer's account as soon
as the same day payment is received, and,
as applicable, that the consumer's check will
not be returned by the financial institution
holding
the
consumer's
account.
Increasingly, vendors are offering these
electronic check conversion services to
businesses that utilize their equipment to
electronically convert checks to electronic
images.
The vendor then gathers up
electronic images of all the checks received
on a daily or more frequent basis and
transmits a file to institution for entry into the
Federal Reserve System for payment. This
process, however, raises a number of
compliance and legal concerns including
BSA and presentment warranties that you, as
the institution first accepting these checks,
must make to the downstream institutions in
the collection process. Model notices can be
found in the Appendix to Regulation E.
Payroll Card Accounts. If your institution
directly or indirectly holds a payroll card
account or issues access devices for payroll
card accounts, you are subject to Regulation
E with respect to those cards and accounts.
A payroll card account is an account directly
or indirectly established by an employer on
behalf of a consumer to which electronic fund
transfers of the consumer‘s wages, salary, or
other employee compensation are made on a
recurring basis, whether the account is
operated or managed by the employer, a
third-party payroll processor, a depository
institution or any other person. It does not
include a one-time EFT of salary related
payments such as a bonus or expense
reimbursement.
The July 2007 amendments also provided
institutions with an alternative to providing
traditional periodic statements for these
accounts.
Instead of traditional periodic
statements, institutions may now provide:
the consumer‘s balance through a
telephone inquiry system;
Regulation E
access to an electronic history, such as
through your Web site, showing
account activity for at least the past 60
days; and
a written history of the consumer‘s
account transactions covering at least
60 days from the date of a written or
oral request from the consumer.
Where the institution utilizes this alternative
to providing periodic statements, the
Regulation E disclosure provided at account
opening must disclose:
the telephone number that the
consumer may call to obtain the
account balance;
the electronic means to access account
activity for at least the past 60 days;
and
a summary of the consumer‘s right to
receive a written history upon request,
including a telephone number for the
customer to call to request the history.
Furthermore, these accounts with alternative
periodic statements carry similar error
resolution procedures except that the 60-day
resolution period does not begin until the
consumer has either accessed the phone or
Web site information service or the institution
has mailed a written history of the account in
response to a consumer‘s request. Section
205.18
ATM Disclosures. For operators of ATMs, if
you do not always charge a fee at an ATM
(for example, you only charge for certain
transactions or only charge for non customer
transactions), you must prominently post a
conspicuous notice on the ATM stating that a
fee may be imposed. If the fee is only
imposed for specific services conducted at
the ATM and the consumer is informed that
such a fee will be imposed either on an ATM
screen or on paper before becoming
committed to paying a fee, an institution may
elect to state that the fee will be imposed. If
the consumer elects to continue the
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transaction after being informed of the fee,
the institution may then impose the fee.
Section 205.16
Preauthorized Transfers
Preauthorized EFT transactions from a
consumer‘s account must be authorized by
the consumer in writing and the consumer
must be given a copy of the authorization.
Whether a tape recorded conversation is
sufficient under the E-sign Act is an open
issue.
Recent amendments to the
commentary removed a note that indicated
that a tape recorded conversation did not
satisfy the requirement to have the
authorization in writing.
Whether this
implicitly allows authorization via a tape
recorded conversation remains to be seen
however that conclusion is consistent with
the E-sign Act and with advances in today‘s
commerce.
If the transfers to a specific payee are
repetitive, but will vary in amount, the
consumer may specify to the payee or the
consumer‘s institution a range in which the
transaction must fall. If a proposed transfer
falls outside the range, or if no range is
specified and the transfer differs from the
amount authorized or the previous transfer,
the financial institution or the payee must
send the consumer a written notice of the
amount and scheduled date of the transfer at
least 10 days before the scheduled
transaction date. Section 205.10(d)(1)
If a transfer is made to an account of a
consumer at another institution, for example,
to transfer interest earned on a certificate of
deposit to an account at another institution,
the institution transferring the funds may
choose whether to provide the consumer with
the option of receiving the notice with each
varying transfer or provide notice only when
the transfer falls outside a specified range or
differs by more than a specified amount. The
anticipated range, however, must be
disclosed to the consumer at the time of
authorization.
Regulation E
A consumer may stop payment of a
preauthorized transfer by notifying the
financial institution orally or in writing at least
three business days before the scheduled
date of the transfer. If the notification is oral,
the financial institution may require that the
consumer provide written verification of the
stop-payment order within 14 days. Although
it is not found entirely within Regulation E,
there is another set of rules institutions need
to be aware of in this field, those of the
National
Automated
Clearing
House
Association, or NACHA. The NACHA rules
require an institution to separate what might
otherwise be considered stop payment
orders into three categories:
true stop
payments, claims of no authorization, and
claims that the authorization already has
been revoked. An institution must take care
to determine exactly which of these things a
consumer is asserting before he acts on the
consumer‘s demands.
In the true stop
payment, the consumer admits he authorized
the debit, but is now directing the institution
not to pay it. No affidavit is necessary, only
the consumer‘s order to the institution not to
pay the item. (And, as mentioned above, that
order may be oral initially, followed up by a
writing.) In a claim of no authorization, the
consumer says he never authorized the
particular person debiting his account to do
so. The NACHA rules require the institution
to get an affidavit from the consumer to that
effect before the institution acts on the
consumer‘s complaint. The same is true as
to a revocation of authorization; the institution
must obtain the consumer‘s affidavit that he
has revoked the authorization before it
reverses the debit entry. Despite the fact that
the affidavit requirement clearly is an
infringement of the consumer protections in
Regulation E, the FRB has never even hinted
at any dissatisfaction with the NACHA rules
in this area.
If a consumer‘s account is scheduled to be
credited by a preauthorized EFT from the
same payor at least once every 60 days,
unless the payor provides notice to the
consumer, the financial institution must do
so. This notice to the consumer can be either
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an oral or written notice that the transfer did
or did not occur within two business days of
the day of the transfer or the day on which
the transfer was to occur, or by providing a
local or toll-free telephone number the
consumer can call to see if the transfer was
made. This requirement of a toll free number
only applies to calls made to the institution
within its primary service area. You can also
satisfy this requirement if you accept collect
calls. When a financial institution receives a
preauthorized credit, it must credit the
account involved on the day the transfer is
received.
For each electronic fund transfer, the periodic
statement (or documents accompanying the
statement) must reflect the following:
The amount of the transfer (this amount
may include ATM charges).
The date on which the transfer was
credited or debited to the consumer‘s
account.
Regulation E
The name of any third party to or from
whom funds were transferred.
The periodic statement must also show:
The number of the account for
which the statement is issued.
Fees or charges to the account for
EFT transactions or access.
The balance in the account at the
beginning and the end of the
statement period.
The
address
and
telephone number to be used for
inquiries or notice of errors
preceded by the words, ―Direct
inquiries to.‖ Section 205.9(b)(1)-(6)
Documentation of Transfers
For any account to or from which EFT
transactions can be made, the financial
institution must provide the consumer a
statement at least quarterly, and a monthly
statement for each monthly cycle in which an
EFT transaction has occurred.
The only exception to the above rules is for
accounts that may be accessed only by
preauthorized transfer to the account. If the
account is a passbook account, no periodic
statement is required if, each time the
passbook is presented, it is updated by
entering the date and amount of each EFT
since the last update.
When a consumer initiates an EFT
transaction at an electronic terminal, the
financial institution must make a written
receipt available to the consumer setting forth
the following information, if applicable:
The amount of the transfer.
The date.
The type of transfer and the type of
consumer‘s account (e.g., checking,
savings) to or from which funds were
transferred.
The type of transfer and the type of the
consumer‘s account(s) to or from which
funds are transferred (e.g., withdrawal
from checking, transfer to checking
from savings).
For each transfer that was initiated at
an electronic terminal, either the
terminal location or the terminal
identification number that was on the
terminal receipt.
If the terminal
identification number is used, the
statement must also show either the
address of the terminal, or a generally
accepted name for its location, or the
name of the business where the
terminal is located.
A number or code, which need not
exceed four digits or letters, and which
identifies the consumer, the consumer‘s
account, or the access device.
Either the location or identification
number of the terminal.
The name of any third party to or from
whom funds were transferred.
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If the owner or operator of an ATM charges a
fee for use of that machine by a consumer,
the Gramm-Leach-Bliley Act requires a notice
in two places: ―on or at‖ the machine, and
either on the screen or on a paper issued by
the machine before the consumer becomes
irrevocably committed to the transaction.
The first (on or at the ATM) must tell the
consumer that such a fee may be imposed.
The second (on-screen or paper) must state
that such a fee will be imposed if the
consumer elects to complete the transaction,
and the amount of the fee. A disclosure of
the fact that an owner or operator of an ATM
or an interchange might charge such a fee
must be in the initial disclosures given by a
card issuing institution to its own customers,
even though it will not charge them for use of
its own or others‘ ATMs.
Section
205.7(B)(11) The institution need not guess
at the amount of such a fee that might be
imposed by some other party.
Error Resolution
If a consumer gives a financial institution
notice of an error in an EFT transaction, the
financial institution must investigate the
alleged error promptly. Section 205.11(C)(1)
A notice of error may be either written or oral.
To be valid, it must be received by the
financial institution within 60 days after the
institution transmitted a periodic statement
(or updated a passbook) on which the
alleged error was reflected. If the notice is
not received until after the 60 day period then
the institution still has the obligation to
investigate and resolve the error but it is
relieved from its obligations to provisionally
credit the account and the strict timeline for
concluding the investigation. Comment 7,
Section 205.11(b)(1)
The notice must identify the consumer and
the account, and the reason the consumer
believes that there is an error in the account
or the periodic statement. If the notice is oral,
the institution may request a written notice,
also. An error is any one of the following:
An unauthorized transfer
Regulation E
An incorrect transfer to or from an
account
The omission of a transfer that should
have been included in a periodic
statement
A computational or bookkeeping error
relating to a transfer
Receipt of an incorrect amount of
money from an electronic terminal
A transfer that is not properly identified
A request for documentation required
by Regulation E, or for additional
information or clarification so that a
consumer can determine whether an
error was made.
Within 10 business days of receipt of a valid
notice of error, a financial institution must
either investigate the transaction and advise
the consumer of the outcome and its
determination or provisionally credits the
consumer‘s account in the amount of the
error (with interest, if applicable). In the latter
case, for disputed transactions the institution
must notify the consumer of the provisional
credit within two business days and give the
consumer use of the funds during the
investigation, which must, in this event, be
completed within 45 calendar days after
receiving the notice. Section 205.11(c)(2) For
disputes
regarding
ATM
transactions
occurring outside the United States and POS
transactions, the investigation must be
completed within 90 calendar days after
receiving the notice. When an error is
asserted in a POS transaction by a consumer
who used a debit card with VISA brand on it,
the rule of this association requires their
member institutions to resolve the dispute
within five, not ten, days.
The time frames may be extended to 20 days
for resolution or provisional recredit and to 90
days for final resolution for disputes alleged
within the first 30 days after the first deposit
to the account was made. When the Fed
extended these time frames in September
1998, it intended the definition of a new
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account to parallel Regulation CC (meaning
an account is new if a party to the account
had not had an account at the institution for
at least 30 days). But as Regulation E is
written, any account is new for the first 30
days after the first deposit, no matter what
the status of its accountholders. The result is
that sometimes an account may be new
under Regulation E, but not under Regulation
CC. For an institution to take advantage of
the increased time frames for new accounts,
it must add appropriate language to its
disclosures. Section 205.7(b)(10)
And understand that the Fed views the 45day period as essentially absolute. If the
institution discovers on day 46 that the
consumer committed fraud against it, the
institution is forbidden to debit the account
then. Its only remedy is to start a lawsuit
against the consumer, because the period
within which it could debit the account has
expired, the Fed says. (If the transaction is
one that is governed by the 90-day limit, then
the same analysis would be used for facts
discovered on day 91 and after.)
The
amounts normally are too small to justify a
lawsuit, so the consumer will get free money.
In most cases, a financial institution‘s review
of its own records is sufficient to fulfill its
responsibility to investigate if the alleged
error concerns a transfer to or from a third
party and there is no agreement between the
institution and the third party for the type of
electronic funds transfer involved. Section
205.11(c)(4) The problem, however, is that
the term ―agreement‖ for purposes of
Regulation E include situations where a third
party has agreed to honor an access device.
So any transaction that involves a debit card,
is PIN based or is a telephone transfer that
occurs with the use of a code is governed by
an agreement and will require an
investigation beyond the institution‘s own
records. This includes POS transactions.
If the institution determines that an error
occurred, it must correct the error within one
business day of that determination and
promptly notify the consumer of the
correction. Section 205.11(c)(2) If it finds that
Regulation E
no error was made, it must notify the
consumer within three business days of the
determination and advise the consumer of his
or her right to request the documents on
which the institution relied. If the account
was provisionally recredited, the financial
institution may debit it, but it must deliver
notice of the amount and date of the debit to
the consumer and notice that it will honor
checks, drafts, and preauthorized transfers to
third parties that would otherwise overdraw
the account up to the amount of the debit for
a period of five business days and without
charge. If a financial institution investigates
an alleged error, finds no error, and the
consumer reasserts it, the financial institution
does not need to investigate it again. Section
205.11(e)
Customer’s Liability for
Unauthorized Transfers
Regulation E limits the liability of a consumer
for unauthorized EFT transactions.
In
general, an EFT transaction is unauthorized if
it was initiated by a person other than the
account holder without the authority of the
account holder and the account holder did
not receive any benefit from the transaction.
A transaction is not unauthorized if the
account holder gave the person initiating the
transaction the access device, unless the
account holder notified the institution that the
person was no longer authorized to use it.
To illustrate: Assume Mr. Smith gives his
daughter his ATM card, tells the daughter the
PIN, and asks her to go get $100 for him
from an ATM. The daughter instead gets
$200, keeps half, and returns her father‘s
card.
That whole $200 withdrawal is
―authorized‖ under Regulation E, and the
institution may decline to reimburse the $100
stolen by the daughter. Later the daughter
slips the card from her father‘s wallet, and,
remembering the PIN, takes another $100
from his account. That transaction is not
―authorized‖ under Regulation E, and the
institution will have to reimburse Mr. Smith
when he demands it. Commentary, Section
205.2(m)
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Regulation E provides two layers of limitation
on a consumer‘s liability for unauthorized
EFT transactions.
One relates to the
consumer learning that his or her access and
device is missing; the other relates to a
consumer‘s failure to report unauthorized
transactions appearing on a periodic
statement.
If a consumer learns that his or her access
device is missing and reports it to the
institution within two business days, then the
consumer‘s liability is the lesser of $50 or the
amount of unauthorized transfers that
occurred prior to the notice. Section
205.6(b)(1) If the consumer fails to report the
missing access device, the consumer‘s
liability is the lesser of $500 or the amount of
the
unauthorized
transfers.
Section
205.6(b)(2) That is, if a consumer knows that
his or her access device has been stolen and
knows that it is being used by the thief, the
consumer‘s maximum liability for failing to
report the missing device is $500. Because
of the stringent limitations on a consumer‘s
liability, a financial institution should have a
system for detecting unusual patterns in
usage for the access devices it issues.
The second layer of liability limitation relates
to a consumer‘s failure to report unauthorized
transactions appearing on a periodic
statement. If a consumer fails to report
unauthorized EFT transactions that appear
on a periodic statement within 60 calendar
days of transmittal of the statement to the
consumer, then the consumer is liable for all
unauthorized transfers after the end of the
60-day period. Section 205.6(b)(3) The
following table sets out the consumer‘s
liability in most circumstances.
Regulation E
In some instances, both limitations can come
into play. For example, if a consumer loses
the account access device, discovers the
loss, does not report it, and does not report
unauthorized transfers shown on the periodic
statement, the consumer‘s liability would be
the lesser of $500 or the amount of
unauthorized transfers that occur up to 60
calendar days after the first periodic
statement plus unlimited liability for transfers
thereafter. In other words, the two liabilities
stack on top of one another.
The two major credit card franchises, Master
Card and Visa, also allow institution to issue
debit and ATM cards (sometimes called
―check cards‖ in marketing materials) bearing
their respective logos.
These two
organizations
recently
dictated
that
institutions issuing such cards must assume
even more liability for fraud and error than
Regulation E requires.
In general, the
institutions must waive the two-day notice
requirement and assume even the first $50 of
the consumer‘s alleged loss. They appear to
require that the transaction have been done
not only with that brand‘s card, but also
through that brand‘s network, if it is to receive
this favorable treatment. If your institution
licenses either of these logos for its cards,
you should give the card association‘s latest
pronouncements on this topic to your counsel
for a final determination of the additional
liability they impose on your institution. You
should then include a summary of that
lessened liability (including all the conditions
that must be met) in your EFT disclosures to
consumers. The following table reflects an
institution‘s federal regulatory liabilities, not
those imposed by contract by the two card
brands.
EVENT
LIABILITY
Lost card, customer notifies institution within Lesser of $50 or unauthorized charges*
two days of discovering loss.
Section 205.6(b)(1)
Lost card, customer does not notify institution Lesser of $500 or unauthorized charges
after discovering loss.
Section 205.6(b)(2)
Unauthorized transfer appearing on periodic No liability Section 205.6(b)(3)
statement, customer notifies institution within
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Regulation E
60 calendar days.
Unauthorized transfer appearing on periodic Unlimited
liability
for
transfers
statement, customer does not notify after 60 calendar days after statement
institution.
Section 205.6(b)(3)
Lost card plus unauthorized transfers Stack liability.
Lesser of $50.00 or
appearing on periodic statement, customer unauthorized charges related to access
notifies institution within two days of device reported missing within two days. If
discovering loss of card
unauthorized transfers first appearing on
periodic statement reported within 60 days of
first statement no additional liability
Lost card plus unauthorized transfers
appearing on periodic statement, customer
fails to notify institution within two days of
discovering loss of card and after 60 days of
first
statement
showing
unauthorized
transfers
Stack liability. Liability related to access card
limited to $50.00 for first two days following
loss and $500.00 for period afterwards and
for unauthorized transfers on periodic
statement liability is zero for transfers
appearing within first 60 days following
statement and unlimited after that
*Liability limits on Visa and MasterCard branded debit card further reduced to 0 in many
circumstances, see Visa and MasterCard rules.
Record Retention
An institution must retain evidence of its
compliance with Regulation E for two years
after a disclosure was required to be given
or an action required to be taken. Section
205.13(b) As is the case under most of the
consumer compliance regulations, if an
institution is notified that it is under
investigation, or is being sued, for an
alleged violation of this regulation, the
institution must retain the records pertaining
to the matter until it is finally resolved.
This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with
the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If legal advice or other
expert assistance is required, the services of a competent professional should be sought.
2.100
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PAGE 2.102 INTENTIONALLY LEFT BLANK
Interbank Liabilities
Common name: Regulation F
Introduction
One of the many bank regulatory provisions
of
the
Federal
Deposit
Insurance
Corporation Improvement Act (FDICIA) was
a section which required the Federal
Reserve Board to limit interbank risk.
Congress supposedly was concerned that
the failure of one bank would cause
financial difficulties to any banks to which
the failed bank owed money.
Regulation F, which dealt with securities of
state member banks, had been rescinded
on January 1, 1989, so, rather than continue
its practice of using double letters on its
regulations (AA, BB, and so on) the Federal
Reserve Board reached back and inserted
this new regulation into the scheme as a
completely
different
text
of
―old‖
Regulation F.
Regulation F sets flat, mandatory limits on a
bank‘s exposure to any correspondent bank
if the correspondent cannot be shown to be
at least ―adequately capitalized.‖ If your
bank‘s correspondent does not meet this
standard, you will have to limit your bank‘s
exposure to that correspondent to a certain
percentage of your own bank‘s total capital.
That percentage will be 50% from June 19,
1994 until June 19, 1995, and 25%
thereafter. Because of potential liability to
shareholders, we recommend that a bank
not have any significant exposure to a
correspondent which is not at least
―adequately
capitalized.‖
Recently
published statistics indicate that fully 188 of
the 200 United States banks most active as
correspondents qualify as ―adequately
capitalized‖ or better. In fact, 125 of those
188 qualify as ―well capitalized,‖ so finding a
correspondent with which to do business
without a major financial worry ought to be
relatively easy.
Regulation F
Regulation F also requires certain internal
policies and procedures to be established
within a bank.
Requirements
Each bank whose deposits are insured by
the FDIC must have a set of internal policies
and procedures to prevent ―excessive‖
exposure to any individual correspondent.
The policies and procedures must take into
account both credit and liquidity risks,
including operational risks. The bank also
must have standards for establishing a
correspondent
relationship,
and
for
terminating such a relationship. Section
206.3
First, a bank must define an amount it will
deem to be ―significant.‖ The regulation and
its accompanying materials give no
guidance on how to establish this threshold
figure. Section 206.3 Drawing on principles
used in securities law and other fields, it
would not be a radical departure from the
mainstream thinking to utilize measures
such as 10% of the bank‘s earnings for the
year, 1% of the bank‘s total risk-based
capital, or a similar formula. The important
thing, in our opinion, is that the formula
generate a dollar amount which the bank
could afford to lose without disturbing its
financial health or strategic plans in any
material fashion.
Exposures of less than the ―significant‖
amount are not subject to the model policy
and procedure, but an officer of the bank
ought to monitor them to be sure that: (1)
they remain under that figure; and (2) even
though they are insignificant, they do not
have any features which would embarrass
the bank, its officers, or directors if the
correspondent failed, or the details became
public. (It is, of course, a good idea to
conduct all the business of the bank in this
latter fashion.)
Where
exposure
to
a
particular
correspondent
is
―significant,‖
the
procedures must provide for periodic review
2.103
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of
the financial condition of
the
correspondent, and must require the bank
to reduce or eliminate the exposure if the
correspondent‘s
financial
condition
deteriorates. The bank may rely on publicly
available information in the case of U.S.
banks, and in the case of foreign banks
where there is information available in the
public domain. A bank may also rely upon a
third party, such as a rating agency or the
bank‘s own holding company, provided the
bank‘s board of directors has reviewed and
approved the general assessment or
selection criteria used by that third party.
This amounts to requiring your bank‘s board
to determine that Sheshunoff, Ferguson, or
some similar service is correct or that the
standards used by your bank‘s holding
company are prudent. The purpose here,
as with so many other regulatory
requirements for board approval is to push
the responsibility and its attendant liability
up to the board of directors‘ level. To put it
bluntly, if your bank suffers a loss because
of improper selection, dealing with, or
monitoring of a correspondent, the
regulators want to be able to pin your board
members with the loss.
Additionally, where the financial condition of
the correspondent and the form or maturity
of the exposure to that correspondent
create a ―significant‖ risk that payment will
not be made in full or on time by that
correspondent, the bank‘s policies and
procedures must ―limit‖ the bank‘s
exposure. We recommend that under these
circumstances, the bank‘s policies and
procedures require it to reduce the
exposure to zero as soon as possible. The
regulation purports to give all kinds of
flexibility in this area, with different limits for
different forms of exposures, different
products, different maturities, and so on.
The regulation also purports to give
flexibility to set fixed amounts or
percentages based on the bank‘s
monitoring, the types of exposures, and the
correspondent‘s financial condition. But if
your bank determines that there really is a
Regulation F
―significant‖ risk that your correspondent will
not pay you in full or on time, we
recommend that you close out the exposure
as rapidly as possible, consistent with safe
and sound banking practices.
Each bank is required to either:
(1)
structure its transactions, or (2) monitor its
exposure to its correspondents in such a
way that its exposure ordinarily does not
exceed its own internal limits. Exceptions
are allowed for excesses resulting from
unusual market disturbances, market
movements which are favorable to the bank,
increases in activity, operational problems,
or other unusual circumstances. Monitoring
may be done on a retrospective, ex post
basis. The level of monitoring required
depends on how close the exposure rises to
the bank‘s own internal limit, the volatility of
the particular type of exposure, and the
financial condition of the correspondent.
The bank must have procedures to address
any excess that arises over its internal
limits. The board of directors must review
and approve the bank‘s correspondent
policies and procedures at least annually.
Calculation of Credit
Exposure Section 206.4
With certain exceptions discussed below, a
bank‘s credit exposure to a correspondent
must include all of the bank‘s assets and
off-balance-sheet items that are subject to
capital requirements under the capital
adequacy guidelines of the bank‘s federal
supervisor, and that involve either claims on
the correspondent or capital instruments
issued by the correspondent. Off-balancesheet items are valued for this purpose on
the basis of their current exposure value.
Refer to our article entitled ―Risk-Based
Capital‖ in this Regulatory Compliance
Service guide, which explains in detail what
exposures of a bank are subject to the riskbased capital adequacy guidelines. Briefly,
the assets and off-balance-sheet items
covered include:
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Regulation F
Loans by the
correspondent
bank
to
the
Deposits by the
correspondent
bank
with
the
Proceeds of checks and other items
deposited in an account at a
correspondent that are not yet
available for withdrawal
Securities of the correspondent owned
by the bank
―Quality assets,‖ as defined below, on
which
the
correspondent
is
secondarily liable
Reverse repurchase agreements
Obligations of the correspondent on
which a creditworthy obligor (in
addition to the correspondent) is
liable, such as loans by the bank to
third parties secured by stock or debt
obligations of the correspondent,
loans to third parties that were
purchased by the bank from the
correspondent with recourse, loans to
third parties by the bank backed by
standby letters of credit issued by the
correspondent, and obligations of the
correspondent to the bank backed by
standby letters of credit issued by
creditworthy third parties
Loans by the bank to third parties
guaranteed by the correspondent or
backed by the correspondent‘s letter
of credit
Loans to third parties secured by stock
or
debt
obligations
of
the
correspondent
Loans to third parties purchased from
the correspondent with recourse
All of the above exposures of any of
the bank‘s subsidiaries and other
entities that are required to be
consolidated in its call report.
Exposures resulting from the merger
or acquisition of another bank for a
period of one year after the merger or
acquisition is consummated
There are a number of exceptions to this
fairly inclusive definition of credit exposure.
They include:
The portion of the bank‘s exposure to
the correspondent that is covered by
federal deposit insurance.
Exposures related to the settlement of
transactions
Intraday (daylight) exposures
Transactions in an agency or similar
capacity where any losses are passed
back to the real party in interest
Exposures not covered by the capital
adequacy guidelines
Any transactions subject to netting
arrangements that are valid and
enforceable under all applicable laws
(to the extent of the contractual
netting)
Transactions,
including
reverse
repurchase agreements, secured by
―government securities‖ or ―readily
marketable collateral,‖ as defined
below
―Government securities‖ means obligations
issued, or fully guaranteed as to principal
and interest, by the United States
government, any department, agency, etc.,
of the United States, or any corporation
wholly owned (directly or indirectly) by the
United
States.
―Readily
marketable
collateral‖ means financial instruments or
bullion that may be sold in ordinary
circumstances with reasonable promptness
at a fair market value determined by
quotations based on actual transactions in
an auction (or a similarly available daily bidand-asked-price) market. ―Quality asset‖
means an asset that is not in nonaccrual
status, and on which principal and interest
are not more than 30 days past due, and
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Regulation F
whose terms have not been renegotiated or
compromised due to deteriorating financial
condition of the additional obligor. An asset
cannot be considered a ―quality asset‖ if any
other loan to the primary obligor on that
asset has been classified as ―substandard,‖
―doubtful,‖ or ―loss,‖ or treated as ―other
loans specially mentioned‖ in the most
recent report of examination of the bank or
an affiliate of the bank by any federal or
state regulatory agency.
July 1992 would allow as an alternative a
leverage ratio of 3.0% or greater when the
institution is rated Composite 1 in its most
recent examination report. That alternative
on the leverage ratio is not available under
Regulation F. A bank is entitled to rely on
information about capital levels of a
correspondent which it obtains from the
correspondent, from a bank rating agency,
or from any other party that it reasonably
believes to be reliable.
Correspondent Capital Levels
Section 206.5
Recommendations
The critical definition of ―adequately
capitalized‖ with respect to a correspondent
in Regulation F is similar, but not identical,
to the definition of the same term as used in
the regulations on prompt corrective action.
For purposes of Regulation F, a
correspondent
will
be
considered
―adequately
capitalized‖
if
the
correspondent has a total risk-based capital
ratio of 8.0% or greater, a Tier 1 risk-based
capital ratio of 4.0% or greater, and a
leverage ratio of 4.0% or greater. The
prompt corrective action standards issued in
Each bank should review its existing
policies and procedures about dealing with
correspondents.
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BANK PROTECTION ACT – REGULATION H ARTICLE
WAS MOVED TO THE MANAGEMENT SECTION
PAGES 2.107 – 2.121 LEFT INTENTIONALLY BLANK
Collection and Return of Checks and Other
Items by Federal Reserve Banks
Regulation J
private-sector system, enables negotiable
instruments to circulate freely throughout the
economy, serving as substitutes for money.
The Federal Reserve Banks collect and clear
cash and noncash ―items‖ (instruments or
promises or orders to pay money) whether
negotiable or not. This definition also
encompasses
―items‖
not
popularly
associated with bank-collection activities,
such as bonds and investment securities.
Among the cash items handled are drafts
payable on demand, such as personal
checks. Because checks and cash items
generally so predominate in bank collection,
this article uses checks as examples when
describing the mechanics of the collection
process.
Collection and Return of
Checks and Other Items
by Federal Reserve Banks
Common name: Regulation J
Introduction
Regulation J governs the collection and return
of checks and other items by Federal Reserve
Banks. When you send (or any commercial
bank sends) a check to a Federal Reserve
Bank for collection, you agree that Regulation
J governs your relationship with the Federal
Reserve with respect to the handling of that
check and its proceeds. In conjunction with
Article 4 of the Uniform Commercial Code
(UCC) and Regulation CC, Regulation J helps
to establish uniformity in the collection and
return process.
It may be helpful to begin with an overview of
the collection process, where the depositary
and the drawee banks on which the check is
drawn are located in different parts of the
country. The diagram on the following page
illustrates the route that a check deposited by
a customer at a local bank in Orlando,
Florida, and drawn on a bank in Pittsburgh,
Pennsylvania, might take if collected under
the Federal Reserve System. Collection
begins when this cash item is deposited into
the customer‘s account with the depositary.
Because Orlando is located in the territory of
the Federal Reserve Bank branch in
Jacksonville, Florida, the deposited check is
initially forwarded, either directly by the
depositary or through a correspondent (if the
depositary does not maintain an account with
the reserve bank) to Jacksonville. Under
Regulation J, the depositary is a ―sender,‖ an
institution that forwards a check to a reserve
bank for collection. The Jacksonville branch
delivers the check to the branch Federal
Reserve Bank in Pittsburgh, which then
sends it, either directly or through a
correspondent bank or processing center, to
the local drawee bank in Pittsburgh. Under
Regulation J, the drawee bank is the ―paying
bank,‖ the bank by or through which the
check is payable. The drawee bank‘s
correspondent acts as a ―presenting bank,‖ a
bank that forwards an item to another bank
for payment. All the banks that handle the
check for collection, with the exception of the
paying bank, are also ―collecting banks.‖
In addition to the regulations, each Federal
Reserve Bank also maintains its own
operating circulars, filling in details and
procedures under the regulations on a wide
variety of topics. The Federal Reserve Bank of
Atlanta, for example, lists operating circulars
on Collection of Cash Items, Check Collection
Time Schedule, and Wire Transfer of Funds,
among others, in its current circular index.
These circulars can be important sources of
information, and should be consulted along
with the regulations.
Regulation J is divided into two sections.
Subpart A describes the collection and return
regulations applicable to checks and other
items. Subpart B governs wire transfers
through Fedwire, the system owned and
operated by the Federal Reserve and used for
the transmission and settlement of payment
orders. This article focuses on Subpart A,
providing an overview of the operation of
Regulation J in the check collection and return
process. It also describes how Regulation J is
similar to Regulation CC.
Forward Collection
The collection function exercised by the
Federal Reserve Banks, along with the
2.122
5/15/08
Regulation J
A possible collection route for a check under Regulation J
$
Depositor
Deposits
Check
Depositary Bank
(Orlando)
Check
Presented
for
Collection
Correspondent
Bank
Paying or Drawee
Bank
(Pittsburgh)
Check Presented
for
Collection
Maintains
Account
Federal Reserve
Branch
(Jacksonville)
Presenting and Sending. When a reserve
bank receives an item for collection, it will
either present that item to the paying bank
itself for payment or send the item to a
subsequent collecting bank for presentment
to the paying bank. Section 210.4 With
respect to most items, presentment is made
at the place requested by the paying bank.
With respect to a check (or any demand
draft), a paying bank under Regulation J is
subject
to
a
same-day settlement
requirement. The paying bank must settle
for or return on that same day any check
presented directly or indirectly by a Federal
Reserve Bank at a location designated by
the paying bank for the receipt of checks.
Federal Reserve
Branch
(Pittsburgh)
In presenting an item for payment and in
carrying out its collection responsibilities,
generally, a reserve bank acts as the agent
or subagent of the owner of the item. This
agency relationship ends once the reserve
bank has received payment on an item
presented and made the proceeds available
to the sender of the item. As an agent or
subagent of the owner, the reserve bank
can be liable for faulty collection not only to
the immediate sender of the item but to any
remote collecting banks in the chain as well.
This liability extends to lack of good faith or
failure to exercise ordinary care in the
handling of the item. In general, however,
the reserve bank exculpates itself from
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5/15/08
Regulation J
liability for anything done, by itself or others,
in the collection process.
before exercising any of its rights against
bank assets.
When any sender forwards an item for
collection to a reserve bank, it makes
certain warranties, or affirmations of fact,
about the item to the bank. Section 210.5
By sending an item, a sender and a reserve
bank each warrant that the item has not
been altered and that each is entitled to
enforce the item. On presentment, each
also makes the Regulation CC warranties to
the paying bank, including that the
settlement amount demanded is equal to
the total amount of the checks presented for
payment and that information encoded after
issue on each check in magnetic ink is
correct.
Settling and Paying. Once the cash item or
check has been properly presented to the
paying bank on a banking day, the paying
bank is required to make the proceeds
available to the reserve bank by the close of
Fedwire on that day, unless the paying bank
returns the check. Section 210.9 Under a
reserve bank‘s operating circular, the time
of settlement may be substantially
advanced. To avoid overdraft charges on a
properly presented cash item, a paying
bank may be required to make the
settlement proceeds available to the reserve
bank by the later of 9:30 A.M. Eastern Time
(the earliest settlement time under the
operating circulars) or the next clock hour at
least one hour after the paying bank
receives the check. Settlement may be
made by debit to an account of the paying
bank on the books of the reserve bank,
cash, or any other form of payment
accepted in the discretion of the reserve
bank. Section 210.9(b) Typically, the paying
bank will pay for the item on the day of
receipt by autocharge or debit to its account
at a Federal Reserve Bank. The paying
bank is deemed to receive the item on its
next banking day if it receives the item after
its ―cutoff‖ hour. This same-day settlement
requirement has been in effect under
Regulation J since 1972, and was intended
to accelerate the collection process. A
variant of the same-day settlement
procedure came into effect in 1994 for
private-sector collection under Regulation
CC. Under the Regulation CC amendment,
a paying bank must settle for or return
checks presented for payment before 8:00
A.M. local time at the place of presentment
on a business day.
In Regulation J, the Federal Reserve also
granted a security interest in all assets of a
sender or prior collecting bank held by a
reserve bank, when that bank directly or
indirectly sends an item to a reserve bank
for collection. Section 210.5(e) The security
interest attaches when any warranty made
to the reserve bank is breached. Generally,
this will occur on the date the reserve bank
handles the check. Once the interest
attaches, the reserve bank may take any
action authorized by law, including setoff, to
recover the amount of the obligation, if the
reserve bank deems itself insecure and
gives prior notice of this fact, or if the sender
or prior collecting bank suspends payments
or is closed. In the past, the banking
industry expressed concern that this would
give the reserve banks a complete selfremedy for any warranty breach without the
need for court order or appearance. The
Federal Reserve Board has answered that
the reserve banks provide check-collection
services for financially troubled institutions
that cannot obtain this service elsewhere,
and need some protection on warranty
claims they may not be able to pass back to
these institutions. The Board also believes
that routine use of setoff will be discouraged
by requiring the reserve bank to provide
notification of its concerns about solvency
Although Regulations J and CC have
brought the Federal Reserve and privatesector collection systems into closer
conformity, there are still important points of
departure. Paying banks, for example, have
no right of setoff on other claims against a
reserve bank which has presented an item
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5/15/08
for collection, as they do against privatesystem presenting banks. The Federal
Reserve Board reasons that paying banks
in the collection chain face no risk of
insolvency when dealing with a reserve
bank, and so do not require the additional
level of protection that the right of setoff
provides against potentially insolvent
private-sector presenting banks. The
Regulation CC funds-availability schedules
are not applicable to Federal Reserve
Banks since they deal only with other
banks. A reserve bank may continue to
defer the availability of credit for an item
received for a period of time it considers
reasonable under the circumstances. An
operating circular of each reserve bank
contains time schedules indicating when
cash and noncash items are counted as
reserves and become available for use by
the sender, paying, or returning banks.
Regulation J
of the two-day/four-day test applies to banks
which are local with respect to the
depositary.
The
item
is
returned
expeditiously if it is received by the
depositary no later than 4:00 P.M. (local
time at the depositary) on the second
business day following the banking day on
which the item was presented to the paying
bank. The four-day test applies to nonlocal
banks in the same manner. The item is
returned expeditiously if it is received by the
depositary no later than 4:00 P.M. on the
fourth business day following the banking
day on which the item was presented to the
nonlocal paying bank.
The paying bank can also meet the
requirement that it act expeditiously under
the forward-collection test. If the item is
returned to the depositary as soon as a
similarly situated bank would send an item
drawn on the depositary for payment, the
paying bank has met the forward collection
test and the return will be deemed effective.
Return. A paying bank has until the close of
its banking day or the close of Fedwire on
the day it receives a check or other cash
item to return the item to the presenting
bank without settling for it. Section 210.12
In practice, few banks have the capacity to
make decisions on dishonor so quickly. The
paying or drawee bank (in the diagram)
which has been presented with a check for
payment may still revoke its decision to pay
and return the item if it acts prior to midnight
of its next banking day. To be entitled to
utilize the ―midnight deadline‖ rule and
return the item on the next banking day, the
paying bank must have taken some action
to settle with respect to the item on the day
the bank received it. If it took no action on
that day, it will lose its right to return the
item and will be held accountable for the
amount of the item.
Earlier in this article, we noted that the
operating circulars are important sources of
information supplementing the regulations.
The ―challenge procedure‖ concerning
return of items is an example of the type of
detailed procedure handled under each
reserve bank‘s operating circulars. Under
the challenge procedure, a reserve bank
seeks to act as an impartial arbiter between
a depositary and a drawee concerning the
timely return of an item within the drawee‘s
midnight deadline, taking statements from
each side about whether the regulations
were adhered to by the drawee. The
Federal Reserve cannot impose a resolution
in a dispute such as this, which may
ultimately wind up in court. But the
existence of the challenge procedure in the
return of items does illustrate the merit of
consulting a reserve bank‘s operating
circulars on collection and return matters.
If the paying bank elects to return the item
and has acted within the midnight deadline,
it must also meet the requirement that it
return the item in an expeditious manner.
The item is returned expeditiously if it meets
either the two-day/four-day test or the
forward-collection test. The two-day portion
In keeping with the Federal Reserve
Board‘s professed desire to conform
Regulation J with the rules applicable to
private-sector banks, the private-sector
warranties made by a returning bank under
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5/15/08
Regulation J
Regulation CC have been extended to
reserve-bank transfers and settlements on
returned items. Among other things, a
Federal Reserve Bank that transfers a
returned check and settles for it warrants to
the transferee that it is authorized to return
the check and that the check has not been
materially altered.
2.126
5/15/08
Consumer Leasing
Regulation M
includes
corporations,
partnerships,
governmental units or agencies, and
unincorporated associations. A lease to a
sole proprietorship (―John T. Jones d/b/a
Jones Consulting‖) is a lease to a natural
person, but would be exempt from
Regulation M because it is for a business
purpose.
Consumer Leasing
Common name: Regulation M
Introduction
Congress enacted a separate statutory
chapter (Chapter 5) of the Truth-in-Lending
Act (TILA) specifically tailored for leases.
The Federal Reserve Board, under the
authority of that law, issued Regulation M. If
your bank engages in personal property
leasing with consumers, then you need to
be aware of the specialized legal regime
established for such transactions. (In certain
limited circumstances, purchases of leases
from a dealer are also covered. There must
be a close relationship between the dealer
and the bank, according to the courts.)
To be subject to Regulation M, the lease
must also be for personal, family, or
household purposes. A lease for a business
purpose is exempt from Regulation M, even
if it is to a natural person. Agricultural or
commercial purposes are considered to be
business purposes.
In determining the purpose of a lease, the
regulation looks to the primary purpose.
Thus, even incidental personal use of the
item by the lessee will not destroy the
exemption as long as the primary use is
business, commercial, or agricultural. If the
personal computer on lease is used
primarily by a certified public accountant in
the practice of her profession, an occasional
video game played by her teenager will not
convert the lease to a Regulation M-covered
transaction.
Defined Terms
Regulation M is a highly technical regulation
of a complex set of activities. It defines very
precisely the things that it covers and the
terms that it uses.
―Consumer lease‖ means a contract for the
lease of personal property to a natural
person, primarily for personal, family, or
household purposes for a period of time in
excess of four months and for a total
contractual obligation of $25,000 or less.
Note that this definition does not cover real
estate. It only applies to the leasing of
something that was not real property under
the law of the state in which the item in
question was located at the time the item
was offered or made available for lease. (If
a bank were to engage in finance leasing of
mobile homes, it would have to consider the
impact of Regulation M.)
The lease must be for a period of time
exceeding four months. This requirement is
to avoid making car rental companies give
Regulation M disclosures on their usually
short-term ―true‖ leases.
Finally, the total contractual obligation of the
lessee must be $25,000 or less. As with the
Truth-in-Lending Act, Congress felt that the
$25,000 figure established a ceiling on
consumer transactions. Thus, a $25,001
automobile lease is not covered by
Regulation
M,
even
though many
automobile leases involve larger sums.
Not defined in this regulation, but mentioned
in the commentary and the court cases
construing the regulation, is the distinction
between an open-end lease and a closedend lease. While many of the concepts in
Regulation M are directly analogous to the
concepts that use similar terminology under
Note also that the lessee must be a natural
person, that is, a human being. Leases to
one, two, or more humans are covered, but
if the lessee (the person renting the item) is
an organization, the lease is not covered by
Regulation M. The term organization
2.127
11/01/04
Regulation Z, these two terms are different
from their Regulation Z counterparts. Under
Regulation M, an open-end lease is one in
which the lessee‘s liability to the lessor at
the end of the lease term is measured by
the difference between the estimated value
of the leased property at the time the lease
is entered into and its value actually realized
at the end of the term. The Regulation M
terminology does not refer to leasing
additional or replacement items, only that
the lessee‘s ultimate liability is not fixed in
advance. This difference between these two
otherwise fairly consistent regulations often
causes confusion.
Consumer Leasing
Regulation M
whether or not the lessee has the
option to purchase the leased
property, and at what price and time
A statement identifying all express
warranties and guarantees made by
the manufacturer or lessor with
respect to the leased property, and
identifying the party responsible for
maintaining or servicing the leased
property, together with a description of
that responsibility
A brief description of insurance
provided or paid for by the lessor or
required of the lessee, including the
types and amounts of the coverages
and costs
Required Disclosures
A description of any security held or to
be retained by the lessor in
connection with the lease and a clear
identification of the property to which
the security interest relates
The lessor is required to give the lessee,
prior to the consummation (generally
synonymous with signing) of the lease, a
dated, written, disclosure statement. This
statement must identify both the lessor and
lessee, and set forth accurately, clearly, and
conspicuously the following information (if
applicable).
The number, amount, and due dates
or periods of payments under the
lease and the total amount of such
periodic payments
A brief description or identification of
the leased property
Where the lease provides that the
lessee shall be liable for the
anticipated fair market value of the
property on expiration of the lease,
the disclosure must state the fair
market value of the property at the
inception of the lease, the aggregate
cost of the lease on expiration, and
the differential between them, and
give a description of the rebuttable
presumption
The amount of any payment by lessee
required at the inception of lease
The amount paid or payable by the
lessee for official fees, registration,
certificate of title, or license fees or
taxes
The amount of other charges payable
by the lessee not included in the
periodic payments, a description of
the charges, and that the lessee shall
be liable for the differential, if any,
between the anticipated fair market
value of the leased property and its
appraised value at the termination of
the lease, if the lessee has such
liability
A statement of the conditions under
which the lessee or lessor may
terminate the lease prior to the end of
the term, and the amount of or
method of determining any penalty or
other charge for delinquency, default,
late payment, or early termination.
A statement of the amount (or method
of determining the amount) of any
liabilities the lease imposes upon the
lessee at the end of the term, and
Each of these disclosure elements is
expanded on by the regulation, and each
has its own commentary by the staff of the
2.128
11/01/04
Consumer Leasing
Federal Reserve Board. Some have been
the subjects of court decisions, as well.
Anyone who attempts to draft leases or
disclosures under Regulation M should
study all of those sources in detail.
Regulation M
the required
misleading.
disclosures
unclear
or
The law and regulation are not oriented
solely to disclosures, but contain some
substantive requirements as well. One of
the more important requirements from a
bank‘s standpoint deals with penalties and
other charges for delinquency, default, and
early termination. These penalties and
charges must be ―reasonable‖ in their
amounts.
When a lease covers multiple articles of
property, the commentary provides that the
lessor may describe each article on a
separate statement. The charges (e.g.,
official fees) that compose the total initial
payment amount and the periodic payments
are not required to be separately broken out
in the initial disclosure. Other disclosure
requirements may require that they must be
stated separately elsewhere. Official fees
and lessee insurance are examples of items
that must be disclosed elsewhere.
The law does provide what it calls rebuttable
presumptions of unreasonableness in certain
situations. One is when the lessee‘s liability
at the end of the lease term is based on an
estimated residual value of the property.
That value is presumed to be unreasonable
to the extent it exceeds the actual residual
value by more than three times the average
monthly payment under the lease; however,
that presumption can be rebutted. For
example, assume that the lease for an
automobile provides for monthly payments of
$400 each. The estimated residual value
established at the time of consummation and
written into the agreement is $5,900. When
the lease expires, the actual residual value of
the car is $4,500. That is $1,400 less than
the original estimated residual value. Three
monthly payments of $400 equals $1,200.
Subtracting that amount from the $1,400
difference between the estimated and the
actual residual values leaves a remainder of
$200. The law establishes a rebuttable
presumption that $200 of the $1,400
differential is unreasonable. Legally, a
rebuttable presumption shifts the burden of
proof from one party to the other. That is,
now the lessor must prove that the $200 is
not unreasonable.
Some fees will be payable on delivery of the
leased property to the lessee, not at the
date the lease is consummated. In an
automobile lease, for example, these fees
might include such things as sales tax,
vehicle registration fees, and delivery
charges. None of these charges is to be
included in the total initial payment amount
disclosed to the customer because they are
to be paid post-consummation. Note that
sales tax and registration fees must be
disclosed under a separate specialized
item, and delivery charges must be included
in the catch-all item entitled, ―other
charges.‖ If, however, a delivery charge is
imposed and paid at consummation, then it
must be included as part of the total initial
payment.
If a mechanical breakdown protection
agreement is part of the lease, it should be
disclosed as an ―other charge‖ unless state
law classifies such agreements as
insurance. In the latter case, it must be
disclosed with the other forms of insurance.
Purchase options must be disclosed in
some detail. Normally under Regulation M,
if a disclosure is inapplicable to the
transaction, no mention of the topic is
required. Purchase options are an
exception. If there is no purchase option
provided to the lessee under the lease
agreement, that fact must be affirmatively
Warranties may be described by saying that
the lessee will receive the standard
manufacturer‘s warranty (if that is the case).
The lessor may expressly disclaim any
additional warranties, and a commentary to
Regulation M classifies such a disclaimer as
―additional information‖ that must not render
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11/01/04
Consumer Leasing
Regulation M
stated. The commentary also provides that
the lessee‘s right to submit a bid to
purchase the property at the termination of
the lease is not an option to purchase for
purposes of the required disclosure if the
lessor is not required to accept that bid and
the lessee does not receive preferential
treatment.
The amount of any payment required
at the inception of the lease or the fact
that no such payment is required, if
that is the case;
Estimates may be used when required
information is unavailable or unknown to the
lessor. Before using an estimate in a
disclosure, the lessor must have made a
reasonable
attempt
to
obtain
the
information. An estimate given must be a
reasonable one, must be based on the best
information available to the lessor, and must
be clearly identified as an estimate.
The lessee shall be liable for the
differential, if any, between the
anticipated fair market value of the
leased property and its appraised
actual value at the termination of the
lease, if the lessee has such liability
The number, amounts, due dates, or
periods of scheduled payments, and
the total of payments under the lease
A statement of the amount or method
of determining the amount of any
liabilities the lease imposes upon the
lessee at the end of the term, and
whether or not the lessee has the
option to purchase the leased
property and at what price and time.
Triggering Terms
Regulation M provides that the mere
mention
of
certain
terms
in
an
advertisement for a lease will trigger
additional disclosure requirements. The
triggering and triggered terms are listed
below. If any triggering term is stated in an
advertisement, that advertisement must also
state all of the triggered terms ―clearly and
conspicuously.‖
Civil Liability
The penalties for Regulation M violations
and the methods for curing them are the
same as for Regulation Z. Refer to the
article ―Regulation Z - Truth in Lending‖ for
this information.
Triggering terms:
Model Forms
The amount of any payment;
The
Federal
Reserve
Board
has
promulgated three model forms as
Appendices C-1 through C-3 to Regulation
M. They cover three commonly encountered
consumer leasing situations: closed-end
vehicle leases, open-end vehicle leases,
and furniture leases. They are somewhat
dated
because
of
the
continuing
inventiveness of marketing and business
techniques by vehicle lessors and others,
but
the
Federal
Reserve
Board‘s
instructions for completing the model forms
are very detailed.
The number of required payments;
and/or
That any (or no) down payment or any
payment is required at the inception of
the lease.
Triggered terms:
The transaction being advertised is a
lease
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11/01/04
Insider Loans
Regulation O
―executive officer‖ of the bank for the
purpose of Regulation O. It does not matter
what the person‘s title or position with the
bank is. The person need not have a title or
draw a salary. The question is does he or
she participate or have the authority to
participate in the major policy-making of the
bank. If the answer is yes, the person is an
executive officer. The term executive officer
as used in Regulation O is somewhat
misleading. In most banks, the executive
officers are considered to be only the three
or four most senior people in the bank. The
intent of Regulation O is to cast a wider net
than that. Section 215.2(e)
Insider Loans
Common name: Regulation O
Introduction
Regulation O governs the credit relationship
between a bank and the bank‘s insiders. It
restricts the amount that a bank may lend to
an individual insider and to all insiders as a
group. It defines the permissible terms of
insider credits and it defines when insider
loans must have prior approval of the bank‘s
board of directors. It also establishes
various reporting requirements for insider
loans.
Under Regulation O, the chairman of the
board of directors, the president, every vice
president, the cashier, the secretary, and
the treasurer of a bank are all presumed to
be executive officers. (The regulation says it
does not matter that the person‘s officer title
contains the word ―assistant,‖ so one would
think that assistant vice presidents are
covered. The agencies have generally
ignored that part of the regulation, however,
and start at the vice president level.) If there
is a person in a bank that holds one of those
titles and does not participate, or have the
authority to participate, in the major policymaking of the bank, then the bank‘s board
of directors by resolution may exclude that
person from being an executive officer. The
resolution may be inclusive or exclusive.
That is it may either state who in the bank
does have the authority to participate in
major policy-making or it may state which
persons with designated titles do not have
the authority. Nonetheless, if a person is
excluded by resolution from being an
executive officer of the bank for Regulation
O purposes, if that person actually does
participate in the major policy-making of the
bank, that person is a Regulation O officer.
The board of directors by resolution cannot
change the underlying facts. For example, if
the chairman of a bank‘s board of directors
does not participate in the affairs of the
bank other than to chair the board meetings
and participate as a director, then the board
Regulation O is a regulation that a bank
should comply with strictly. For one thing,
every time that the bank is examined, the
examiners will review every new or renewed
loan to any of the bank‘s insiders and the
examiners will review all of the deposit
accounts
of
the
bank‘s
insiders.
Accordingly, a compliance error will not go
unnoticed. More important, if an examiner
sees that a bank‘s management will not
comply with the regulations governing their
own loans, that is a pretty bright red flag
that things may be amiss elsewhere.
What Borrowers Are
Covered?
Insider. The broad scope of Regulation O
covers persons that are deemed to be
―insiders‖ of the bank. A person is an insider
if he or she is a principal shareholder,
director or executive officer of the bank or
an organization that is a related interest of
one of those persons. A person is also an
insider of a bank if he or she is an insider of
one of the bank‘s affiliates. Section 215.2(h)
Executive Officers. Any person who
participates, or has the authority to
participate, in major policy-making functions
of the bank (other than as a director) is an
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3/15/07
Insider Loans
Regulation O
Related Interests. Here again, the Fed
used a term that is somewhat confusing. A
person‘s ―related interest‖ is a business
entity (corporation, partnership, trust, joint
venture, etc.) which the person controls.
Section 215.2(n) For this purpose, a person
controls a business entity if he or she owns,
controls or has the power to vote 25% or
more of the entity. Additionally, a person is
presumed to control a business entity if he
or she owns, controls or has the power to
vote more than 10% of the entity and is an
executive officer or director of the entity or if
he or she owns more than 10% of the entity
and no one else owns a greater percentage
of the entity. Section 215.2(c). For example,
if Mr. Jones owns 25% or more of ABC
Company, he controls the company and it is
his related interest. If Mr. Jones owns more
than 10% of ABC Company and he is an
executive officer or director of ABC
Company, he is presumed to control the
company and it is his related interest.
Finally, if Mr. Jones owns more than 10% of
ABC Company and no one else owns a
greater percentage than he does, he is
presumed to control the company and it is
his related interest.
of directors could by resolution exclude the
chairman as an executive officer. On the
other hand, if the chairman takes a more
active role in the bank than just as a
director, regardless of what resolution might
have been enacted, the chairman is an
executive officer. Section 215.2(e)
Directors. Directors are those persons
elected by the shareholders of a bank or
other company to be the bank or other
company‘s directors, to meet together
periodically as a board, and to deliberate
and vote upon the issues that come before
them. Advisory directors and honorary
directors are not elected by the
shareholders and do not have the authority
to vote at directors meetings. Accordingly,
advisory and honorary directors are not
directors for Regulation O purposes.
Section 215.2(d)
Principal
Shareholder.
A
principal
shareholder is a person or entity (other than
a bank or a bank holding company) that
directly or indirectly owns, controls, or has
the power to vote 10% or more of any class
of voting securities of a bank. In calculating
whether a person owns, controls or has the
power to vote 10% of a class of the bank‘s
securities, you attribute to that person any
securities owned by the person‘s spouse,
minor children and adult children who still
reside with the parent. Thus if a person
owns 6% of the stock of a bank, and the
person‘s spouse owns 5%, both the person
and the person‘s spouse are principal
shareholders. If a person does not own any
stock in a bank, but the person‘s spouse
owns 10% or more, the nonowning person
is a principal shareholder, because of the
attribution to that person of the spouse‘s
stock. If a bank is owned by a bank holding
company, then the principal shareholders of
the bank holding company (using the same
rules described above) indirectly control the
bank and are thus principal shareholders of
the bank as well. Section 215.2(m)
―Related Interest‖ also includes any political
or campaign committee controlled by a
person or that will benefit that person. So,
for example, if a bank director is the
treasurer of a campaign committee, or is the
candidate for office, the campaign
committee is a related interest of that
director. Section 215.2(n)
A person‘s relatives are not related
interests. Thus an executive officer‘s
spouse, children or parents are not related
interests of the executive officer. If the
spouse of an executive officer or director of
a bank borrows money from the bank,
absent something else that would bring it
under Regulation O, that loan is not
governed by the requirements of Regulation
O.
Insider Of An Affiliate. Some of the
requirements of Regulation O extend to
extensions of credit by a bank to the
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insiders of an affiliate of that bank or to
specific categories of insiders of an affiliate.
For the purpose of Regulation O, an affiliate
of a bank is any company that owns 25% or
more of the bank and any other company
that company owns 25% or more of. Thus, if
a bank is owned by a holding company, the
holding company is the bank‘s affiliate.
Additionally, any company that the holding
company owns 25% or more of is the bank‘s
affiliate. Moreover, if anyone owns 25% or
more of the holding company, that person
as well as any companies that person owns
25% or more of are the bank‘s affiliates.
Section 215.2(a)
Insider Loans
Regulation O
money from the bank and transfers the
proceeds of the loan to the executive officer,
that loan is, for Regulation O purposes, an
extension of credit to the executive officer.
On the other hand, if the spouse of an
executive officer borrows money to put into
his or her own business, that is not an
extension of credit to the executive officer. If
the business prospers, the executive officer
may benefit indirectly from the business‘s
profits, but that is not defined as a tangible
economic benefit from the loan. Section
215.3(a)
If the proceeds of a credit are being used by
the borrower to purchase property, goods or
services from an insider, that is an
exception to the tangible economic benefit
rule, provided that the credit is not on more
favorable terms than the bank would
ordinarily extend. For example, if a bank
customer borrows money to purchase an
automobile from an automobile dealership
owned by a bank director, the director will
receive the tangible economic benefit from
the loan. When the automobile is purchased
the director will have the money. That loan
is an exception to the tangible economic
benefit rule and the loan is not attributed to
the director provided that it is not on more
favorable terms than the bank would
otherwise offer. For example, a bank could
not charge 8% interest on regular
automobile loans and 7% if the borrower
was going to use the money to buy the
automobile from the bank‘s director. Section
215.3(f)(2)
Insiders of an affiliate are the same
categories of persons that are insiders of a
bank, that is the affiliate‘s principal
shareholders, directors, executive officers
and the related interests of each.
Extension of Credit
General. Regulation O governs extensions
of credit by a bank to the insiders of the
bank and the insiders of the bank‘s
affiliates. The general rule is that any
transaction whereby a covered person
becomes obligated, either directly or
indirectly, to pay money to the bank is an
extension of credit under Regulation O. Any
loan, line of credit, letter of credit, purchase
of an obligation with recourse, overdraft or
other transaction causing the insider to be
obligated to the bank is an extension of
credit to the insider. Likewise, any extension
of credit on which the insider is a guarantor
is treated as an extension of credited to the
insider. Additionally, if the insider pledges
collateral for an extension of credit, even
though he or she is not directly obligated to
pay the credit, that credit is treated as an
extension of credit to the insider. Finally, if
the proceeds of a credit are transferred to
the insider or used for the ―tangible
economic benefit of the insider,‖ the credit is
treated as a credit to the insider. If the
spouse of an executive officer borrows
Exceptions To Extensions Of Credit.
Regulation O excepts certain insider
obligations to a bank from what would
otherwise fall within the definition of
extension of credit. The two principal
exceptions are an indebtedness of $15,000
or less as an open-end credit card or credit
line and an indebtedness of $5000 or less
as an interest-bearing overdraft credit plan
or line. Section 215.3(b) In both cases the
terms of the plan or line must not be more
favorable to the insider than similar plans
offered to the general public. In each case
there can be multiple credits that make up
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the indebtedness. For example, an insider
could have a credit card with a $5000 limit
and an unsecured credit line with a $10,000
limit. Both would fall under the exemption. If
the insider had a $20,000 unsecured credit
line, none of the line would fall within the
exemption. The regulation does not allow
the bank to say that the first $15,000 of the
line is exempt and the top $5000 is not. If
the insider had three credit lines for $5000,
$7000 and $10,000 respectively, the bank
could designate the $5000 and the $10,000
credit lines as exempt from Regulation O
and the $7000 as a Regulation O extension
of credit.
Insider Loans
Regulation O
could be loaned to an executive officer.
(See below.)
Lending Prohibitions of
Regulation O For All Insiders
Preferential Loans. The primary restriction
of Regulation O is that a bank may not
make an extension of credit to an insider or
to an insider of its affiliate on terms and
conditions (including interest rates and
collateral adequacy) that are more favorable
to the borrower than similar extensions of
credit made in comparable transactions to
persons that are not insiders. A loan to an
insider may not involve more than normal
risk of repayment or have other features
unfavorable to the bank. In other words, in
underwriting an insider‘s loan application, a
bank must use a credit standard that is at
least as rigid as that used for similar
noninsider loan applicants, and the loan
terms must not be more favorable than
would be extended to a similarly situated
person who was not an insider. Frequently
the reason that a person is asked to
become a member of a bank‘s board of
directors is that the person has a significant
banking relationship with the bank and the
bank wants to cement that relationship. The
person has both a large deposit and large
loan relationship with the bank that the bank
does not want to see go elsewhere. Prior to
the time that the person became a member
of the bank‘s board, he or she received
preferential loan terms because of the
magnitude of the banking relationship. Now
that the person is on the bank‘s board may
he or she continue to receive the same
preferential terms he or she received prior
to becoming a board member? Yes, the
person can. The board member may be
afforded the same preferential terms that
any other customer of the bank would
receive based on the person‘s business
relationship with the bank. The board
member may not receive any special
preferential terms based solely on the fact
that he or she is on the board. Section
Additional extensions of credit that are
exempt are:
An advance against accrued salary or
an advance for payment of authorized
expenses incurred or to be incurred
on behalf of the bank;
An inadvertent overdraft;
Receipt of a check in the ordinary
course of business;
An acquisition of an indebtedness
through merger or foreclosure;
Any indebtedness to a bank for the
purpose of protecting the bank against
loss or of giving financial assistance to
the bank. Section 215.3(b)
Regulation O only applies to credit extended
to an insider. A loan made to a person prior
to the time that the person was an insider
does not come under Regulation O. When
the person becomes an insider, however,
any extension of a previously existing loan,
after the person became an insider, would.
A loan made to a person before he or she
became an insider must be brought into
compliance at its first maturity after the
person became an insider. Also previously
existing loans are counted in determining
whether prior board approval is required for
a new loan and for how much new money
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215.4(a)(1)
There is one exception to
Regulation
O‘s
prohibition
against
preferential loans terms for insiders. An
insider may obtain an extension of credit on
terms more beneficial than those available
to the public if the same benefit is widely
available to all bank employees and is not
more beneficial to insiders than other bank
employees. Accordingly, if a bank has a
policy pursuant to which it provides its
employees reduced rate loans or it waives
fees on employee loans, insiders may take
advantage of the policy to the same extent
as any other employee. If a bank offers loan
incentives to its employees, it should define
the incentive plan in a written policy that all
employees are made aware of. Section
215.4(a)(2)
Insider Loans
Regulation O
from the bank to exceed $500,000. Section
215.4(b)
If an insider has extensions of credit which
in the aggregate require approval by the
bank‘s board of directors, and if one or more
of those extensions of credit is a revolving
credit line, the credit lines must be
reapproved by the bank‘s board at least
every 14 months. Regardless of the term of
the credit line, advances under the line may
only be made within 14 months of the date
of the last approval by the bank‘s board.
Take the example of Joe Smith above.
Assume Joe‘s new loan application for
$100,000 is approved. Also assume that the
board had never approved Joe‘s credit line
because at the time it was granted the level
of Joe‘s borrowings did not require prior
approval. Because the new loan causes
Joe‘s extensions of credit to exceed
$500,000 the bank cannot make any new
advance under the credit line until it too has
been approved by the bank‘s board of
directors. The best policy is for a bank‘s
board of directors to reapprove annually all
revolving credit lines for all insiders and
insiders of its affiliates. It is mandatory for
those insiders who have credit extensions
that require prior board approval and a good
policy for all insiders to avoid the Catch 22
that Joe‘s bank found itself in. Section
215.4(b)
Prior Approval. Unless a bank has prior
approval of its board of directors, it may not
make an extension of credit to an insider or
to an insider of an affiliate in an amount that
would cause that person‘s extensions of
credit from the bank to exceed the greater
of $25,000 or 5% of the bank‘s capital and
surplus, but in no event, an amount greater
than $500,000. If the insider is a director he
or she must abstain from participating
directly or indirectly in the voting on his or
her loan approval. If a bank‘s capital and
surplus is $10,000,000 or more the
$500,000 limitation applies. If a bank‘s
capital and surplus is less than $10,000,000
then the 5% of capital applies down to a
capital and surplus of $500,000 where the
$25,000 limit applies. For determining
whether prior board approval is required,
extensions of credit to an insider are
aggregated with any extensions of credit to
that insider‘s related interests. For example,
Joe Smith a director of a bank applies for a
new loan of $100,000. Joe has an existing
loan for $200,000 and Joe‘s related interest
Joe‘s Autos, Incorporated, has a line of
credit with the bank for $250,000, none of
which is advanced. The new loan would
have to be approved in advance by the
bank‘s board of directors for it would cause
Joe‘s total aggregate extensions of credit
Individual Lending Limit. For the purpose
of calculation of its loans to one borrower
limit for an insider or the insider of an
affiliate, a bank must aggregate its
extensions of credit to the insider with its
extensions of credit to the insider‘s related
interests. That aggregate amount may not
exceed the bank‘s legal lending limit on
loans to a single borrower. Section 215.4(c)
Aggregate Lending Limit. In general, a
bank may not extend credit to its insiders,
the insiders of its affiliates and their related
interests, in the aggregate, in an amount
greater than the bank‘s unimpaired capital
and surplus. However, if the deposits of the
bank are less than $100,000,000 the
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aggregate lending limit may be increased to
200% of the bank‘s unimpaired capital and
unimpaired surplus, if the bank‘s board of
directors determines that the higher limit is
in keeping with safe and sound banking
practices, and is necessary to attract or
retain directors or to prevent the restriction
of credit in the bank‘s community. The
bank‘s board must renew the resolution
annually. Additionally, to qualify for the
200% of capital limit, a bank must meet all
capital requirements and have received a
satisfactory grade in its most recent report
of examination. Section 215.4(d)
Insider Loans
Regulation O
Overdrafts of Directors and
Executive Officers
General. The general rule is that a bank
may not pay into overdraft an item of an
executive officer or director of the bank or
an executive officer or director of an affiliate
of the bank. The overdraft prohibition does
not apply to principal shareholders of the
bank (unless the person is also a director or
executive officer) or to a related interest of
an insider. Section 215.4(e) [Note: Be
cautious about paying the overdraft of a
related interest of an executive officer or
director. The payment of an item into
overdraft is an extension of credit. While the
payment of the overdraft may be technically
permissible, if the insider owner of the
related interest has an aggregate credit
relationship with the bank in excess of
$500,000 (or an appropriate lesser amount,
based on the bank‘s capital) then prior
board approval is required before any
additional extension of credit may be
granted. What one part of the rule may
allow, another part of the rule may take
away.]
As with every regulation, there are
exceptions. The following categories of
loans are not included in determining the
aggregate amount of extensions of credit
that a bank has to Regulation O covered
persons.
Loans secured by United States
obligations or guaranteed both as to
principal and interest by the United
States.
Loans secured by an unconditional
takeout
commitment
or
an
unconditional guaranty of any agency
or bureau of the United States or any
corporations wholly owned by the
United States.
An overdraft of a director or an executive
officer is the most difficult insider credit to
deal with from a management perspective.
First, understand that the regulation does
not prohibit a director or executive officer
from writing a NSF item. That is not a
violation of the regulation. The violation
occurs when the bank pays the NSF item
into overdraft. Legally, an item has not been
―paid into overdraft‖ as long as the paying
bank has the right to return it to the bank
that accepted the item for deposit. For
example, if a bank receives a NSF item of
an executive officer in its cash letter on
Monday, it has until midnight on Tuesday to
return it. Until midnight on Tuesday comes
and goes without the item being returned,
the item has not been paid into overdraft.
The fact that the account may show as
overdrawn on a report Tuesday morning
does not mean that the account is legally
Loans secured by a deposit in the
same bank.
Credit arising from the purchase of
installment consumer paper from an
insider with full or partial recourse
provided that the maker‘s credit is
documented and that an officer of the
bank, appointed for that purpose,
certifies that the bank is relying
primarily on the maker‘s credit and not
the guarantor for payment of the
obligation. Section 215.4(d)(3)
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overdrawn. It only means that there are
items in processing that, if paid, will
overdraw the account. Accordingly if, in the
above example, prior to midnight Tuesday a
deposit is made to the account of the
executive officer to cover the item, the item
was never paid into overdraft. (An item paid
against uncollected funds is not an overdraft
unless the uncollected items are returned
unpaid.).
Insider Loans
Regulation O
credit under Regulation O; thus it does not
impact how much the bank can lend the
insider. We also believe that if the credit line
is drawn upon to pay an overdraft, it should
be repaid monthly so that it is continuously
available. Absent that, or if the credit line is
exceeded, all overdrafts should be
dishonored. In that way, junior officers are
not put in the difficult position of challenging
their superiors; all executive officers and
directors are treated equally, and the
executive officers and directors will learn to
enforce self-discipline.
If the executive officer or director has a
written,
preauthorized,
interest-bearing
repayment plan (i.e., an overdraft credit line)
or a written agreement for the transfer of
funds from another account at the bank
from which funds will be transferred to pay
NSF items then there is no violation.
Section 215.4(e)(1) The authorization for
the transfer must be in writing and in place
prior to the time that the NSF item is
received. If a bank, without prior
authorization, transfers funds from one
account of an executive officer to cover a
NSF item in a second account, then the
second account is deemed overdrawn.
We also believe that it is a good policy for a
bank to encourage its directors and
executive officers not to be co-account
holders with their family members, such as
their spouse and their children. An
executive officer‘s spouse is not an insider.
A bank may pay overdrafts on the account
of a spouse of an executive officer just as it
would the account of any other customer. If
the executive officer is a co-owner of his or
her spouse‘s account, it becomes subject to
Regulation O and the prohibition on
overdrafts.
Inadvertent Overdrafts. The only overdraft
of a director or executive officer or a director
or executive officer of an affiliate that a bank
may pay is an overdraft that is ―inadvertent.‖
An overdraft is inadvertent if in the
aggregate it is $1000 or less and the
account does not remain overdrawn more
than five days. Section 215.4(e)(2)
Additionally, examiners generally take the
position that if an executive officer or
director has more than three overdrafts in a
12-month period, although each was $1000
or less, they have ceased to be inadvertent.
If a bank does pay an inadvertent overdraft
it must impose its normal NSF charge and
may not waive it.
Additional Restrictions For
Loans To Executive Officers
General. Loans to executive officers of a
bank are more rigidly controlled than loans
to persons in any other covered class.
[Note: Loans to executive officers of
affiliates are subject to the general
requirements of Regulation O, but they are
not subject to the requirements for loans to
executive officers.] All loans to executive
officers are governed by the general
requirements of Regulation O, such as no
favorable terms and prior board of director
approval where required. In addition loans
to executive officers by a bank are subject
to other restrictions.
Policy. We believe that it is a good policy
for a bank to require all of its executive
officers and directors to have an overdraft
line of credit or other protection to prevent
overdrafts on their accounts. A $5000
overdraft credit line is not an extension of
Lending Limit. The amount of credit that a
bank may extend to an executive officer is
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limited to the following (and by the loans-toone-borrower rules):
Insider Loans
Regulation O
the loan to ABC Corporation then it
becomes a direct extension of credit to the
executive officer and falls back within the
executive officer lending limits. If the
executive officer does not guarantee the
loan then it would be a loan on preferential
terms and a violation of Regulation O for
that reason.
A bank may lend an executive officer
an unlimited amount of money to
finance the education of the executive
officer‘s children.
an unlimited amount of money for the
purchase, construction, maintenance
or improvement of an executive
officer‘s residence, provided that the
extension of credit is secured by a first
lien on the residence. The residence
does not have to be the executive
officer‘s principal residence. It may be
a vacation home or a secondary
residence. Each executive officer,
however, is entitled to only one loan in
this category.
Other Requirements. Every extension of
credit made to an executive officer must be
preceded by the submission of the officer‘s
current detailed financial statement. This is
a requirement even if the loan that the
officer is applying for is one for which the
bank usually does not require financial
statements, such as an automobile loan.
―Current‖ and ―detailed‖ have the same
meaning as the bank‘s policy for financial
statements for customer loan applications.
If, with a loan application, a bank normally
requires financial statements that are not
more than three months old, than an
executive officer‘s financial statement that
was six months old would not be current.
The level of detail is the level of detail that
the bank requires in the financial statements
of other loan applicants.
an unlimited amount of money if the
loan is secured by deposits with the
bank, or by U.S. Government
securities or guarantees.
For all other purposes, a bank may
lend an executive officer no more than
the greater of $25,000 or 2.5% of the
bank‘s capital and surplus, but in no
event more than $100,000. If a bank‘s
capital and surplus is greater than
$4,000,000 the maximum amount that
the bank can loan an executive officer
under this category is $100,000. If the
bank‘s capital is less than $4,000,000
the
amount
it
can
lend
is
proportionately less.
Every loan made to an executive officer
must have a provision in it that the loan is
callable at the bank‘s option any time that
the executive officer becomes indebted to
another bank, or other banks in the
aggregate, in an amount greater than his or
her bank can lend to the officer. This
provision can be included with each
extension of credit or the executive officer
can sign a blanket provision that would
apply to all extensions of credit from his or
her bank. We recommend that the call
provision be written so that it only applies
while the bank owns the loan, thus if the
loan is sold, the call provision does not go
with it. Section 215.5(d)(4) Although the
Financial Services Regulatory Relief Act of
2006 truncated some of the Regulation O
reporting requirements, as reflected below,
the requirement of a call provision remains.
The lending limits to an executive officer do
not apply to the related interests of an
executive officer. Thus if an executive
officer owns ABC Corporation the bank can
make unlimited extensions of credit to ABC
Corporation. On the other hand, in most
banks it is a requirement that the owners of
a small business guarantee all loans to the
business. If the executive officer guarantees
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Insider Loans
Regulation O
that each insider provide the names of each
related interest to the bank and a further
request that the insider notify the bank
promptly if he or she acquires or disposes of
any related interest during the year. If a
bank does not maintain an accurate, up-todate record of the related interests of its
insiders, it could inadvertently violate
Regulation O very easily.
Reporting Requirements
Executive Officers. Every loan made by a
bank to an executive officer of the bank
must be reported to the bank‘s board of
directors at the next board of directors‘
meeting after the loan is made.
Executive Officers and Directors. If an
executive officer or director owns shares in
a bank, and the shares of the bank are not
publicly traded, then each year the
executive officer or director must report to
the board of directors the unpaid balance of
any loan secured by the shares of the bank
owned by the executive officer or director.
Section 215.10
Suggestions for Compliance
Because of the content of Regulation O,
compliance violations will not be overlooked
by examiners. During every examination
they will look at the deposit accounts of
every insider and every new extension of
credit to every insider. Every bank should
have a zero tolerance for Regulation O
violations. Every insider is under a legal
duty to avoid causing Regulation O
violations for his or her bank. The following
are some suggestions that may help.
Executive
Officers
and
Principal
Shareholders. Upon receipt of written
request from anyone, a bank must disclose
the name of any executive officer or
principal shareholder who, combined with
his or her related interests, had credit
outstanding at the end of the prior quarter
equal to or greater than the lesser of 5% of
the bank‘s capital and surplus or $500,000.
Section 215.11(b)
Make sure that all people who qualify
as executive officers know that
Regulation O applies to them. Also
make sure that the appropriate people
in operations and in lending know who
all of the bank‘s directors, executive
officers, principal shareholders and
their related interests are.
Record Keeping
General. Regulation O requires that each
bank maintain records necessary for
compliance
with
the
regulation‘s
requirements. To accomplish this, as a
minimum, a bank must maintain a list of all
of the insiders of the bank, and the insider
category into which each person falls. It
must also maintain a similar list of the
insiders of its affiliates. A bank must also
maintain a record of all extensions of credit
to its insiders and to the insiders of its
affiliates. The credit record should reflect
the amount and terms of each credit.
Discourage executive officers and
directors from being co-owners on
accounts of their family members.
Encourage or require executive
officers and directors to have
overdraft protection for their deposit
accounts.
Though it is not mandatory, we believe that
it is a good policy for a bank to annually
provide to all of its insiders a definition of
―related interest‖ together with a request
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Insider Loans
Regulation O
and that all employees generally know
the content of the policy.
Appoint one senior lending person to
handle all applications for credit from
insiders. Segregate insider loan files
from the bank‘s general loan files to
insure that the information in those
files remains confidential.
Make sure that the files on all loans to
insiders are thoroughly documented.
From an examiner‘s standpoint, if it
isn‘t in writing, it didn‘t happen.
Sometimes the form is more important
than the substance.
Assure that the approval process for
insider loans (including the credit and
collateral review) is at least as
thorough and to the same or higher
standards than if the person were a
not an insider.
Avoid blanket grants of credit lines to
directors. While this does not violate
Regulation O, it is a flag to examiners
indicating that they should look
further.
If a loan is granted to an insider, make
sure that it is on terms that are not
more favorable than loans that are
granted to borrowers in general.
Have the board of directors of the
bank reapprove all revolving lines of
credit to insiders at least every 14
months.
If the bank has a policy of preferential
credit terms for its employees, make
sure that the policy is in writing,
approved by the board of directors
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Insider Loans
Regulation O and W
generally speaking, an insider of a national
bank need not comply with a state law
restriction that is tighter than federal law.
Insider Related
Regulations
Specific Cases
Common name: Regulation O
and W
Reference: 12 C.F.R. 215 and
12 C.F.R. 223
The FDICIA‘s amendments to the statutes
that regulate insider borrowing further
complicated the already complex interaction
of those laws and regulations. There are
now five major groups of loan rules a bank
and a bank insider may need to consider.
For this purpose, we define ―insider‖ as a
director, executive officer, 10% or greater
shareholder, any business controlled by
such a person, and any political or
campaign committee controlled by, or that
will benefit, such a person. (Such
businesses and committees are called
―related interests‖ of the director, executive
officer, or shareholder concerned.) The five
groups of rules are:
Introduction
The insider lending standards mandated by
Congress in the Federal Deposit Insurance
Corporation Improvement Act (FDICIA) took
effect in 1982. In this article, we will explain
the interaction of the several federal laws
that now restrict loans to insiders of banks,
as well as the possibility for state laws to
impose even stricter limits. Furthermore, we
have supplied, in a procedure following this
article, a suggested methodology for
avoiding the pitfalls. This article assumes
you have a basic understanding of
Regulation O.
The National Bank Act lending limit
(section 5200 or 12 U.S.C. 84)
Federal Reserve Act Section 23A and
its portions of Regulation W (dealing
with loans to ―affiliates‖)
General Principles
Congress decided that people who
influence financial institutions ought to be
tightly restricted in their borrowing
relationships with those financial institutions.
One overriding principle of the regulatory
scheme Congress established is that if
several different rules might possibly apply
to a situation, the strictest rule will apply.
That is, if a state law imposes a tighter limit
on an insider of a state-chartered bank than
does federal law, that insider must comply
with the tighter state law. If federal law is
more restrictive than state law, the insider
(of either kind of bank, state or national)
must comply with the federal law. And
finally, if one federal law imposes a tighter
restriction than another federal law, an
insider (of either kind of bank) must comply
with the tighter of the two federal laws. The
only exception to this principle is that,
State laws on lending limits and loan
terms (for state-chartered banks,
whether or not they are members of
the Federal Reserve System)
Federal Reserve Act Section 22(h)
and its portions of Regulation O
Federal Reserve Act Section 22(g)
and its portions of Regulation O
In each case, remember, the bank and its
insider must comply with the most restrictive
limit applicable to the particular situation.
The following explains each of the five
groups of rules.
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Insider Loans
The National Bank Act. The individual
lending limits of the National Bank Act are
brought into play by Section 22(h) to
establish dollar limits on loans to the bank‘s
insiders after certain ―terms‖ and ―process‖
tests have been met (market terms,
repayment risk, underwriting procedures,
board approval). All extensions of credit by
a bank by any one of its insiders (which
includes related interests), cannot exceed
the amount a national bank could have
loaned to that insider under Section 5200 of
the Revised Statutes. That section has been
on the books for a long time. It has a
number of exceptions built into it, and a
great deal of lore about those exceptions.
We will summarize the major portions of it
that apply to insider lending in this section.
In general, Section 5200 limits loans by a
bank to any one insider to 15% of the
bank‘s unimpaired capital and unimpaired
surplus if the loan is unsecured. It allows
further loans of up to an additional 10% of
the bank‘s unimpaired capital and
unimpaired surplus if the loan is fully
secured by certain kinds of marketable
collateral. 12 USC §84.
2
The exceptions to it apply only for
purposes of the small piece of Section
22(h) into which they are expressly
carried by the statute.
Section 23A of the Federal Reserve Act.
This law, as implemented by Regulation W,
usually is thought of as something that
applies only to bank holding companies, as
it limits lending to affiliates in the normal
bank holding company situation. But there
are times when it can be a problem to
insiders of ―unit‖ banks that are not part of a
holding company system. The interplay of
this law with the insider loan limits of
Regulation O and its related statutes is
worth some study.
Assume that Jane Doe is a 25%
shareholder of Second Bank, which has $1
million in unimpaired capital and unimpaired
surplus. Further assume that Ms. Doe also
owns 25% of Doe Moving & Storage
Corporation, 40% of JD Paving, Inc., 15% of
Smith & Doe Realty Corporation, and that
she is an executive vice president of this
last company. Under Regulation O, all three
of these corporations are ―related interests‖
of hers and, therefore, ―insiders‖ of the
bank. The moving and storage corporation
and the paving corporation are ―affiliates‖ of
Second Bank for purposes of Regulation W
because they are 25% or more owned by a
person who owns 25% or more of the bank.
The section also contains exceptions for
types of loans that are not subject to any
limits and types of loans that are subject to
separate (usually higher) limits. Among the
unlimited types of loans are those secured
by a segregated deposit account in the
lending bank, and those secured by U.S.
Treasury and similar securities. Loans
subject to higher limits include those
secured by certain kinds of bills of lading
and warehouse receipts, which are subject
to a limitation of 35% of the bank‘s
unimpaired capital and unimpaired surplus.
Under Regulation O, Second Bank may
lend no more than $150,000 to Ms. Doe and
the three corporations on an unsecured
basis and an additional $100,000 if the
loans are fully secured, for a total allowable
under Regulation O of $250,000. Note,
however, that the bank is not allowed to
lend more than $1 million to all of its
insiders and their related interests. If it lends
the maximum amount permitted to Doe and
her interests on an individual basis, it will
Note two things about the national bank
lending limit as now incorporated into
Regulation O:
1
Regulation O and W
It applies to state-chartered banks as
well as national banks.
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Insider Loans
Regulation O and W
Federal Reserve Act Section 22(h) and
its Portions of Regulation O. These rules
are what most bankers think of when
someone mentions Regulation O. As
amended on May 18, 1992, they require
loans by a bank to its own insiders to be
made on substantially the same terms
(including, but not limited to, interest rates
and collateral) as comparable loans to
noninsiders. Such loans must ―not involve
more than the normal risk of repayment.‖
(One hopes the risk of repayment is 100%.
Section 215.4(a)(1). Presumably the
drafters meant risk of non-payment.‖
have used a quarter (an eighth under the
small bank ―trial‖ exemption) of its total
funds for loans to all of its insiders. The
other insiders may well have credit needs of
their own, so some allocation of credit
among the bank‘s insiders may be
necessary.
Regulation W lays another template of rules
atop the Regulation O rules in this scenario.
Regulation W requires all loans to Doe‘s
moving and paving companies to be
secured because no unsecured loans are
allowed to ―affiliates.‖ It also imposes a loan
limit of 10% (of capital and surplus) as to
each affiliate individually. Therefore, loans
to the moving corporation and the paving
corporation are capped at $100,000 each.
Finally, Regulation W puts a 20% aggregate
limit on the bank‘s loans to all of its
affiliates. Therefore, a $100,000 loan to
each of the two affiliate companies would
exhaust the bank‘s legal ability to lend to
any other similarly related company of Ms.
Doe or any other 25% or more shareholder
of the bank.
A bank must follow credit underwriting
procedures no less stringent than those
used in comparable loans to noninsiders.
This requirement directly addresses the
process by which credit decisions are made,
regardless of the results of that process. A
bank must be able to show the examiners
that the process was no more biased toward
the insider borrower than the process used
for noninsider borrowers.
If the amount of a new credit requested,
when added to the amount of all other credit
outstanding to an insider, would exceed the
higher of $25,000 or five percent of the
bank‘s unimpaired capital and unimpaired
surplus, then the loan must be approved
before disbursement by the majority of the
bank‘s entire board of directors. Any credit
that would bring the aggregate to that
insider above $500,000 must be approved
in advance by the board no matter how
large the bank‘s capital and surplus may be.
The interested party is prohibited from
participating in the consideration of the loan.
Section 215.4(b)
State Laws (for State-Chartered Banks).
A state-chartered bank is a creature of state
law, and, under our federal system of
government, is subject to the laws of the
state that created it. Many states now have
insider loan laws that roughly parallel the
federal ones. The key word here is
―roughly.‖ For a variety of reasons, some
states did not follow the federal laws‘
pattern exactly and so impose tighter
restrictions in some areas and looser ones
in others. In one state, for example, the
definition of ―insider‖ does not include
political or campaign committees as the
federal definition does. If your bank is statechartered, do not be misled into thinking you
can use that definition instead of the more
restrictive federal one. On the other hand,
some state equivalents of Regulation O
impose tougher restrictions on insider
borrowings, and a state bank and its
insiders must comply with those more
restrictive limits.
Also under this section is an aggregate‖
lending limit. A bank with deposits of $100
million or more must be sure that all its
loans to all of its insiders do not exceed, in
total, 100% of the bank‘s unimpaired capital
and unimpaired surplus. Section 215.4(d)(1)
The bank‘s unimpaired capital and
unimpaired surplus is defined as the sum of:
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Insider Loans
Regulation O and W
parent holding company or of its ―sister‖
banks or nonbank subsidiaries owned by
the same bank holding company.
The bank‘s Tier 1 and Tier 2 capital
included in the bank‘s risk-based
capital under the capital guidelines of
the appropriate federal banking
agency, based on the bank‘s most
recent call report; and
Under these rules, an executive officer
borrowing at his or her own bank will be
subject to the limit specified in the National
Bank Act for loans secured by a first lien on
his or her residence and loans to finance
the education of his or her children. All other
loans to an executive officer by his or her
own bank must not exceed 2.5 percent of
the bank‘s unimpaired capital and
unimpaired surplus. Banks for which this
formula would result in a limit of less than
$25,000 may nevertheless lend up to
$25,000 to such an executive officer for
such purposes. Banks for which the formula
would result in a limit of more than $100,000
are capped at $100,000Section 215.5(c)
The balance of the bank‘s allowance
for loan and lease losses not included
in the bank‘s Tier 2 capital for purpose
of calculation of risk-based capital by
the appropriate federal banking
agency, based on the bank‘s most
recent call report. Section 215.2(i)
Note that additions to equity capital or
valuation reserves during a quarter will not
begin to count for purposes of the
aggregate limit until after the bank has filed
its call report for that quarter, reflecting
those additions.
The permission under Section 22(g) and its
portions of Regulation O to make loans up
to the general lending limit to an executive
officer for residential or educational
purposes does not exempt such loans from
the general individual limit of Section 22(h)
and its portions of Regulation O. These
loans also are not exempted from the
aggregate limitation on loans to all insiders
as a group.
Banks with less than $100 million in
deposits have a limit of 200% of unimpaired
capital and unimpaired surplus, as defined
above. Section 215.4(d)(2)
Congress directed the Federal Reserve to
do a zero-based review of the exceptions
from the definition of the term, ―extension of
credit‖ for the purpose of the aggregate
lending limit. The Fed did so, and adopted
exceptions for loans secured by U.S.
obligations or deposits in the lending bank
and those with certain other collateral or
enhancements. They are described in more
detail in the article immediately before this
one.
As you can see, the rules are not simple. As
with all Regulation O matters, the penalties
for noncompliance are severe. Under the
penalty provisions, penalties can run up to
$1 million per day against the bank and
separately against each individual involved
in a violation. Training bank insiders and
loan personnel obviously is critical to the
compliance effort. Training the people
employed at insiders‘ related interests, who
handle the borrowing relationships of those
organizations, also would be wise.
Federal Reserve Act Section 22(g) and
its Portions of Regulation O. These rules
apply only to executive officers who borrow
from their own banks. They do not apply to
directors or principal shareholders, nor do
they apply to executive officers of a bank‘s
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Privacy of Consumer
Financial Information
Regulation P
continue to obtain information from deposit
operations and from other departments of
the financial institution in the same manner
that it does now. Also, the Act does not
affect a financial institution‘s disclosure of
consumer information to an affiliate of the
financial institution; however the Act does
require the fact that information will be
disclosed to an affiliate be stated in the
financial institution‘s privacy notice.
Privacy of Consumer
Common name: Regulation P
Introduction
Part V of the Gramm-Leach-Bliley Act,
which became law November 12, 1999,
contains rules which require a financial
institution to safeguard the confidentiality of
any ―nonpublic personal information‖ which
it has about a consumer. The Act prohibits
a financial institution from disclosing such
information to any nonaffiliated third party
(with exceptions) unless the consumer has
been provided a copy of the institution‘s
privacy notice and has been given the
opportunity to opt out of having his or her
information so disclosed. A copy of the
institution‘s privacy notice (and opt out
notice if required) must be given to a
consumer before the financial institution
may disclose information about the
consumer to a nonaffiliated third party, other
than for an excepted purpose. Section
216.4(a)(2)
Definitions
Nonpublic personal information. As with
most regulations, the most difficult part of
interpreting what the regulations require
understands the defined terms. One of the
most difficult terms to decipher is the term
―nonpublic personal information,‖ which is
the information about a consumer that is at
the heart of the regulation. Unfortunately
the regulation defines nonpublic personal
information in terms of ―personally
identifiable financial information‖ and what is
―publicly available information.‖
Section
216.3(n)
The most practical definition of ―nonpublic
personal information‖ about a consumer is
everything that the financial institution
knows about that person, for it includes: (a)
all of the information that the person has
provided the financial institution in
connection with an application for a financial
product or service; (b) all of the information
that the financial institution has about the
person resulting from any transactions
between the person and the financial
institution and transactions that the
institution has processed to the person‘s
accounts; and (c) any other information that
the financial institution has obtained about
the person from any other source in
connection with providing a financial product
or service to the person. Section 216.3(o)
Nonpublic personal information therefore
includes all of the information that a person
has provided to a financial institution about
himself or herself, everything that the
financial institution has learned about the
person through processing his or her
accounts and everything that the financial
institution has learned about the person
If the financial institution‘s privacy notice
(and opt out notice) has not been previously
provided, it must be provided to a consumer
when the consumer establishes a customer
relationship with the institution. Section
216.4(a)(1) If a customer relationship is
established, the financial institution‘s privacy
notice must be provided to the consumer
customer annually thereafter so long as the
customer relationship continues. Section
216.5 The consumer must also be given the
ability to ―opt out‖ of having his or her
nonpublic personal information shared. If
the consumer exercises the opt out right,
then the financial institution may not
disclose that consumer‘s information to a
nonaffiliated third party other than for an
excepted purpose. Section 216.7
The Act does not affect internal
communications of consumer information.
The loan department, for example, can
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from third parties. Even the mere fact that
the person is a customer, or has in the past
been a customer, of the financial institution
is included in the definition. Section
216.3(o)(2)(i)(C)
Privacy of Consumer
Regulation P
business or commercial purpose. Although
the regulation is not precise on this point, if
a financial institution has both consumer
and nonconsumer relationships with a
person, the information about the person
obtained
through
the
nonconsumer
relationship
is
technically
nonpublic
personal information about a consumer. A
person is a consumer if he or she applies to
a financial institution for a loan or applies to
be prequalified for a loan regardless of
whether the application is approved. A
person who purchases a cashier‘s check
from a financial institution, uses its ATM
machine or purchases travelers checks is a
consumer as to the financial institution that
he or she obtained the service from. The
definition is intended to be inclusive rather
than exclusive.
Anyone who, for a
consumer purpose, obtains a financial or
financially related product or service from a
financial institution, applies for a service or
product from a financial institution, or
provides a financial institution information
about himself or herself is a consumer.
The only limitation on the scope of
nonpublic personal information is the
exclusion of ―publicly available information.‖
Publicly available information is defined as
information available to the general public
from government records or widely
distributed media such as telephone books,
a newspaper or on an unrestricted Internet
site. Section 216.3(p) If information about a
person is publicly available, then it is not
nonpublic personal information and its
disclosure is not limited.
A person‘s
address is usually publicly available from
telephone books and other generally
available public information. But what if a
person does not have a telephone, or has
an unlisted telephone number. The process
of sorting out which customer‘s information
is publicly available and which customer‘s
information is not would be enormous. The
best practical policy is to treat all information
that a financial institution has about a
person as nonpublic personal information
and subject to the regulation.
Customer. A customer is defined as a
consumer who has a customer relationship
with a financial institution. Section
216.3(e)(1) A customer relationship is a
consumer relationship that has a continuing
obligation over time as contrasted to an
isolated transaction. Section 216.3(i)(1) A
customer, by definition, is always a
consumer. A person who has a relationship
with a financial institution for a commercial
purpose only is not a customer under the
definition of the regulation. A customer is a
person who has a continuing relationship
with a financial institution pursuant to which
the institution provides one or more financial
products or services to the person that are
to be used primarily for personal, family, or
household purposes. In other words, a
customer is a consumer who has a
relationship with the financial institution that
has a continuing obligation on the part of
the institution or the person. A person is
only a consumer when he or she obtains a
financial product or service in an isolated
transaction or applies for a product or
service that will not have a continuing
For the purpose of this article the term
consumer information or information about a
consumer will be used to describe the
information that falls within the regulation‘s
control.
Consumer. A consumer is a person, or the
legal representative of a person, who
applies for, obtains, or has obtained a
financial product or service that is to be
used primarily for personal, family, or
household purposes from a financial
institution. A person, in this regard, means
a real, live, human being. The regulation
does not cover relationships with juridical
entities
such
as
corporations
or
partnerships. Also, the regulation does not
cover persons whose only relationship with
a financial institution is for other than a
personal, family, or household purpose; that
is, a person whose only relationship is for a
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relationship. That consumer becomes a
customer when he or she enters into a
continuing relationship with the financial
institution. For example, when a person
applies for a consumer purpose loan, he or
she becomes a consumer.
Privacy of Consumer
Regulation P
Institution A sells the loan to Financial
Institution B but keeps the servicing rights,
that person remains a customer of Financial
Institution A and becomes a consumer of
Financial Institution B.
In a lending
relationship, a borrower is a customer of the
institution that services his or her loan and a
consumer of each nonservicing institution
that owns an interest in the loan. Section
216.3(i)(2)(i)
When the loan is actually made, he or she
becomes a customer. Anyone who, for a
consumer purpose, has a deposit account,
a loan, or an investment advisory
relationship with a financial institution is a
customer. Anyone who, for a consumer
purpose, purchases an investment product
through a financial institution or obtains
continuing investment advice from a
financial institution is a customer. Section
216.3(i)(2)(i) A person who uses a financial
institution‘s ATM but does not have any
other relationship with the institution is a
consumer but not a customer. Even though
the person may use the ATM repeatedly, he
or she does not establish a continuing
relationship.
If a person purchases a
regular life insurance policy through a
financial institution the person becomes a
customer. Even though the purchase of the
policy may be a single transaction, the
relationship established by a life insurance
policy is continuing. On the other hand, if
the insurance that the person purchases is
travel insurance for a specific trip, the
relationship is not a continuing one, or at
best continuing for a brief period of time,
and the person does not become a
customer. Section 216.3(i)(2)(ii)
Affiliate. An affiliate is any company that
controls, is controlled by, or is under
common control with another company.
Control for this purpose means ownership
or the power to vote, directly or indirectly,
25% of any class of voting shares of a
company, control over the election of a
majority of the directors or governing body
of a company, or the power to exercise,
directly or indirectly, a controlling influence
over the management or policies of a
company.
Accordingly, if a financial
institution is owned by a holding company,
the holding company and all of the other
financial institutions and non-financial
companies owned by the holding company
are the financial institution‘s affiliates.
Likewise, any subsidiaries of a financial
institution are its affiliates. If someone owns
25% or more of the stock of a bank holding
company, then that person is an affiliate of
the financial institution as is any other
company that person owns 25% or more of.
Financial Institution. A financial institution
is any institution which engages in activities
that are financial in nature or incidental to
such financial activities; that is, the
institution is in the business of providing
financial products or financial services.
Financial products and financial services
are products and services that a financial
holding company could offer by engaging in
an activity that is financial in nature or
incidental to such a financial activity as
defined in the Bank Holding Company Act
and by the Federal Reserve‘s Regulations H
and Y. Fundamentally, a financial product
or financial service is any product or service
that a financial institution or bank holding
One thing to be cautious about is the area
of loan brokerage. If a person applies for a
loan for a consumer purpose, the person
becomes a consumer but not a customer at
the time of application. On the other hand,
if the person enters into an agreement or
understanding whereby the financial
institution undertakes to arrange or broker
the loan for the consumer, then that is
deemed to be a continuing relationship and
the consumer is a customer also. In a
related vein, if a person obtains a loan from
Financial Institution A, he or she is a
customer of that institution. If Financial
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company can offer under the revised rules
of Gramm-Leach-Bliley or a product or
service that has been determined to be
incidental to a permitted product or service.
As a technical note, the ―complementary‖
activities that a financial institution is
allowed to provide, such as travel services,
are not included. A financial institution is
any organization whose business is
providing financial products or services.
Privacy of Consumer
Regulation P
because in that instance the financial
institution has a practical method of
delivering the notice prior to the
consummation of the customer relationship.
Where the exception applies, the disclosure
may be provided a reasonable time after the
customer relationship is established.
Section 216.4(e)
The notice must be provided to every
customer at the time that a customer
relationship is established. If two or more
individuals open a joint account, delivery of
the notice to one of them constitutes notice
to all of them. If a person is a customer of
the financial institution and has been
provided a copy of the notice, he or she
need not be provided additional copies if he
or she subsequently establishes additional
customer relationships with the financial
institution. Section 216.4(d)
Notice Requirements
A financial institution must prepare a written
notice that ―clearly and conspicuously,‖
accurately reflects the financial institution‘s
privacy policy and practices. The notice
must be provided to an individual who
becomes the financial institution‘s customer
prior to the time the customer relationship is
established. Section 216.4(a)(1)
A financial institution must also provide a
copy of the notice to each customer at least
once during each consecutive twelve-month
period during
which the customer
relationship exists between the financial
institution and the individual.
Section
216.5(a) If an individual is a credit customer,
the customer relationship ends when the
loan is paid off or the loan is sold and the
financial institution no longer services it. If
the loan is an open-end loan such as a
credit card, the relationship ends if the loan
has no amount outstanding and the financial
institution no longer sends statements. If an
individual is a deposit customer, the
customer relationship ends when the
account is closed or when it becomes
dormant or inactive based upon the
individual financial institution‘s policy of
what constitutes dormancy or inactivity. All
other relationships between a financial
institution and an individual are presumed to
have terminated if the financial institution
has not communicated with the individual
about the relationship for a period of twelve
consecutive months, other than to send
privacy notices. Section 216.5(b)
Accordingly, prior to the opening of a
deposit account, the closing of a loan or the
beginning of any other financial relationship,
a financial institution must provide its
prospective customer a copy of its privacy
notice. There are two exceptions to the
requirement to provide the notice prior to
the establishment of the relationship. One
is when the relationship is not established
by an action on the part of the customer,
such as in a financial institution merger or a
branch acquisition, or where a financial
institution purchases the servicing of the
customer‘s loan. The other is when the
customer is not present in the financial
institution in person at the time the
relationship is established, the institution
does not have a practical method of
delivering the notice and the customer
agrees to receive the notice at a later date.
Section 216.4(e)(1) For example, if the
customer relationship is established over
the telephone, the exception would apply if
the customer consented to later delivery of
the notice.
If the relationship were
established over the Internet, the exception
would not apply, even if the customer
consented to later delivery of the notice,
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A financial institution must also provide the
notice to a consumer who is not a customer
prior to the time the financial institution
discloses
any
nonpublic
personal
information about that consumer to a
nonaffiliated third party other than in a
circumstance excepted by Section 14 or 15
of the regulation. Section 216.4(a)(2)
Accordingly, if a person applies for a
consumer loan, the person becomes a
consumer. That relationship alone does not
trigger the giving of a privacy notice. If,
however, the financial institution is going to
disclose information about that consumer to
a nonaffiliated third party, other than
pursuant to one of the exceptions in Section
14 or 15 of the regulation, the consumer
would have to be provided a copy of the
financial institution‘s privacy notice.
Privacy of Consumer
Regulation P
Because use of the new model language is
required in order to be presumed to be
compliant, most financial institutions will
want to use the model language, and we
strongly recommend it. As a result, the
discussion below reflects the requirements
of the new model privacy notices.
The new model privacy notice contains
detailed
instructions
with
strict
requirements. Generally, a privacy notice
that complies with the new model language
must contain the items below in the format
contained in Appendix A:
The last date of revision to be located
in the upper right-hand corner of page
one;
The types of personal information that
the institution collects and shares.
Section 226.6(a)(1), (a)(2)
This
information is disclosed in the ―What?‖
box on the privacy notice. All financial
institutions must include the term
―social security number‖ as well as at
least five of the following: income,
account balances, payment history,
transaction or loss history, credit
history,
credit
scores,
assets,
investment experience, credit-based
insurance scores, insurance claim
history, medical information, overdraft
history, purchase history, account
transactions, risk tolerance, medicalrelated debts, credit card or other
debit, mortgage rates and payments,
retirement assets, checking account
information, employment information,
and wire transfer instructions;
Content of Privacy Notice
A financial institution‘s privacy notice must
be accurate at the time it is provided, but it
may reflect both current as well as future
potential policies and practices. Section
216.6(d)
In 2009, the model language for the privacy
notice under Regulation P was amended.
The sample clauses that were in the
regulation prior to the amendment are valid
until December 31, 2010. However, as of
January 1, 2011, an institution should use
the new model privacy form included in
Appendix A if it intends to meet the safe
harbor for compliance, even though use of
the model form is technically not required.
Revised Appendix A to the regulation
contains three versions of the new model
privacy notice: 1) a privacy notice without an
opt out, 2) a privacy notice with an opt out
where the customer can opt out by
telephone and/or online, and 3) a privacy
notice with an opt out where the customer
can opt out by mail. The appendix also
contains a fourth version, which is an opt
out form variation. The new model privacy
notices are included at the end of this
chapter.
The reasons how and why the
financial institution shares or uses
personal information. The model form
includes seven reasons for sharing.
These correlate directly with the
provisions in the regulation as well as
affiliate sharing rules under the Fair
Credit Reporting Act and Regulation
V.
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Privacy of Consumer
Regulation P
financial institution that shares under
this reason may provide an opt out,
though it isn‘t required. The Fair Credit
Reporting Act would also apply to this
situation and the rules are discussed
in our Fair Credit Reporting Act
Chapter later in this manual.
For
our
everyday
business
purposes. Sharing ―for our everyday
business purposes‖ will apply to those
financial
institutions
that
share
information according to the provisions
in Section 14 and 15.
For our marketing purposes. If a
financial institution shares information
with service providers for marketing
purposes under Section 13, then it
would disclose this under ―for our
marketing purposes‖. An opt out is
not required where an institution
shares information under one of the
exceptions, such as Section 13.
However, an institution that shares
under
such
exceptions
may
nonetheless allow the customer to opt
out of the information sharing.
For
our
affiliates’
everyday
business
purposes
–
creditworthiness. If the information
that the financial institution shares with
its affiliates is about the customer‘s
creditworthiness, then it would use ―for
our affiliates‘ everyday business
purposes
–
information
about
creditworthiness‖.
Although it is
referred to as ―information about
creditworthiness‖ in the model form,
FCRA
actually
refers
to
communication of other information
among persons related by common
ownership or affiliated by corporate
control,
if
it
is clearly and
conspicuously disclosed to the
consumer that the information may be
communicated and the consumer is
given the opportunity to opt out of the
sharing.
Unlike all the previous
reasons, a financial institution that
shares under this reason must provide
the customer an opportunity to opt out.
For joint marketing with other
financial institutions. If a financial
institution
shares
information
according to the joint marketing
exception in Section 13, it should use
the reason ―for joint marketing with
other financial companies‖. The joint
marketing exception to the regulation
only applies if a financial institution
has entered into a joint marketing
agreement with another financial
institution and with any service
provider used in connection with said
marketing agreement.
The joint
marketing agreement must be to offer
financial
services
or
products.
Customers may be provided with the
opportunity to opt out of this sharing
but it is not required by the regulation.
For our affiliates to market to you.
If the information being shared is so
that a financial institution‘s affiliates
may market to a consumer, this
should be disclosed under ―for our
affiliates to market to you‖. This is the
only reason that may be omitted from
the notice, but it may only be omitted if
the financial institution does not have
any affiliates,
does not share
information with its affiliates, the
affiliates do not use the information
shared by the institution to market to
the institution‘s customers, or the
affiliate marketing notice is provided
separately. This section incorporates
the requirements of the Fair Credit
Reporting Act and Regulation V to
For
our
affiliates’
everyday
business purposes – transactions
and experiences.
A financial
institution that shares information
about its own transactions and
experiences with a customer with its
affiliates should use the reason ―for
our affiliates‘ everyday business
purposes
–
information
about
transactions and experiences‖.
A
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provide customers with an opt out
where
the
institution
shares
information with affiliates for marketing
purposes.
Privacy of Consumer
Regulation P
that they use to collect personal
information. Additional language is
required in this section of the notice,
depending on whether the institution
collects information from affiliates or
credit bureaus.
For nonaffiliates to market to you.
Finally, if a financial institution shares
information with non-affiliates for
marketing purposes but such sharing
does not fit within the Section 13
exception, the sharing must be
disclosed under ―for nonaffiliates to
market to you‖. Since this sharing
does not fit within one of the
Regulation P exceptions to providing
an opt out, a financial institution that
participates in this kind of sharing
must provide its customers with the
opportunity to opt out.
A description of state privacy laws.
There is an option to provide ―other‖
information on state laws if the
institution later provides ―other‖
information after the definition section.
The effect on opting-out on a joint
account.
Whether it has affiliates and whether it
shares with them or not. If there are
none, state so.
Whether it has a list of nonaffiliates
that it shares with. If there are none,
state so.
If an opt out is included in the notice, a
method to exercise the opt out must
be included.
Customers may be
provided with one or more opt out
methods such as a toll-free number, a
website or an address if a mail in opt
out form has been provided. This
section of the model notice has very
specific requirements. As a result, an
institution that provides an opt out
should carefully review the instructions
for the model form when developing
its privacy notice.
Whether the financial institution
participates in joint marketing.
―Other‖ information can be provided so
long as it is limited to state privacy
information or acknowledgement of
receipt of forms.
The preparation of this notice is the most
difficult requirement of the regulation. A
financial institution must examine every
circumstance
in
which
it
provides
information about a consumer to an affiliate
or an unaffiliated third party and every
element of customer information that it
discloses under any circumstance. It must
then evaluate whether the person to whom
the information is provided and/or the
information that is provided must be
disclosed and whether or not the consumer
has an opt out right regarding it.
Customer service contact information.
The name of the financial institution
that is providing the notice. Joint
notices are allowed as long as all
financial institutions are identified in
the notice. If only one institution is
providing the notice, then this may be
omitted.
A financial institution must also consider
how its business may change in the future
and whether it might want to disclose
elements of customer information that it
does not now disclose or disclose
information to affiliates or unaffiliated third
parties to whom it does not now disclose
information. If either event has a significant
Information about how the institution
safeguards
personal
information.
Additional language may be inserted
up to 30 additional words.
How personal information is collected.
Institutions must list at least five of the
methods specified in the instructions
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potential of occurring, a financial institution
would be wise to reserve the right to
disclose
information
under
those
circumstances in the future.
Privacy of Consumer
Regulation P
that the financial institution discloses or
reserves the right to disclose customer
information to nonaffiliated third parties and
that the customer has the right to prohibit
the financial institution from doing that if he
or she so elects. Section 216.7(a) The
notices must also state a reasonable means
for the customer to exercise his or her opt
out election. The consumer‘s opt out right
does not have to be all or nothing. A
financial institution may give a consumer the
ability to opt out of information disclosure by
category of information or by category of
third party or both.
Accordingly, if a
financial institution allowed a consumer to
do so, the consumer could allow certain
categories of his or her information to be
disclosed to certain categories of third
parties and simultaneously prohibit the
disclosure of any information to any other
third parties. This very flexibility adds to the
complexity of complying with the regulation.
Once a consumer has been given a copy of
the financial institution‘s privacy notice, the
financial institution may not disclose
information about that consumer to a third
party unless the category of the information
and the category of the third party has been
described in the notice. It is critical that all
levels of management in a financial
institution understand this fact and the
ramifications of disclosing information
inappropriately. If a financial institution‘s
business plan changes between annual
notices, it will have to provide an amended
notice to all of its customers before it may
begin disclosing information that the prior
notice did not describe as being subject to
disclosure or begins disclosing information
to third parties that had not been described
as parties to which information would be
disclosed. Section 216.8
The opt out notice must be provided to a
consumer either in writing or, if the
consumer consents to electronic delivery,
then electronically. Section 216.9(a) The
opt out notice may be on the same form as
the privacy notice. Section 216.7(b) Like
the privacy notice there is a requirement
that the opt out notice be clear and
conspicuous. If not provided electronically,
the opt out notice, like the privacy notice,
may be hand delivered or sent by mail to
the person‘s last known address.
Limitation on Disclosure of
Consumer Information and
the Consumer’s Opt out
Rights
The general rule is that a financial institution
may not disclose information about a
consumer to a nonaffiliated third party until it
has provided the consumer a copy of the
financial institution‘s privacy notice and, if
appropriate, a notice of the consumer‘s right
to opt out of having his or her information
shared. If the opt out provisions apply, the
consumer must also have been provided a
reasonable opportunity to opt out of the
information sharing. Section 216.10 By the
term ―opt out‖, the regulation means a
direction from the consumer to the financial
institution not to share his or her information
with unaffiliated third parties other than in
circumstances that the consumer does not
have the right to opt out of. Section
216.10(a)(2) The opt out notice must state
After receipt of the privacy notice and the
opt out notice, if applicable, a consumer
must be given a reasonable time to opt out.
If the notices are provided to the consumer
by mail, the regulation states that 30 days
would be a reasonable time. If the
consumer is conducting an isolated
transaction, the notices could be provided at
that time and the consumer could be
required to opt out immediately if he or she
did not want his or her information shared.
Section 216.10(a)(3) A consumer‘s right to
opt out is continuing. Section 216.7(f) Even
though he or she may not exercise the right
to opt out at the time of receiving the notice,
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or within 30 days after having received it by
mail or within a reasonable time of receiving
it electronically, he or she may also opt out
at any subsequent time. Once an election is
made by a consumer to opt out, the
resulting restriction of information disclosure
on the part of the consumer remains valid
until the consumer revokes the opt out
election in writing (or electronically if the
consumer has agreed to electronic
communication). Section 216.7(g)
The requirements to provide opt
for certain information sharing
affiliates are discussed in the
Credit Reporting Act Chapter in
Manual.
Privacy of Consumer
Regulation P
and the financial institution has
entered into a contract with the third
party. Section 216.13(a)
The
contract must require the third party
to maintain the confidentiality of the
information to at least the same
extent that the financial institution
must maintain its confidentiality. The
contract also must limit the third
party‘s use of the information solely
to the purposes for which the
information is disclosed or for
permitted purposes under Section 14
or Section 15.
outs
with
Fair
this
The services that qualify under
Section 13 include a joint marketing
agreement with another financial
institution pursuant to which the two
institutions jointly offer, endorse, or
sponsor a financial product or
service. Section 216.13(b) It appears
fairly clear that the only joint
marketing agreements that qualify
under this section are joint marketing
agreements between two or more
financial institutions for the marketing
of a financial product or service.
Section 216.13(c)
If one of the
parties to the joint marketing
agreement is not a financial institution
or if what is being marketed is not a
financial product or service, then the
arrangement would not qualify under
this section and the consumer
information disclosure would be
subject to the consumer‘s right to opt
out. Of course, the definition of
―financial institution‖ under GrammLeach-Bliley is broader than the
traditional
definition.
Section
216.13(k)
Exceptions to the Opt Out
Requirements
Three sections of the regulation define
circumstances in which a financial institution
may provide consumer information to a
nonaffiliated third party even though the
consumer may have opted out of the
sharing of his or her information. First, it
must be remembered that the privacy
restriction places no limitation on a financial
institution sharing consumer information
with an affiliate. That consumer information
sharing must be disclosed in the privacy
notice but it is not limited by the regulation.
The restrictions on sharing information
between affiliates that would be deemed to
be a credit report imposed by the Fair Credit
Reporting Act do remain in place, however.
The three circumstances in which consumer
information may be shared with a
nonaffiliated
third
party
despite
a
consumer‘s opt out notice are contained in
Sections 13, 14 and 15 of the regulation.
Section 14 Exceptions. Section 14
allows a financial institution to provide
information about a consumer to
nonaffiliated third parties without
providing the affected consumer either
the privacy notice or the opt out notice
when the information is provided to
service or process a financial product
permits a financial institution to
provide consumer information to a
nonaffiliated third party to perform
services for the financial institution or
functions on the financial institution‘s
behalf if the institution has provided
the privacy notice to the consumer
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or service requested or authorized by
the consumer.
Privacy of Consumer
Regulation P
Finally, a financial institution may
provide consumer information to a
nonaffiliated third party if it involves
the actual or proposed secondary
market sale or securitization of the
consumer‘s account or the servicing
rights to the account. Section
216.14(a)(2) In general, it is the intent
of this section to enable a financial
institution to provide information about
a consumer to nonaffiliated third
parties in order to evaluate a
consumer‘s request for a product or
service, to consummate the product or
service, to administer, audit, or
maintain the product or service and
transactions made thereunder, or to
enforce the rights of the financial
institution or other parties, including
the consumer, relative to a product or
service or a transaction thereunder.
It also allows providing information to
nonaffiliated third parties as necessary to
carry out a transaction for a consumer or to
administer or maintain the product or
service of which the transaction is a part.
A financial institution may also provide
consumer information to nonaffiliated third
parties to enforce its rights or the rights of
other parties to a transaction. Section
216.14(a)
Accordingly, if a consumer
applies to a financial institution for a loan,
the financial institution could supply
information about the consumer and the
transaction to an appraiser, an attorney, a
title company and other nonaffiliated third
parties who are involved in the ordinary
course in the settlement of the loan. If a
financial institution needs to provide
consumer information to a third party to
administer an account of a consumer or to
effect a transaction requested by a
consumer, it may do so. Many financial
institutions provide customer account
balance files to an ATM switch. This is
permissible without notice to the customer
under this exception. If a financial institution
were to provide a vacation package bonus
to consumers who opened deposit accounts
with a certain minimum balance, it could
provide the company providing the package
the names and addresses of the consumers
who earned the bonus. A financial institution
may provide transaction confirmations or
statements to a consumer‘s agent or broker
or other nonaffiliated third party that
reasonably requires the information. A
financial institution may also provide
information about a consumer to a
nonaffiliated third party for the purpose of
underwriting insurance that the consumer
has requested, for the purpose of reinsuring
that insurance, or for any purpose related to
administering an insurance product that the
customer has from the financial institution.
Section 216.14(b)(2)
In our conversations with the
regulators, we have discussed three
examples of customer information
sharing that shed some light on the
scope of this exception. If a customer
of a financial institution is giving a
merchant or some other person a
check drawn on the financial
institution and the merchant calls the
financial institution and asks whether
there are presently funds in the
account to pay the check, the financial
institution may respond to the request.
The reason is that the information
disclosure is in furtherance of a
transaction that the customer has
initiated which the financial institution
is an integral party to. If a customer
uses the financial institution as a
credit reference with a third party and
the third party calls the financial
institution to verify the reference, the
financial institution may not respond
to the request. In this instance, the
financial institution is not a party to the
transaction initiated by the customer.
To respond, the financial institution
would have to have the customer‘s
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consent. Finally, another financial
institution, a title company or an
automobile dealer requests a payoff
figure on a customer‘s loan. The
financial institution may not provide
the information without the customer‘s
consent. Again, as with the credit
reference, the financial institution is
not an integral party to the transaction
which the customer has initiated. As a
result
of
the transaction the
customer‘s loan may be paid, but that
is incidental, not integral to the
transaction.
Privacy of Consumer
Regulation P
Information disclosures to the
financial institution‘s attorneys,
accountants, auditors, agencies
rating the financial institution or
agencies assessing the financial
institution‘s
compliance
with
industry standards.
Information disclosures specifically
permitted or required by law (and in
compliance with the Right to
Financial Privacy Act) to law
enforcement agencies including
government
regulators,
selfregulatory organizations, or for an
investigation on a matter related to
public safety.
provides an additional laundry list of
circumstances in which a financial
institution may disclose consumer
information to nonaffiliated third
parties and nonaffiliated third parties
to whom consumer information may
be disclosed that do not have to be
described in the financial institution‘s
privacy notice and from which the
consumer may not opt out. Section
216.15(a) The list includes:
Information
disclosed
to
a
consumer reporting agency in
accordance with the Fair Credit
Reporting Act or the disclosure of
information reported to the financial
institution by a consumer reporting
agency (but subject in both cases to
the provisions of the Fair Credit
Reporting Act).
Information
disclosed
to
a
nonaffiliated
third
party
in
connection with the proposed or
actual sale, merger, transfer or
exchange of a financial institution or
an operating unit of a financial
institution (provided
that
the
information disclosed relates only to
consumers of the same unit).
Information disclosures made with
the consent of or at the direction of
the consumer, provided that the
consumer has not revoked the
direction or consent.
Information disclosures to protect
the security of the financial
institution or the confidentiality of
its records, or to protect against
actual or potential fraud or
unauthorized
transactions,
to
control risk or to resolve consumer
disputes or inquiries.
Information disclosed to comply
with federal, state or local laws,
rules or other applicable legal
requirements, or to comply with a
properly authorized civil, criminal or
regulatory investigation, subpoena
or summons, or to respond to
judicial process or governmental
regulatory
authorities
having
jurisdiction over the financial
institution
for
examination,
compliance, or other purposes
authorized by law.
Information disclosures to persons
holding a legal or beneficial
interest relating to the consumer or
persons acting in a fiduciary or
representative capacity relative to
the consumer.
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This section also authorizes the disclosure
of consumer information without providing
the privacy and opt out notices if the
consumer has directed or authorized the
disclosure. Section 216.15(a)(1) There is
no requirement in the regulation that the
consumer direction or authorization be in
writing.
It authorizes the disclosure of
consumer information to agents of the
financial institution when the information is
needed for the agents to perform their
services for the financial institution.
Examples are attorneys, accountants and
rating agencies. It authorizes the disclosure
of consumer information to law enforcement
agencies, regulatory agencies and in
response to judicial process.
Privacy of Consumer
Regulation P
disclose the customer information to a
nonaffiliated third party for a Section 14 or
15 purpose. Section 216.11(c)
This section of the regulation poses an
information management problem in the
following respect. Suppose a financial
institution receives information about a
consumer from multiple sources including a
nonaffiliated financial institution. The
consumer has been provided the financial
institution‘s privacy notice and the opt out
notice and has not elected to opt out.
Under the privacy rules, the financial
institution can disclose all of the information
it has received about the consumer to a
nonaffiliated third party other than the
information it received from the nonaffiliated
financial institution. It could disclose that
information only if the other financial
institution could disclose it under similar
circumstances, which is something the
financial institution receiving it would seldom
know. Accordingly, a financial institution
must categorize customer information by
source if it is a category of information that
the financial institution might disclose. The
same problem exists with information that a
financial institution receives from a
consumer credit report. The information on
that report may be shared only with an
affiliate, and then only if the consumer has
not elected to opt out under the Fair Credit
Reporting Act. A financial institution that
discloses information that it received on a
credit report regarding a consumer to a
nonaffiliated third party may be deemed a
credit reporting agency.
Limits on Redisclosure and
Reuse of Information
The general rule is, if a financial institution
receives information about a consumer from
a nonaffiliated financial institution, it may not
disclose that information to another person
which is not affiliated with either the
financial institution or the financial institution
from which the institution received the
information unless the disclosure would be
lawful if the financial institution which
provided the information made it directly to
such other person. Section 216.11(b) The
exception to the rule is that the financial
institution may disclose the consumer
information that it received from the
nonaffiliated financial institution to a
nonaffiliated third party for the purpose of a
Section 14 or 15 exception, but for that
purpose only. Section 216.11(a) Likewise, if
a financial institution provides customer
information to a nonaffiliated third party, that
party may not disclose the information to
any person nonaffiliated with it unless the
disclosure would be lawful if the disclosure
were made by the financial institution
directly to the other nonaffiliated person.
Section 216.11(d) Again, the exception
applies, that the person receiving the
information from the financial institution may
Sharing Account Number
Information
The regulation contains a prohibition of
disclosing a customer‘s account number, or
other access code for a credit card account,
deposit account or transaction account to a
nonaffiliated third party for use in
telemarketing, direct mail marketing or
electronic marketing to the customer. There
are two limited exceptions, but the better
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policy is never to disclose a customer‘s
account number or access code to an
account for any purpose, other than as
required to service the account.
Privacy of Consumer
Regulation P
institution must comply with the portions of
both the state and the federal regulations
that provide the greatest consumer
protection. Legislation exists in several
states providing greater protection than the
federal regulation provides. An institution
should check with its legal counsel on
privacy laws that may exist at the state
level.
Relation to State Laws
The regulation does not supersede any
state law or regulation unless the state law
or regulation is ―inconsistent‖ with the
regulation. Section 216.17(a) A state law or
regulation is not inconsistent with the
regulation if it affords greater consumer
information protection than the regulation.
Section 216.17(b) Accordingly, if a state
has privacy laws or regulations, a financial
The rules and opt out requirements for
sharing information with affiliates are
described in the Fair Credit Reporting
Act chapter of this manual.
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Prohibition Against Payment
of Interest on Demand Deposits
Regulation Q
Adequate supporting documentation should
be kept listing all costs of any premium. Do
not try to circumvent the regulation by
dividing funds into another deposit account
for the purpose of giving more than two
premiums in a 12-month period.
Prohibition Against
Payment of Interest on
Demand Deposits
Common name: Regulation Q
Reference: {REPEALED
Effective 7/21/2011}
A bank may waive fees for ordinary banking
services with respect to a deposit, and such
a waiver will not be considered as payment
of interest. § 217.2(d). Such fees would
include check printing, safe-deposit box
charges, demand deposit service charges,
night deposit service charges, traveler‘s
checks, and similar charges. Regardless of
the above limitations, a premium that is not
directly or indirectly related to the balance in
the demand deposit or the length of time the
account is maintained is not considered
payment of interest on that demand deposit
account and will not be subject to the above
limitations. §217.101(b). This is an
interpretation made by the Federal Reserve
in May 1997.
Regulation Q prohibits the payment of
interest on demand deposit accounts, either
directly or indirectly. §217.3. A demand
deposit, normally a noninterest-bearing
checking account, is a deposit having a
maturity of less than seven days or a
deposit for which the bank does not
reserve the right to require written notice
from its customer at least seven days prior
to making a withdrawal from the account.
§217.2(a). If the bank has such a
requirement on a deposit, the deposit is
classified as a savings or time deposit under
Regulation D.
For example, a bank would be permitted to
offer a premium such as a $50 toaster for
opening a demand deposit account, as long
as there is no minimum deposit required
and there is no minimum length of time
required to maintain the deposit. However, if
there was, for example, a minimum $100
deposit required or the deposit had to
remain in the account for at least 30 days,
the $50 toaster would be considered
interest and not permitted under Regulation
Q. Another example of a permitted premium
would be a bonus for using an ATM or debit
card tied to a checking account more than a
certain number of times a month. In this
case, the use of the ATM or debit card is not
tied to a minimum deposit or duration
requirement. Such a premium is not
dependent on the opening of the account or
an addition to the account, and is, therefore,
not interest under Regulation Q.
Interest is defined as either a monetary
payment to the depositor‘s account for
maintaining a deposit with the bank, or as
the giving of premiums such as
merchandise, credit, or cash to the
depositor in connection with the account.
§217.2(d). However, certain premiums are
not considered interest under Regulation Q
if they meet all of the following guidelines.
The premium is given to the depositor
only when the account is opened or at
the time of an additional deposit to an
existing account.
No more than two premiums are given
per account in a 12-month period.
The value of the premium(s) including
taxes,
shipping,
warehousing,
packaging, and handling costs does
not exceed $10 for deposits of less
than $5,000 or does not exceed $20
for deposits of $5,000 or more.
§217.101(a).
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Exceptions for Banks
from the Definition of Broker
Regulation R
government wanted to insure that the
behaviors it believed caused the Great
Depression weren‘t going to happen again.
The Securities Exchange Act was one result
of this goal, as was the Glass-Steagall Act
of 1933, which put up most of the barriers
for regulated financial institutions from
selling securities and other non-deposit
investment products. These laws were
designed to control what regulated financial
institutions did when it came to certain lines
of business. The part of the Securities
Exchange Act that is important for our
purposes as banking professionals is the
part that states when a person or entity sells
a non-deposit investment product, that
person or entity must have a license to do
so in order to obtain a fee. This is known as
the broker rule of the Securities Exchange
Act. It can be found in Section 3(a)(4) of the
Securities Exchange Act.
from the Definition of
Broker
Common name: Regulation R
As if we did not have enough things to worry
about, in 2007 the regulators added a new
regulation to the soup mix, Regulation R.
Regulation R defines what is permissible
and how certain sales of non-deposit
investment products, specifically securities,
must be conducted by those financial
institutions that offer securities without a
license.
This entire regulation boils down to whether
a financial institution engages in unlicensed
securities sales when it offers securities to
its customers. Regulation R contains
guidelines that permit a financial institution
to sell securities without a license, but only
in certain enumerated circumstances that
we will discuss in this chapter. If your
financial institution does not have any
securities activities through a trust
department, through a third party or through
a
licensed
broker/dealer
employee,
Regulation R does not apply to you. But
realize that eventually your financial
institution will offer securities to your
customers, and when it does you had better
know Regulation R.
Since the Depression, regulated financial
institutions have been ineligible to engage in
the sale of securities because of these laws.
Over time, that slowly began to change.
Until 1999, the only real guidance for
financial institutions on the ―how to‘s‖ of
non-deposit investment products was joint
agency guidance issued in 1994. The
guidance
covered
all
non-deposit
investment products.
Then Congress
enacted the Gramm-Leach-Bliley Act in
1999. That Act created firm guidelines for
how financial institutions sold and disclosed
the sale of non-deposit investment products
to consumers. The GLBA eliminated most
of the restrictions placed on financial
institutions by the Glass-Steagall Act and
opened the doors for the pursuit of
revenues from non-deposit investment
activity. The GLBA also amended some of
the provisions of the Securities Exchange
Act under the broker rules, which alleviated
some of the restrictions on financial
institutions acting in a securities sales
capacity.
A Brief History
In order to understand Regulation R, you
must first understand its roots. Regulation
R is in a sense the great-grandchild of the
Securities Exchange Act of 1934. When the
Securities Exchange Act was enacted in
1934, the country was in the process of
recovering from the Great Depression.
There are numerous banking laws and
regulations today that were born during this
tumultuous period in our history, typically as
anti-competitive measures.
The federal
Even though the GLBA was enacted in
1999, it took until 2006 for the ball to start
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rolling on regulations. When Congress
enacted the Financial Services Regulatory
Relief Act of 2006, there was a mandate for
regulations to be issued. The Securities
and Exchange Commission and the Federal
Reserve were charged with developing
these regulations. Today, as a result of that
mandate, we have Regulation R and the
accompanying broker rule exceptions.
Regulation R
collateral-trust certificate, pre-organization
certificate or subscription, transferable
share, investment contract, voting-trust
certificate, certificate of deposit for a
security, any put, call, straddle, option, or
privilege on any security, certificate of
deposit, or group or index of securities
(including any interest therein or based on
the value thereof), or any put, call, straddle,
option, or privilege entered into on a
national securities exchange relating to
foreign currency, or in general, any
instrument commonly known as a
―security‖'; or any certificate of interest or
participation in, temporary or interim
certificate for, receipt for, or warrant or right
to subscribe to or purchase, any of the
foregoing; but does not include currency or
any note, draft, bill of exchange, or banker's
acceptance which has a maturity at the time
of issuance of not exceeding nine months,
exclusive of days of grace, or any renewal
thereof the maturity of which is likewise
limited.
In addition to the broker rule exceptions, the
GLBA requires a financial institution to
make certain disclosures when selling nondeposit investment products to consumers
(those are the ―not a bank product, not
guaranteed by the bank or any government
agency, may go down in value, not insured
by the bank‖ disclosures) and requires
certain other actions in order to maintain
compliance with the clear separation of
insured vs. non-insured products. These
disclosures are discussed separately in the
Non-Deposit Investment Products and
Advertising articles in this manual.
Regulation R regulates certain exceptions to
the broker rules as defined by Section
3(a)(4) of the Securities Exchange Act of
1934. The types of items that we are
referring to are items such as stocks and
other registered securities that are listed on
the American and New York, Stock
exchanges, or otherwise are publicly traded.
Keep in mind that this article is not designed
to serve as everything you need to know in
securities if you are a regulated financial
institution. You should contact competent
legal counsel with experience in securities
dealings to determine whether you are
covered.
The definition also includes equity
securities, which are any stock or similar
security; or any security future on any such
security; or any security convertible, with or
without consideration, into such a security,
or carrying any warrant or right to subscribe
to or purchase such a security; or any such
warrant or right; or any other security which
the Commission shall deem to be of similar
nature and consider necessary or
appropriate, by such rules and regulations
as it may prescribe in the public interest or
for the protection of investors, to treat as an
equity security. The definitions alone are
enough to make you seek competent
counsel!
What is a security? Regulation R contains
certain exceptions for the unlicensed sales
of securities. A security, defined by 15 USC
78c(a)(10), is any note, stock, treasury
stock, security future, bond, debenture,
certificate of interest or participation in any
profit-sharing agreement or in any oil, gas,
or other mineral royalty or lease, any
There are some securities that are still
securities but are considered exempt from
certain provisions of the Securities
Exchange Act, therefore, are not subject to
the broker exceptions in Regulation R.
Those are 1) government securities; 2)
municipal securities; 3) any common trust
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fund not defined as an investment company;
4) any single trust fund, or a collective trust
fund maintained by a bank; 5) any security
issued by an insurance company, issued in
connection with a qualified plan; 6) any
security issued by any pooled income fund,
collective trust fund, collective investment
fund excluded from the definition of an
investment company; 7) any security issued
by any church plan; 8) a company, or
account excluded from the definition of an
investment company; 9) and such other
securities (which may include, among
others, unregistered securities.)
Regulation R
The Broker Exceptions
12 CFR
§218
The FDIC issued a copy of the Federal
Register citation in FIL-92-2007.
The broker exceptions include: The
networking exception – for third-party
arrangements by the financial institution to
sell NDIPs; Trust and fiduciary activities;
Certain stock purchase plans - transfer
agent activities; certain sweep accounts;
private security offerings; Safekeeping and
custody activities; select identified banking
products; foreign transactions; and de
minimis transactions. We will discuss each
one separately.
The unlicensed sales of securities.
Some
financial
institutions
have
departments wherein securities are sold or
managed. In order to bring securities and
other non-deposit investment activities
within the realm of permissible banking
activities, the Gramm Leach Bliley Act
codified several exceptions to the broker
rule of the Securities Exchange Act, known
as the ―the broker exceptions.‖
The Networking Exception
12
CFR §218.700.
This exception permits a financial institution
to avoid being considered a broker if the
financial
institution
has
a
written
arrangement with a registered broker under
which the broker offers brokerage services
to an institution‘s customers. To fall under
this exception, a financial institution usually
has a contractual arrangement with an
unaffiliated third party or an affiliated one.
For non-affiliated third-party arrangements,
you may or may not have your employees
serving as licensed order takers for a
brokerage house. For affiliated third-parties,
they may be wholly owned subsidiaries of
the institution or sister companies. Whether
using an affiliated or unaffiliated third party,
there must be a written agreement in place
in order to use this exception.
―Broker‖ is also defined by the Securities
Exchange Act in 15 USC §78c(a)(4). A
broker is someone who engages in the
business of effecting transactions in
securities for the accounts of others and
receives a fee for those transactions. The
Securities Exchange Act says you must be
licensed to sell securities and to receive a
fee from those sales.
Regulation R
provides certain exceptions that permit a
financial institution to sell securities, receive
a fee but yet not have a license to do so. In
other words, these exceptions permit a
financial institution to take orders, sell and
manage securities without the need to
obtain a broker‘s license provided the
financial institution is acting in a certain
capacity. Regulation R tells us what those
certain capacities are so that regulated
financial institutions don‘t violate the
Securities Exchange Act.
Referral fees. The main part of the
networking exception rule which will affect
most institutions for any of the broker
exceptions is the rule on the restrictions of
payment of referral fees. Most institutions
are already familiar with this particular rule –
it says that the payment of a referral fee to
unlicensed personnel is prohibited unless it
is a one-time, nominal, fixed sum that is not
contingent upon the sale of any investment
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product. The new final rule actually explains
what that means and gives financial
institutions some options as to how to pay
non-broker employees for referrals!
Regulation R
salary. But the factor must be the same for
everyone in the job family.
Option three uses twice the employee‘s
actual base hourly wage or 1/1000th of the
employee‘s actual annual base salary –
that‘s an easy calculation and will be
calculated on a per employee basis. The
fourth and final option is a payment not to
exceed $25, a flat fee, which is indexed for
inflation every five years. The first time it
will adjust will be April 2012. Until then, it‘s a
maximum of $25. Please note that the rule
is silent on how to tax the employee
receiving the fee – so whether you gross up
or down, it doesn‘t matter – choose one way
and be consistent.
Regulation R provides four options for
compensating non-broker employees for
referral activity. A financial institution must
use one of the following four standards, or a
combination thereof: 1) Twice the average
minimum and maximum hourly wage set for
the current or prior year for the job family; 2)
1/1000th of the average of the minimum and
maximum annual base salary established
for the current or prior year for the job
family; 3) Twice the employee‘s base hourly
wage or 1/1000th of the employee‘s actual
annual base salary; or 4) a flat fee of up to
$25, indexed for inflation every five years.
When the referral fee part of GLBA was
originally drafted, it appeared that ―tellers‖
were the only ones who could receive such
a nominal one-time fixed fee.
The rule,
however, was not intended to limit
payments or referral activities to just tellers.
The rule was originally written that way
because it was suspected that tellers would
be doing most of the referring. However,
the new version of the rule includes any and
all non-licensed employees who could make
a referral – CSRs, branch managers, office
runners - anyone unlicensed counts.
The first two options talk about calculating
the amount of the fee based on average
salaries in a job family.
Section
§218.700(c)(1)(i). A ―job family‖ is defined
as any grouping of jobs that include duties
or positions involving similar responsibilities
and requiring similar skills, education or
training that a financial institution has
established and uses in the ordinary course
of business to distinguish its employees for
the purposes of hiring, promotion and
compensation.
Hopefully, your HR
department will have job descriptions!
That‘s what you would use to group certain
employees under a job family. There is no
perfect formula for what a job family is but
you ought to be okay so long as you can
justify the job family. You could lump your
tellers, CSRs and safe deposit department
together assuming those departments meet
the standards for that job family.
The referral fee rule also permits some
flexibility as to how a financial institution
chooses to allocate the fee provided it is in
one of the four ways just discussed. What
that means is that an institution can choose
to use all four methods, or one, two or three
of the methods, across its different business
lines. For example, for tellers, an institution
could use the $25 flat fee, but for loan
officers, an institution could use the
standard for 1/1000th of the annual base
salary. An institution is also permitted under
the rules to pay fees to more than one
employee for the same referral activity, but
only if all employees ―personally participate‖
in the referral is some meaningful way. For
example, a teller refers a customer to a loan
If you use one of the first two methods for
compensating non-licensed personnel, you
will have to do some math. Option one says
pay twice the average minimum and
maximum hourly wage for the job family and
option two says use 1/1000th of the average
of the minimum and maximum annual base
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officer because the customer wanted some
information about mortgage loans. Once
the customer gets to the loan officer, they
may indicate the need for more information
about loans and securities and the loan
officer sends them to the securities
department. Under the rule, it would not be
acceptable to give both the teller and the
loan officer a referral fee, because the teller
did not personally participate in the referral
of the security. It would likewise not be
allowable under the same scenario to pay
the branch manager since the branch
manager also was not involved in any part
of the referral. Whatever a financial
institution chooses to do, it should
document the methods it will use in its
procedures to avoid criticism from
examiners.
Regulation R
whether a purchase or sale of a security
occurs; 2) whether there is an account
opening with the broker/dealer; 3) a
transaction involving a particular type of
security; or 4) multiple security transactions.
So a financial institution, when determining
whether to pay a referral fee to a non-broker
employee, cannot set the payment of the
referral fee contingent upon these types of
transactions.
A financial institution,
however, can restrict the payment of a
referral fee to a non-broker employee in two
situations. First, the payment of a referral
fee to a non-broker employee can be limited
to situations when the referred person
keeps an appointment or otherwise makes
contact with the broker; or second, the
customer meets an objective, base-line
qualification (including citizenship or
residency requirements) for different
classes of customer or for different business
lines of divisions of the bank or the brokerdealer. Keep in mind that the rule prohibits
―incentive compensation‖ – in other words,
you can‘t base the referral fee (or any other
compensation) to non-broker employees on
the number of referrals, the quality of
referrals, the frequency of referrals, etc.
They mean it when they say, a one-time
fixed fee not contingent upon a sale or
transaction. However, the rule does not
prohibit a financial institution as an
employer from compensating a valued
employee on other criteria so long as
referrals to brokers have absolutely nothing
to do with the criteria. While securities sales
may enhance the financial institution‘s
overall profitability, the overall growth and
the portion by which the securities sales
have enhanced that growth are irrelevant
and not factors to be considered when
providing raises to your employees or other
bonus compensation.
The next part of the rule says the fee can
only be a one-time fee for each referral.
That doesn‘t mean that if Sam Teller refers
Joe Customer to the securities desk he can
only get one fee for the referral for Joe
Customer. An employee can receive a
referral fee for each referral made to a
broker-dealer, including separate referrals
of the same individual or entity. What
cannot happen is that Sam Teller cannot get
multiple fees for the same referral. But fees
for different referrals from the same
customer are allowable. Furthermore, Sam
Teller can receive additional referral fees for
referring Joe Customer to different
departments within the institution itself,
including the trust, fiduciary, or custodial
department.
The very last part of this rule says that the
payment of the fee cannot be contingent
upon whether the referral results in a
transaction.
The regulators were kind
enough to define that by setting forth those
activities that were considered ―contingent
upon a transaction‖ for purposes of paying a
referral fee, and those that weren‘t. The
types of activities considered to be
―contingent upon a transaction‖ include: 1)
The regulations also clarify that the payment
of the fee must be in cash. Non-cash items
(vacations, consumer goods, stocks, paid
time off) are expressly prohibited. Any
payment must be cash.
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Even though the referral fee rule is
contained within the networking exception,
the restrictions on payments of a fee to nonlicensed personnel apply across the board
to all of the broker-dealer exceptions in
Regulation R. So make sure that is clear in
training sessions and your policy and
procedures.
Regulation R
referral fees, providing disclosures to the
referred customer about the compensation
for the referral, and a requirement that the
broker-dealer perform a suitability analysis.
In order to use this exception to the referral
compensation rule found in §218.700
discussed earlier, you must follow the above
criteria.
Be advised that there is no
requirement that you use the exceptions for
high net worth and institutional customers
and compensate employees differently. A
financial institution can simply use the same
compensation rules found in §218.700
across the board for all employees if it so
chooses.
Exception for High Net Worth
and Institutional Customers
This exception to the rule falls within
§218.701. There are two subparts to this
section that allow for different compensation
structures to a non-licensed employee – the
first is the referral of an ―Institutional
Customer‖; the second, is the referral of a
―High Net Worth Customer.‖ Let‘s define
what an institutional customer is first.
If your institution decides to use the
§218.701 exceptions for institutional and
high net worth customers, be sure that your
policies and procedures meet the regulatory
requirements. The methods for calculating
the referral fees for non-licensed personnel
under that section are complex. The fee
structure for such referrals permits the
referral fee to be based on a fixed
percentage of the revenues received by the
broker dealer for investment banking
services provided to the customer. To
confuse matters more, there is an
alternative method for determining referral
fee compensation under §218.701. The
referral fee can be a predetermined dollar
amount (or determined on a pre-set
formula) so long as the dollar amount does
not vary based on 1) the revenue generated
by, or the profitability of securities
transactions conducted by, the customer
with the broker dealer; or 2) the quantity,
price, or identity of the securities purchased
or sold over time with the broker dealer; or
3) the number of customer referrals made.
―Predetermined‖ means BEFORE the
referral is made. The prohibition against a
variance based on the number of referrals
does not prohibit an employee from
receiving a fee for each customer referred.
What it would prohibit is a scaled structure
where the fee increased for each referral.
An institutional customer is defined as any
non-natural person such as a corporation,
partnership, limited liability company, trust,
limited liability partnership and any other
non-natural person (that means they are not
living, breathing and are incapable of
bleeding), with assets of at least $10 million
in investments; $20 million in revenues; or
$15 million in revenues if referred by a nonbroker employee.
A high net worth customer is defined as a
natural person who either individually or
with their spouse combined has a net worth
of at least $5 million, excluding the primary
residence and associated liabilities of the
person (and the spouse if combined).
If one of these types of customers is
referred by non-licensed personnel, you can
compensate the non-licensed personnel
under a different structure than what we
previously discussed. Before you do so
however, you need to create policies and
procedures that address these issues, such
as the thresholds for institutional and high
net worth customers, limiting the types of
employees that could qualify for such
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Regulation R
calculation is similar to the relationship-total
compensation percentage just discussed
above. A financial institution would divide
the relationship compensation attributable to
the trust and fiduciary business as a whole
during each of the immediately preceding
two years by the total compensation
attributable to the trust and fiduciary
business as a whole during the relevant
year; then translate the quotient obtained for
each of the two years into a percentage;
and then average the percentages obtained
for each of the two immediately preceding
years. No matter which of these two
compensation calculations is used to
determine
whether
it
is
chiefly
compensated, a financial institution must
also adhere strictly to the other conditions in
the trust and fiduciary exception and with
Section 3(a)(4)(C) of the Securities
Exchange Act which relates to trade
execution.
The Trust and Fiduciary
Exception 12 CFR §218.721.
This exception is exactly what it says it is –
this permits a financial institution to effect
transactions in securities for customers
without being registered as a broker
provided that these transactions are
effected in the financial institution‘s trust
department and that trust department is
regularly examined for compliance with
fiduciary principles and standards. The
financial institution must also be ―chiefly
compensated‖ for those activities in that
department on the basis of 1) an
administration or annual fee; 2) a
percentage
of
the
assets
under
management; 3) a flat, capped, per-order
processing fee that does not exceed the
cost incurred by the bank in executing such
securities
transactions;
or
4)
any
combination of such fees.
See
§218.721(a)(4). To determine whether the
institution is chiefly compensated for its trust
activities, there are two tests that can be
used. The first test uses the relationshiptotal compensation percentage for each
trust or fiduciary account, which must be at
least 50 percent. Warning – there is a
mathematical formula for calculating this
figure- divide the relationship compensation
attributable to the account during each of
the immediately preceding two years by the
total compensation attributable to the
account during the relevant year; then
translate the quotient obtained for each of
the two years into a percentage; and then
average the percentages obtained for each
of the two immediately preceding years.
§218.721(a)(1)
This exception also contains an advertising
restriction so make sure your marketing
department is aware of this. A financial
institution cannot advertise or otherwise
publicly solicit brokerage business, other
than by advertising the trust department and
the types of transactions the trust
department can undertake. The fact that
there is a securities sales function cannot
be more prominent that the rest of the trust
department advertisement.
Exceptions within the trust and fiduciary
exception. There are some miscellaneous
exceptions to §218.721 in which you don‘t
have to calculate whether the bank is chiefly
compensated for trust and fiduciary
activities. These exceptions to the trust and
fiduciary rule are listed in §218.723. These
include exceptions for Special Accounts,
Foreign Branches, Transferred Accounts
and a de minimis number of accounts.
Special accounts are deemed to be those
accounts opened less than 3 months during
a relevant year. Accounts held at foreign
branches of a U.S. bank are excluded
For the second test a bank can use in
determining
whether
it
is
chiefly
compensated, turn to §218.722. This test is
a bank-wide approach and consists of
calculating the ―aggregate relationship total compensation percentage‖ which must
be at least 70 percent. §218.722(a)(2). The
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because those accounts are not likely to be
held by a U.S. person and the laws of the
United States don‘t protect foreign persons
generally. Transferred accounts are those
acquired through merger, consolidation,
acquisition or similar transaction by the
institution for 12 months after the institution
acquired them. And ―de minimis number‖
refers to the lesser of 1 percent of the total
number of trust or fiduciary accounts held
by the institution or 500 accounts.
Regulation R
registered under the Investment Company
Act.
Safekeeping and Custody
Exception 12 CFR §218.760
Under this exception,, a financial institution
is exempt from the broker rules for custodial
and safekeeping activities such as 1)
providing safekeeping or custody services
for securities, including the exercise of
warrants on the customer‘s behalf; 2)
facilitating the transfer of funds or securities
as a custodian or clearing agency in
connection with the clearance and
settlement of its customer‘s transactions in
securities; 3) effecting securities lending or
borrowing transactions with or on behalf of
customers as part of the above-described
custodial services, or investing cash
collateral pledged in connection with such
transactions; 4) holding securities pledged
by a customer to another person or
securities subject to purchase or resale
agreements involving a customer, or
facilitating the pledging or transfer of such
securities by book entry or as otherwise
provided under applicable law, if the bank
maintains separate records identifying the
securities and customer; and 5) serving as a
custodian or provider of other related
administrative services to any individual
retirement account, pension, retirement,
profit sharing, bonus, savings, incentive or
other similar benefit plan.
Sweep Account and
Transactions into Money
Market Funds 12 CFR §218.740
We typically don‘t consider ―money market
funds‖ as bank products.
But for our
purposes, a money market fund under this
exception means an open-end investment
company registered under the Investment
Company Act of 1940 regulated as a money
market fund pursuant to 17 CFR Section
270.2a-7. ―No-load‖ means that 1) the class
or series is not subject to a sales charge or
a deferred sales charge; and 2) total
charges against net assets of the class or
series of securities for sales or sales
promotion, expenses, personal service, or
the maintenance of shareholder accounts,
do not exceed one-quarter of one percent of
the average net assets annually.
The
financial institution must also provide the
customer directly or indirectly some other
product or service that could be an escrow,
trust, fiduciary or custody account or a
deposit product or extension of credit.
There are some other restrictions that are
designed to protect customers seeking
these products, however, they deal with the
specific transaction, and not compliance
under Regulation R so we will not discuss
them here.
This rule deals with order-taking for
employee benefit plan accounts and
individual retirement or similar accounts.
This includes employer-sponsored plans
like 401(k)s and plans under Section 457,
403(b), 414(d) (e) or (f) of the Internal
Revenue Code, any non-qualified deferred
compensation plan (secular or rabbi trust)
and some others. It also includes HSAs,
Roth IRAs, Coverdell education savings
accounts and Archer medical savings
account. This section contains employee
compensation
restrictions
based
on
So what this exception deals with are banks
that effect transactions as part of a program
for the investment or re-investment of
deposit funds into any no-load, open-end
management
investment
company
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referrals based on a percentage of the 12b1 ―marketing‖ fees received by a financial
institution for
a custody account‘s
investment or a portion of the fee received
when a securities transaction is executed
for the account. A non-licensed employee
is permitted to receive compensation under
this exception as defined within §218.700 –
the nominal, one-time, fixed fee not
contingent upon a transaction. Remember,
the compensation rules of §218.700 apply
to all non-broker employees regardless of
which exception a bank relies on to effect
securities transactions.
Regulation R
Company Act; 3) any bank, savings
association broker, dealer, insurance
company
or
business
development
company; 4) any small business investment
company licensed by Small Business
Administration; 5) any state-sponsored
employee benefit plan, or any other
employee benefit plan, within the meaning
of the Employee Retirement Income
Security Act of 1974; 6) any trust whose
purchases of securities are directed by a
person; 7) any market intermediary exempt
from the Investment Company Act; 8) any
associated person of a broker or dealer
other than a natural person; 9) any foreign
bank; 10) the government of any foreign
country; 11) any corporation, company, or
partnership that owns and invests on a
discretionary
basis,
not
less
than
$25,000,000 in investments; 12) any natural
person who owns and invests on a
discretionary
basis,
not
less
than
$25,000,000 in investments; 13) any
government or political subdivision, agency,
or instrumentality of a government who
owns and invests on a discretionary basis
not less than $50,000,000 in investments; or
14) any multinational or supranational entity
or any agency or instrumentality thereof. A
qualified investor falls under this exception
whereas the purpose of having an
institutional or high net worth customer
classification is very different.
Miscellaneous Exceptions –
Sections 218.771 through
218.776.
The remaining sections in Regulation R deal
with very specific exceptions, many of which
will not typically apply to most financial
institutions. §218.771 exempts U.S. banks
from
securities
transactions
under
Securities
Exchange
Commission
Regulation S (not the same as the Federal
Reserve Regulation S) when dealing with
non-U.S. persons outside the United States.
The reasoning behind it is that there is no
reason to protect non-U.S. persons.
§218.772 securities lending transactions
apply when a bank lends to or on behalf of
an individual or entity that the bank believes
is either a qualified investor as defined
under Section 3(a)(54)(A) of the Securities
Exchange Act or an employee benefit plan
that owns and invests on a discretionary
basis, not less than $25 million in
investments. Keep in mind that the qualified
investor referred to in this section is not the
same as the institutional or high net worth
customer referred to in §218.700.
As
defined by the Securities Exchange Act, a
Qualified investor is 1) any investment
company registered under the Investment
Company Act; 2) any issuer eligible for an
exclusion from the definition of investment
company pursuant to the Investment
§218.775 provides an exemption from the
broker
rules
in
certain
exempted
transactions in Investment Company
Securities such as mutual funds, and
variable insurance products such as
variable annuity contracts and variable life
insurance policies.
This exception
specifically includes open-end investment
company offerings such as mutual funds.
An open-ended investment company is
defined under Section 5(a)(1) of the
Investment Company Act as a management
company which is offering for sale or has
outstanding any redeemable security of
which it is the issuer.
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Effective
Date
12
Regulation R
won‘t have to comply until September 1,
2009. On the other hand, if your fiscal year
starts October 1, your institution will need to
comply October 1, 2008.
§218.776 provides an exemption for certain
transactions in a company‘s securities for
that company‘s employee benefit plans and
participants. Basically, any institution that
acts as a custodian of an employee benefit
plan for a company and works with that
company‘s stock through a transfer agent is
exempt from the broker rules under this
exemption.
The
Limited Liability 12 CFR §218.780
There is a limited liability provision for any
transaction where the financial institution
entered into a contract prior to March 31,
2009, and acted as a broker in good faith,
without complying with the exceptions in
Regulation R.
CFR
§218.781
A bank must comply with Regulation R by
the start date of its fiscal year starting after
September 30, 2008. That means if your
fiscal year starts September 1, 2008, you
Since this topic requires significant legal
advice, obtain competent legal counsel for
all non-deposit investment activity.
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Reimbursement for
Providing Financial Records
Regulation S
Financial Record. Any original or copy of,
or information derived from, any record held
by a financial institution pertaining to a
customer‘s relationship with the financial
institution.
Reimbursement for
Providing Financial
Records
Common name: Regulation S
(Subpart A)
Government Authority. Any agency or
department of the United States, or any
officer, employee, or agent thereof. (This
regulation does not cover state or local
governments or agencies.)
Scope
Reimbursable Costs
Regulation S, subpart A, describes the
conditions under which a financial institution
may receive reimbursement for gathering
and providing financial records pursuant to
the Right to Financial Privacy Act (RFPA).
12 U.S.C. 3415
Subject to the exceptions outlined below,
when seeking access to customer financial
records, a government authority, or a court
issuing an order or subpoena in connection
with grand jury proceedings, shall pay for
the reasonably necessary costs directly
incurred in ―searching for, reproducing or
transporting books, papers, records, or
other data.‖ If you have records stored at an
independent storage facility and that facility
charges a fee to search for, reproduce, or
transport the requested records, this fee
may be included in the reimbursement.
As you might imagine, rates and procedures
are also established. However, as a
regulation where the government pays, it
should be greeted positively, despite its
exceptions.
Definitions
Person. An individual or partnership of five
or less individuals.
Reimbursement of search and processing
costs should cover the total time your
employees spend in locating, retrieving,
reproducing, and preparing financial records
for shipment. It does not include time for
analysis of the material or costs of legal
advice connected with the request. If you
itemize separately, search and processing
costs may include the actual cost of
extracting information stored by computer in
the format in which it is normally produced,
based on computer time and necessary
supplies. Employee time for the computer
search will be paid only at the hourly rates
established for clerical/technical and
manager/supervisory personnel in the
reimbursement schedule (set forth below).
Customer. Any person (as defined above)
or a representative of that person who uses
any service of a financial institution, or for
whom a financial institution acts or has
acted as a fiduciary in relation to an account
maintained in the person‘s name. A
customer does not include a partnership of
more than five persons or a corporation.
Financial Institution. Any office of a bank,
savings bank, credit card issuer, industrial
loan company, trust company, savings
association,
building
and
loan,
or
homestead
association
(including
cooperative banks), credit union or
consumer finance institution located in any
state or territory, the District of Columbia,
Puerto Rico, Guam, American Samoa, or
the Virgin Islands.
Copies of photographs, films, computer
tapes, and items not specifically described
in the reimbursement schedule (set forth
below) are reimbursed at actual cost. (Save
your receipts, if any.) You may also be
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reimbursed
for
transportation
costs
reasonably
necessary
to
transport
employees to locate and retrieve the
requested information and to take that
information to the examination place.
(Again, save your receipts and records of
such activity.)
Reimbursement for
Regulation S
earlier. (This exception does not apply
to partnerships of more than five
individuals and corporations.)
Records sought by the General
Accounting Office when it is
investigating a government authority.
Records sought by the Federal
Housing Financing Board or federal
home loan banks in their efforts to
extend credit.
Exceptions
That‘s the good news, but there are
exceptions. The costs for assembling or
providing information or records related to
the following are not reimbursable:
Disclosure of the name and address
of any customer to the Department of
Veterans Affairs when the information
is
used
to
administer
that
department‘s benefit programs.
Records provided as an incident to
perfecting a security interest, proving
a bankruptcy claim, or collecting a
debt you are owed either to you
directly or as a fiduciary.
Most exceptions are not significant, but
obviously, the corporate and IRS exceptions
put a big dent in the recovering of costs
under the regulation.
Records necessary to permit a
government agency to carry out its
responsibilities under a government
loan, loan guaranty, or loan insurance
program.
Reimbursement Conditions
Payment will be made only for direct and
reasonably necessary costs that are
incurred in the reimbursable areas. The
agency will separately consider all costs
and you must completely comply with the
request before any costs may be paid. If the
request for information is withdrawn or
revoked in any way, you may be reimbursed
up to the time you are notified of such
cancellation. Search and processing time
should be billed in 15-minute increments
and specific itemization and detail must be
given. Carefully document all charges and
save receipts when available.
Records not identifiable to a particular
customer.
Records disclosed to a financial
supervisory agency in the normal
course of the agency‘s functions.
Records disclosed in accordance with
Internal Revenue Code procedures.
Records required by federal statutes
or rules.
Records sought under Federal Rules
of Civil or Criminal procedure or
comparable rules of other courts
where the government and customer
are parties.
The court or agency that is demanding the
records is required to notify you of the
necessity to submit a bill or itemized invoice
and provide you with an address to submit
your bill. It must also notify you when its
records request is withdrawn or when a
proceeding is terminated. However, you
must submit a bill that is itemized and
specifically details all of the costs involved.
Records sought by a government
authority in connection with an
administrative subpoena from an
administrative law judge when the
government and customer are parties.
Records when the financial institution
is itself being investigated or the
person is not a customer, as defined
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Reimbursement for
Regulation S
Reimbursement Schedule
Reproduction:
Photocopy, per page
Paper Copies of microfiche, per frame
Duplicate microfiche, per microfiche
Storage media
$
.25
$
.25
$
.50
Actual cost
Search and Processing:
Clerical/Technical, hourly rate
Computer Support Specialist, hourly rate
Manager/Supervisory, hourly rate
$22.00
$30.00
$30.00
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Lending on Securities
Regulation U
a security that is currently a margin stock.
Any carrying credit is a purpose credit.
Current Market Value. If quotations are
available, a security‘s current market value
is the preceding business day‘s closing
sales price. If there is no closing sales price
a bank may use any reasonable estimate of
market value (typically the median of the
prior day‘s closing bid and asked price). If
the credit is used to finance the purchase of
a security, the purchase price (plus
commissions) may be used.
Common name: Regulation U
Introduction
Regulation U is one of the few Federal
Reserve Board regulations whose purpose
is neither the protection of the safety and
soundness of banks nor the protection of a
bank‘s customers. Its purpose is to limit the
amount of credit available to the securities
market and thereby reduce the increased
market volatility which it causes. Regulation
U was promulgated pursuant to the
Securities Exchange Act of 1934; it limits
the amount a bank may lend upon the
collateral of equity securities where the
purpose of the loan is to acquire or carry the
securities.
Maximum Loan Value. A percentage
assigned by the Federal Reserve Board of
current market value of a security. At
present the percentage is 50%.
General Requirements §221.3
No bank or any affiliate of a bank (including
a bank holding company or a bank
subsidiary) may extend any purpose credit,
secured directly or indirectly by margin
stock, in an amount that exceeds the
maximum loan value of the collateral
securing the credit. If a bank is extending a
new credit, the credit will be secured by
margin stock and the purpose of the credit
is either to purchase the margin stock or to
refinance a loan that was originally made to
purchase the margin stock, the loan may
not exceed 50% of the stock‘s current value.
§221.7(a) To fall under the restrictions of
Regulation U a loan must pass the following
tests:
Definitions §221.2
Margin stock. A margin stock is:
Any equity security registered or
having unlisted trading privileges on a
national securities exchange such as
the New York or American Stock
Exchanges, or NASDAQ.
Any debt security convertible into
margin stock or carrying a warrant or
right to subscribe to or purchase
margin stock.
Any warrant or right to subscribe to or
purchase a margin stock.
The stock involved must be margin
stock. Lending on the collateral of
nonmargin stock, such as the stock of
a closely held corporation is not
restricted.
Certain securities issued by an
investment company registered under
Section 8 of the Investment Company
Act of 1940.
The loan must be secured directly or
indirectly by the margin stock. A loan
is indirectly secured by stock if the
borrower‘s right to sell, pledge, or
dispose of the stock is restricted; or if
the exercise of such a right gives the
bank the right to accelerate the
maturity of the credit.
Purpose Credit. Any credit extended for
the purpose of purchasing or carrying a
margin stock is purpose credit.
Carrying Credit. Any credit which enables
the borrower to maintain, reduce, or retire
indebtedness originally incurred to purchase
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Regulation U
A mixed-collateral loan need not be
underwritten as two loans, and it may be
documented on one set of loan documents.
The purpose of the loan must be to
purchase or carry margin stock.
The Dreaded Margin Call. Unlike
regulations governing lending by securities
dealers and others on the collateral of
margin stock, Regulation U does not require
a margin call if the maximum loan value of
the stock falls below the loan amount
because of a reduction in the stock‘s current
market value. For Regulation U purposes a
bank is not required to track the market
value of Regulation U loan collateral. If a
loan met the requirements of Regulation U
at the time it was made, subsequent events
will not cause the loan to be in
noncompliance. Additionally, if a loan was in
compliance when made, it may be renewed
even though the maximum loan value of the
collateral has fallen below the loan amount.
§221.3(a)(2)
Withdrawal
and
Substitution
of
Collateral. A bank may allow a customer to
withdraw or substitute collateral for a
Regulation U loan provided that the
withdrawal or substitution does not:
Cause the credit to exceed the
maximum loan value of the collateral,
or
Increase the amount by which the
credit exceeds the maximum loan
value.
For the purpose of withdrawal or
substitution, use the maximum loan value of
the collateral on the day of a withdrawal or
substitution to calculate what is permissible
or required. .§221.3(f)
Mixed-collateral Loans. §221.3(d)(4) and
§221.120 Documentation of a purpose loan
secured in part by margin stock and in part
by other collateral must identify how much
of the loan was allocated to each (nonmargin stock) collateral type. The amount
allocated to the other collateral must not
exceed the amount which a bank,
exercising sound banking judgment, would
lend on the collateral, without regard to
other assets of the customer held as
collateral for unrelated transactions. For
example, a customer who owns vacant land
valued at $50,000 on which the bank‘s
standard loan-to-value ratio is 60%, wants
to borrow $90,000 to purchase $100,000 of
margin stock. Collateral for the loan will be
the vacant land and the stock. The
maximum loan value of the stock is
$50,000. The maximum value the bank
could allocate to the land is $30,000; thus
the bank could not make the loan at the
loan amount requested. The bank may not
consider the $50,000 value in the stock that
is unencumbered in assigning a collateral
value to the land, even though the bank‘s
underwriting standards would allow it to do
so but for the restriction of Regulation U.
Single-Credit Rule. In general, all purpose
credits extended to a customer are treated
as a single credit, and all of the collateral
securing the credit is considered in
determining whether or not the credit is in
compliance.§221.3(d) A bank that has
extended purpose credit secured by margin
stock may not subsequently extend
unsecured purpose credit, unless the
maximum loan value of the collateral for the
first loan equals or exceeds both credits. If a
bank extends the unsecured purpose credit
first, then the two loans and the collateral
must be consolidated for the purposes of
the withdrawal and substitution rules.
If a bank makes secured purpose credit and
nonpurpose credit to the same borrower the
bank may treat the credits as separate
loans but it must not consider the excess
collateral value of the secured purpose
credit in underwriting the nonpurpose credit.
Special Purpose Loans and
Exempt Transactions
There are special rules for extending
purpose credit to securities brokers and
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dealers, arbitrage transactions, distribution
loans, and to other persons involved in the
making of securities markets. §221.5 The
requirements for those loans are very
technical and are beyond the score of this
article.
Regulation U
The opportunity to realize a profit or avoid a
loss is not an emergency.
FR U-1
Anytime a bank extends credit secured
directly or indirectly by margin stock in an
amount in excess of $100,000, the bank
must require its customer to fill out and sign
Form FR U-1, which must also be signed
and accepted by a duly authorized officer of
the bank.§221.3(c)(1) The requirement for
the FR U-1 exists regardless of whether or
not the loan is a purpose loan. If the loan is
a revolving credit, the FR U-1 can be signed
either when the credit is established or with
each draw.§221.3(c)(2)
There are also transactions that are exempt
from Regulation U. The only two
exemptions that the loans of most banks
would ever fall under are:
Loans to other banks §221.6(a)
A customer emergency. .§221.6(h)
A customer emergency must be a case of
extreme
hardship
not
reasonably
foreseeable at the time the loan was made.
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Securities Inquiries
Regulation U
of the corporate entity itself.) The most
common type of equity security is common
stock. The owner of shares of such stock
has the right to dividends, if declared, and a
pro-rata portion of whatever is left after the
corporation is liquidated and all creditors
paid in full. Preferred stock entitles its
holder to a ―preference‖ over holders of
common stock. The preference may be as
to dividends, or assets upon liquidation of
the corporation, or both.
Common name: Regulation U
Reference: 17 C.F.R. 240.17f-1
Introduction
The Securities Inquiries rules are not part of
Federal Reserve‘s Regulation U. They are
part of regulations issued by the Securities
Exchange Commission (―SEC‖) which apply
to banks, brokers, securities dealers, and
others whose normal business activities
bring them into contact with physical
securities instruments. We cover these
SEC rules here in the ―Lettered
Regulations‖ section of the manual because
they need to be considered when a bank
accepts securities as collateral for a loan
transaction.
Debt securities, most commonly bonds or
debentures, evidence no ownership interest
in the corporation that issued them.
Instead, they show that the corporation has
borrowed money from the holder of the
security and will pay it back, with interest,
on a certain schedule. It used to be that
debt securities were called bonds or
debentures depending upon what kind of
property secured them and what kind of
master agreement they were issued under,
but those distinctions are often ignored
today.
The primary purpose of the regulation under
which these activities are conducted is to
prevent (and perhaps deter) the fraudulent
use of lost, stolen, counterfeit, or missing
stock or bond certificates. In essence, a
central ―bulletin board‖ is established on
which people post notices that certain
securities have been lost, stolen, and so on.
People who are about to engage in
transactions involving stock or bond
certificates are supposed to look at that
bulletin board before completing their
transactions. The basic theory is similar to
doing a UCC search before lending money
against equipment, inventory, and accounts:
you want to see if anybody has filed
anything that would tell you your collateral is
not worth what you believe it is worth. As
with UCC searches, however, ―the devil is in
the details,‖ and we will explore some of
those bedeviling details here.
Types of Security. There are three types
of physical forms that are relevant for
purposes of this article: certificated, global,
and uncertificated. Certificated means there
is a piece of paper which evidences the
security (a securities certificate). Typically,
these instruments will have elaborately
engraved borders and images of people,
cities, or industrial plants to make
counterfeiting difficult. Some are ―bearer‖
instruments, meaning no one‘s name is
shown on them as owner. Others are in
―registered‖ form, meaning the owner‘s
name is typed or printed on the certificate.
A global certificate issue of securities is one
in which a single ―master‖ certificate
representing all the shares issued is
registered in the nominee name of a
registered clearing agency. The individuals
who own shares in such an issue cannot
obtain certificates for their particular shares.
Their ownership interests are registered on
the books of the clearing agency.
Definitions. There are several kinds of
securities. The two most common are
equity securities (stocks) and debt securities
(bonds or debentures). An equity security
evidences someone‘s ownership of a
portion of the corporation that issued the
security. (Not of the corporation‘s real
estate, equipment, or funds, but ownership
Finally, an uncertificated security is just
what the name suggests, a security for
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which absolutely no certificate is issued, not
even a single global one for the whole
issue.
The examples most familiar to
bankers are certain U.S. Treasury
securities, the ownership records of which
are kept on the books of the Federal
Reserve.
More and more business
corporations are issuing such securities,
however, and the Uniform Commercial
Code in many states has been amended to
accommodate bankers‘ needs to perfect a
security interest in such securities.
Regulation U
recommend that a bank appoint one (or a
few) people inside the bank to perform the
inquiries.
The Inquiry
The government has established a fairly
elaborate procedure for inquiries. In order to
begin to be able to comply, a bank must first
have a FINS Financial Institution Numbering
System) number. Your bank may already
have one. If not, you may get one by writing
on bank letterhead to:
Obviously, there can be no lost, stolen, or
counterfeit certificate for securities of an
uncertificated issue. While it is theoretically
possible that there could be one, and only
one, in a global certificate issue, it is
extremely unlikely. So, as a practical (and
legal) matter, the only time a banker will be
concerned about lost, stolen, or counterfeit
securities is when he or she is confronted
with the classic, old-fashioned certificated
security, be it for shares of stock or principal
amount of bonds or debentures.
DTCC
55 Water Street, 50th Floor
New York, NY 10041
Attn: FINS Publication
The letter should say you want a FINS
number, and that you are a bank. There is
no fee for this service (and that is the last
time you will hear that statement in this
article; everybody else in this scene charges
for their services).
After your bank is assigned a FINS number
you may register as an ―inquirer.‖ There are
two varieties, direct and indirect, and they
register on different portions of the same
forms. To obtain the forms, contact:
The Basic Rule
Every bank the deposits of which are
insured by the FDIC must ―inquire‖ of a
government-established information center
with respect to ―every securities certificate
which comes into its possession or keeping,
whether by pledge, transfer, or otherwise,‖
to determine whether the certificate has
been reported as lost, stolen, or counterfeit.
So, if a borrower pledges bonds,
debentures, or shares of stock as collateral
for a loan, whether consumer, commercial,
or some other classification used by the
bank, the bank must ―inquire.‖ If a trust
department customer transfers stocks,
debentures or bonds to the bank as trustee
for his/her grandchildren, the bank must
―inquire.‖ If a customer hands you
certificates for stocks, debentures, or bonds
to be held by the bank for safekeeping in
the vault, the bank must ―inquire.‖ Any
department of a bank might receive
securities from outside the bank, so
everyone needs to be aware of the need to
inquire in these circumstances. We
Securities Information Center
P.O. Box 55151
Boston, MA 02205-5151
Forms may also be obtained from the
Thomson Financial Internet Web Site at
https://www.secic.com/sic/docs/registration/
main.html.
Most medium-size and smaller banks will
choose to become indirect inquirers. This
means that they will contract with another
institution that is a direct inquirer to pass
along their inquiries and pass back the
responses from the Securities Information
Center (SIC). A direct inquirer pays annual
fees for inquiry rights and semiannual fees
based on usage. Typically, a direct inquirer
that contracts to act as intermediary for an
indirect inquirer will pass on the usage fees
plus a markup and additional fees, as well.
The indirect inquirer will receive no direct
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confirmations from SIC, but the logs,
memos, and similar evidence preserved at
all three points in the chain (indirect inquirer,
and direct inquirer, SIC) should be adequate
evidence of the inquiry and the response.
Regulation U
Uncertificated securities
Global securities issues
Any securities issue for which an
owner cannot obtain a negotiable
certificate.
Direct inquiries (and indirect ones,
depending on the terms of the agreement
between the institutions) may be made by
telephone, fax, mail, or computer hookup.
Probably the most frequently used inquiry
method is telephone. The inquirer describes
the security in question, including issuer,
class of securities, certificate number,
CUSIP (Committee on Uniform Securities
Identification Procedures) number, and
other information. The SIC staffer will advise
whether these facts and numbers match
those of a securities certificate which has
been reported as lost, stolen, or counterfeit
(a ―hit,‖ in the jargon of the trade). If they do
not match, the transaction may proceed; if
they do, senior management and the bank‘s
security officer should be notified. They
should then investigate the matter, and if
the status of the certificate is confirmed as
lost, stolen, or counterfeit, they must file
reports of suspected criminal activity, call
law-enforcement officers, and take other
action as appropriate.
Exempt Circumstances. A bank need not
inquire about a securities certificate
received:
Directly from the issuer or issuing
agent at issuance
From another bank, a broker or dealer
in securities, or any other party that is
a ―reporting institution‖ under the
regulation
From a Federal Reserve Bank
From a person with whom the bank
has entered into at least one prior
securities transaction if the certificate
either:
Is registered in the name of that
person (or his/her/its nominee)
Was previously sold to such
person, as evidenced by the
bank‘s own internal records.
Permitted Inquiries. Even if a certificate
qualifies for an exemption as just described,
a bank is permitted to inquire of SIC with
respect to that certificate. If there is some
reason to suspect a problem, that may be a
worthwhile course of action. Because of the
fees involved, however, most banks will not
do it as a general matter in exempt cases.
When Required
The inquiry described above must be made
whenever the face value of the bond or
debenture certificate, or the market value of
the stock certificate, exceeds $10,000. Even
if the value is over $10,000, there are
exempt
securities
and
exempt
circumstances.
Record Keeping. A bank is required to
―maintain and preserve in an easily
accessible ―location‖ all confirmations or
other information received in response to
inquiries. The retention period is three
years.
Exempt Securities. A bank need not
inquire about:
Securities which have not
assigned CUSIP numbers
been
Bond coupons
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Transactions Between
Banks and Their Affiliates
Regulation W
loss caused by risky or inappropriate
transactions between the insured bank and
its affiliated organizations.
Banks and Their
Affiliates
How does Regulation W try to accomplish
this? It achieves its goals in four major
ways. First, it limits a bank‘s ―covered
transactions‖ with any single ―affiliate‖ to no
more than 10% of the bank‘s capital and
surplus and covered transactions with all
affiliates, in the aggregate, to no more than
20% of capital and surplus. §223.11 and
§223.12 Second, it requires all transactions
between the bank and its affiliates to be on
safe and sound terms and conditions.
§223.13 Third, it prohibits the bank from
purchasing low-quality assets from affiliates,
and finally, it requires that a bank‘s
extensions of credit to affiliates and
guarantees of its affiliates be adequately
secured to prevent loss to the bank.
§223.15
Common name: Regulation W
Introduction
Sections 23A and 23B of the Federal
Reserve Act are intended to protect against
depository institutions suffering losses in
transactions with their own affiliates. While
these sections apply by their terms to banks
that are members of the Federal Reserve
System (‖member banks‖) other federal law
brings insured nonmember banks under the
requirements of these two sections of the
Act. Although the Fed has always had the
authority to issue regulations to administer
Sections 23A & B, for years it relied on a
series of Board interpretations and informal
staff letters to provide practical guidelines
for compliance. The Gramm-Leach-Bliley
Act of 1999 required the Fed to issue final
rules by May 12, 2001 covering certain
types of affiliate transaction exposure. Fed
took the opportunity to create a new lettered
regulation, Regulation W, to address the full
range of activities covered by Sections 23A
and B and its accumulated series of
interpretations and letters.
Definitions
Covered Transactions.
A covered
transaction under this regulation includes:
A loan or extension of credit to an
affiliate;
A purchase of an investment in, or
securities issued by, an affiliate;
A purchase of assets, including assets
subject to repurchase, from an
affiliate;
So what exactly does Regulation W attempt
to regulate? Regulation W limits a bank‘s
risk exposure from transactions with
affiliates. It also limits the ability of an
insured bank to transfer its Federal subsidy
to its affiliates. Regulation W is an extension
of the protections against insider abuse that
are found in Regulation O which deals
exclusively with the extension of credit to
insiders of the bank. It therefore is primarily
a Safety/Soundness set of rules which are
intended to protect both the bank and the
Federal Deposit Insurance System against
The acceptance of securities issued
by an affiliate as collateral for any
loan, even though the borrower is not
the affiliate;
The issuance of a guarantee,
acceptance, or letter of credit on
behalf of an affiliate, and,
In general, any credit-related transaction
or asset sale with an affiliate is a covered
transaction. Service-type contracts are
not covered by Regulation W, but may be
governed by other regulations. §223.3
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Affiliate. An ―affiliate‖ includes:
Regulation W
Any company where control results
from the exercise of rights from a debt
previously contracted. For example, a
bank‘s holding company forecloses on
the stock of a company and becomes
its owner. The company is not the
bank‘s affiliate. 12 CFR §223.2
Any company that controls the bank
(e.g., a bank holding company);
Any company controlled by the
company that controls the bank (e.g.,
all subsidiaries of a bank holding
company, including other banks);
Restrictions
A bank subsidiary of the bank;
Regulation W places certain restrictions on
covered transactions between a bank and
an affiliate:
A company that is controlled by the
same person or group that controls
either the bank or the company that
controls the bank. For example, A
owns 25% of the holding company
that owns Bank B. A also owns 25%
of Company C. Company C is an
affiliate of Bank B. (For this purpose,
control of a company exists if a
shareholder or group of shareholders
own directly or indirectly 25% of any
class of voting securities or control the
election of a majority of the board of
directors.);
The aggregate amount of covered
transactions between a bank and its
subsidiaries with any affiliate may not
exceed 10% of the capital stock and
surplus of the bank. §223.11
The aggregate amount of all covered
transactions between a bank and its
subsidiaries with all affiliates may not
exceed 20% of the capital stock and
surplus of the bank. §223.12
A bank (or its subsidiaries) may not
purchase a low-quality asset from an
affiliate unless the bank, pursuant to
an independent credit evaluation, had
committed to purchase the asset prior
to the time it was acquired by the
affiliate. §223.15
Any company sponsored and advised
on a contractual basis by the bank or
a subsidiary or affiliate of the bank;
and
Any investment company to which the
bank or a subsidiary or affiliate of the
bank is investment advisor.
All transactions between a bank and
an affiliate must be consistent with
safe and sound banking practices.
§223.13
An affiliate is not:
A nonbank subsidiary of a bank;
Any company whose only business is
owning the premises occupied by the
bank;
In addition to the above restrictions, each
loan, extension of credit, guarantee, etc. to
or for the benefit of an affiliate must be
secured at the time the transaction is
entered into by one of the following:
Any company engaged solely in
conducting a safe-deposit business;
and,
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Regulation W
Obligations
of
or
obligations
guaranteed by the United States or its
agencies, items eligible for rediscount
or purchase by a Federal Reserve
bank, or deposit accounts of the bank,
equal in value to 100% of the credit.
The purchase of
nonrecourse basis
banks; and,
loans on a
from affiliated
The purchase of a loan from an
affiliate that was originated by the
bank and sold to the affiliate subject to
a repurchase agreement or with
recourse.
By obligations of a state or a political
subdivision of a state equal in value to
110 percent of the credit.
Putting It All Together
Other debt instruments, including
receivables, equal in value to 120% of
the credit.
A bank may have three categories of
affiliates:
Stock, leases, or other real or
personal property equal in value to
130% of the credit.
1
Other banks where there is an 80%
commonality of ownership. -- The most
frequent instance is sister banks within a
bank holding company. Also included
are banks, whether or not in a holding
company that directly or indirectly have
80 percent of their stock in common
ownership. An example is a series of
one-bank holding companies all owned
by the same person or group of people.
2
Other banks where there is not an 80%
commonality of ownership. -- This
instance occurs any time there is a
commonality of ownership between two
banks that involves at least 25%, but not
80% of their stock.
3
Nonbank companies -- The most
frequent instance is a bank‘s holding
company and all of the holding
company‘s nonbank subsidiaries. Also
included is any company that is 25%
owned by any person or persons who
own 25% of the stock of the bank. Any
bank that has 25% of its stock owned by
one person or a small group of people
that have other business interests in
common, must be cautious that it
recognizes all of its affiliates.
Neither a low-quality asset nor securities
issued by an affiliate are acceptable
collateral.
12 CFR §223.42
Exceptions
The requirement that all transactions with
an affiliate comport with safe and sound
banking practices is always in effect. The
other restrictions, however, are not
applicable to:
A transaction with an affiliate that is a
bank, where either party owns 80% of
the voting stock of the other, or both
are under common control by a
company that owns at least 80% of
the voting stock of each;
Deposits made in an affiliated bank in
the ordinary course of correspondent
business;
Giving
immediate
credit
for
uncollected items received in the
ordinary course of business;
For category 1, the only restrictions are that
a bank may not purchase a low-quality
asset (unless previously committed for) and
all transactions must be on terms and
The purchase of assets having a
publicly available market quotation at
market price;
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conditions that are consistent with safe and
sound banking practices.
Regulation W
A bank must maintain a current total of
nonexempt transactions with each of its
affiliates and with all affiliates in the
aggregate. Each time credit is extended to
an affiliate, both figures must be checked to
see that the new credit does not violate
either the 10% to one affiliate or the 20% to
all affiliates rule.
For categories 2 and 3, all of the restrictions
apply, as well as the exemptions to the
restrictions, with the exception of the
exemption for banks that have 80% of their
stock in common ownership.
In any extension of credit to an affiliate,
collateral values must be carefully checked
to ensure that they meet the requirements.
The regulation only requires adequate
collateral value at the time the credit is
extended. A better policy is to require an
affiliate to maintain the required collateral
throughout the term of the credit.
The Rules in Practice
A bank must maintain a current list of its
affiliates divided by the three classes. It
must also maintain a schedule of all credit
relationships it has with those affiliates and
whether each relationship is exempt.
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Truth in Lending
Regulation Z
For owner-occupied rental property (such as
a duplex), if the loan is to purchase the
property and the property contains more
than two units, it is for a business purpose.
On the other hand, if the loan is to improve
or maintain the property, it is a consumer,
Regulation Z covered loan unless the
property contains more than four units. For
loans secured by rental property, for
purposes other than acquisitions or home
improvement, regardless of the number of
units in the property, determine the use of
the proceeds of the loan and if it is a
consumer purpose, Regulation Z applies.
Comment #4 to Section 226.3(a)
Truth in Lending
Common name: Regulation Z
Background
Regulation Z applies only to credit offered,
applied for, or extended to an individual for
a consumer purpose. Section 226.1 The
first requirement, therefore, is that the
borrower be a live human being. Loans to
entities such as corporations, partnerships,
churches,
associations,
governmental
agencies, and estates are not covered.
Loans to trusts are not covered except
loans to land trusts where they are used to
hold title to property for financing
convenience, such as is common in the
state of Illinois.
Generally, a loan amount that exceeds
$25,000 is exempt from Regulation Z unless
it is secured by real property or by personal
property used or expected to be used as the
principal dwelling of the consumer; there is
an express written commitment to extend
credit in excess of $25,000 (regardless of
whether or not such amount is ever drawn);
or it is a private education loan. Section
226.3(b)
For this purpose, real property
means dirt. Thus, a loan of any amount to
an individual for a consumer purpose is
subject to Regulation Z if it is secured by
vacant land, a home, an office building, or
any other structure where land is included.
A dwelling is a residential structure of one to
four units, regardless of whether it is
attached to land, and used as a principal
dwelling. Section 226.2(a)(19)
Thus, a
mobile home or a houseboat is a dwelling if
it is used as a residence. This exception
also exempts private education loans from
the limit. Employer-sponsored retirement
plans are also exempt from Regulation Z,
provided that the extension of credit
secured by the plan complies with the
applicable Internal Revenue Service
requirements.
The second requirement is that the loan be
for a consumer purpose rather than a
business, commercial, or agricultural
purpose. In most instances, it is clear-cut
whether a loan is or is not for a consumer
purpose, but sometimes the distinction is
not clear. Where a loan has a ―mixed‖ use,
that is, some of the proceeds will be used
for a business purpose and some for a
consumer purpose, the commentary to the
regulation indicates that the primary
purpose of the loan controls. The better
policy is to apply Regulation Z to any loan
where a significant part of the proceeds are
used for a consumer purpose, particularly if
the loan will be secured by the borrower‘s
principal residence and the right of
rescission might apply.
Loans to purchase or improve rental
property (or the refinancing of those loans)
have some special rules. If the property will
not be owner-occupied, a purchase money
or improvement loan is considered to be for
a business purpose and Regulation Z does
not apply. A property is considered non
owner-occupied if the owner does not intend
to occupy it for more than 14 days during
the coming year. Comment #3 to Section
226.3(a)
Definitions
Regulation Z has some specifically defined
terms. As with other regulations, frequently
these defined terms have a different
meaning than their normal ―dictionary‖
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meaning or their meaning as used in other
regulations. Whenever you read a
regulation, the first step is to make sure you
recognize and understand the defined
terms.
Truth in Lending
Regulation Z
It must be a condition of the credit
extension, and not of a type payable
had it been a cash transaction.
Examples of finance charges include
interest, loan fees, and premiums for private
mortgage insurance. In each case the
charge is paid by the consumer, imposed by
the lender, and would not have been paid in
a cash transaction. Examples of items that
are not finance charges are license fees or
title recording fees that must be paid in both
cash and credit transactions, discounts
available to both cash and credit customers,
and credit life insurance premiums in cases
where the financial institution did not require
the insurance coverage but the customer
voluntarily chose to purchase it.
Business Day. A business day is any day a
lender‘s offices are open to the public for
carrying on substantially all of its business
functions. If a financial institution has only
its drive-through tellers open for handling
deposit account transactions, but is not
open to take loan inquiries or loan
applications, it is not substantially open. For
the purpose of the right of rescission,
―business days‖ has a different definition.
For rescission, every day except Sunday
and federal public holidays is a business
day. Saturday is a business day for
determining a rescission period regardless
of
whether
the financial institution is
open. There are also variations of the term
―business day‖ when it comes to delivery
and receipt of certain disclosures. Verify
that you are using the correct definition
when determining ―business days‖ for
disclosure purposes.
A complete
discussion of applicable business day
definitions appears in each relevant section
in this chapter. Section 226.2(a)(6)
Charges imposed on the customer for the
services of third parties are finance charges
(unless the particular charge falls within an
exclusion) if the lender required the service
as a condition of the loan or retains any
portion of a non-required fee, in which case
the retained portion is a finance charge.
Section 226.4(a)(1) This is true even if the
lender allows the customer to select the
provider. For example, if a lender requires
private mortgage insurance on a loan, but
allows the customer to select the insurance
company, the premium is nevertheless a
finance charge. In the same vein, a lender is
deemed to require the use of a third-party
service if the consumer cannot obtain the
credit on the same terms without using the
third party. The classic example is a
financial institution that charges a two-point
loan fee to customers who come to it
directly, but only one point to customers
who use a broker. In that case the broker‘s
fee is a finance charge because the use of
the broker was required to obtain the more
advantageous terms. Sometimes the
required third party in turn requires the use
of a fourth party and the financial institution
requires the consumer to pay the fourth
party‘s charges. The fourth-party charge in
that case is also a finance charge unless
the third party is a settlement agent and the
lender did not require the use of the fourth
Finance Charge
The most important definition in Regulation
Z is that of finance charge, for in one way or
another almost all of Regulation Z revolves
around that definition or one of its elements.
The finance charge is the cost of consumer
credit expressed in dollars. The overall
finance charge on a loan may be made up
of several components, each of which is in
turn a finance charge, for example, interest
and loan fees. Section 226.4(a)
For a charge to be a finance charge, it must
pass three tests. It must be:
Payable directly or indirectly by the
consumer;
Imposed directly or indirectly by the
creditor; and
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Truth in Lending
party. Section 226.4(a)(2) An example is a
settlement agent that requires the use of a
courier and passes the courier fee on to the
consumer. The courier fee is not a finance
charge unless the lender required the
settlement agent to use a courier.
Regulation Z
Recognize that if these fees are charged in
a transaction that is not secured by real
estate or is not a residential mortgage
transaction, they are finance charges. One
of the excluded charges is a charge for a
credit report. Accordingly, on a loan to
purchase a mobile home to be used as the
purchaser‘s principal dwelling and secured
by the mobile home only (a residential
mortgage transaction), a charge to the
consumer for a credit report is not a finance
charge. On a loan to refinance that
purchase money loan, or if the mobile home
were to be used as a second home, the
transaction would not be a residential
mortgage transaction and the charge for the
credit report would be a finance charge. In
working with Regulation Z or any other
regulation, be very cautious to read every
word and not allow logic to cause you to
read into the language something that is not
there or read out something that is there.
Exclusions from the Finance Charge.
Many charges fall within the definition of
finance charge but they fall within a specific
exclusion to the finance charge. The
exclusions are as follows:
Application fees charged to all
applications for credit regardless of
whether credit is extended or denied.
Section 226.4(c)(1) To qualify, a lender
does not have to charge an application
fee for every loan that it makes, but it
must for every loan within a class. For
example, assume a lender charges all
applicants for automobile loans a $50
application fee, but charges mortgage
customers a fee only if their loan is
approved. In that case the automobile
loan fee could be excluded from the
finance charge but the mortgage loan
fee could not be. Examiners have taken
the position that if fees are frequently
refunded when not required, then they
are not being charged to all applicants.
The fees and charges imposed on the
customer in real property secured or
residential mortgage transactions that are
not finance charges are as follows:
Fees for title examination,
Fees for an abstract of title,
Title insurance premiums,
Charges for a violation of the loan terms
by the consumer. Sections 226.4(c)(2)
and (3) Late fees, delinquency fees,
default charges, charges for exceeding
a credit limit, and other similar fees
imposed on a consumer for violating the
terms of a loan agreement are not
finance charges.
Survey fees (includes fees for an initial
determination of whether a property is
in a flood hazard area),
Document preparation charges,
Notary fees,
Appraisal fees,
Fees for participating in a credit plan are
not finance charges if they are assessed
periodically. Section 226.4(c)(4) For
example, a fee imposed quarterly or
annually for a home-equity credit line is
not a finance charge.
Credit report fees, and
Amounts paid into escrow if the items
being escrowed for are not finance
charges.
As to the items enumerated, the finance
charge exclusion extends also to the cost of
verifying or confirming the information in the
item. There are two additional requirements
that the charge must meet to qualify for the
In transactions secured by real property and
in residential mortgage transactions, there
are a series of other charges that are not
finance charges. Section 226.4(c)(7)
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Truth in Lending
Regulation Z
Insurance Exclusion from Finance
Charge. The premium for insurance written
in conjunction with a credit transaction is or
is not a finance charge depending generally
on the type of insurance involved and
whether or not the creditor requires it.
Premiums for credit life, accident and
health, income continuation, and other
similar types of insurance are not finance
charges if the creditor does not require the
coverage,
provides
an
appropriate
disclosure of the premium, and the
consumer signs or initials an affirmative
written request for the insurance. Section
226.4(d)(1) If the creditor requires this type
insurance coverage, it is always a finance
charge.
finance charge exclusion. First, the amount
must be reasonable. Second, the charge
must be incurred for a service performed in
connection with the underwriting or
settlement of the loan. Section 226.4(c)(7) A
charge for a service performed after the
closing of a loan is a finance charge even
though it would have been exempt had the
service been performed at or prior to loan
closing, even though the consumer may pay
for the service prior to or at settlement.
Comment #3 to Section 226.4(c)(7) An
example is a flood determination. The
charge for an initial determination of
whether a property is or is not in a flood
hazard area, done prior to loan closing, to
determine whether flood insurance is
required on the loan is not a finance charge.
A charge for future determination, to be
made during the life of the loan, is a finance
charge. The fact that the lender performs
the service and retains the fee does not
affect the exclusion. If a financial institution
performs an appraisal with its own
personnel, the fee it charges the consumer
for the appraisal is not a finance charge so
long as it is reasonable and bona fide.
Premiums for casualty insurance such as
fire and extended coverage or flood on a
home, or collision and comprehensive on an
automobile are not finance charges even
though the lender requires the coverage, if
the lender discloses to the consumer that
the policy may be purchased from anyone
the consumer chooses. If the consumer
chooses to purchase the policy from the
lender, disclosures must be given regarding
the premium for the exclusion to continue.
Section 226.4(d)(2)
In general, a fee for attending or conducting
a loan closing is a finance charge. That
charge does not fall within one of the
exclusions.
If, however, an attorney
charges for attending or conducting a
closing, and the attorney does not separate
the closing fee charge from his or her other
charges, but bills the aggregate charge as a
lump sum, then the closing fee may be
excluded from the finance charge as long as
it is ―incidental‖ to the total charge.
Comment #2 to Section 226.4(c)(7) For
example, if a $500 attorney‘s fee consists of
$250 for document preparation, $200 for
title work, and $50 for attending the closing,
the entire $500 may be excluded from the
finance charge provided it is billed as a
lump sum. There is no definition for what is
―incidental,‖
however,
so
financial
institutions must be careful that this
provision is not abused.
Recording Fees and Taxes Exclusion
from Finance Charge. Fees paid to public
officials for recording, perfecting, releasing,
or satisfying a security interest are not
finance charges. Accordingly, documentary
stamps, taxes, or recording fees necessary
to record a mortgage or fees to file a
satisfaction of mortgage are not finance
charges; however, to qualify for this
exclusion, the fees must be itemized and
disclosed. Section 226.4(e)
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Truth in Lending
Regulation Z
yourself with them in order to verify that the
forms you are using are compliant.
Open-End Credit
Open-end credit is a loan where the
borrower may redraw amounts previously
paid. Home equity lines of credit, overdraft
lines of credit, personal unsecured lines of
credit and credit cards are the examples of
typical open-end credit plans.
Section
226.2(a)(20)
General Rules for Disclosures on OpenEnd Credit. All disclosures required by the
regulation must be clear and conspicuous
and generally must be in writing and in a
form that the consumer may keep. If there
are multiple consumers liable for payment of
the plan, the disclosures must be given to at
least one of the borrowers primarily liable on
the account. An exception occurs when the
right of rescission applies; then, it must be
given to all who have the right to rescind.
Most disclosures have specific formatting
requirements and must include consistent
use of terminology. For example, when the
terms ―finance charge‖ and ―annual
percentage rate‖ are required to be
disclosed, they must generally be more
conspicuous than any other required
disclosure. Section 226.5
If a consumer may re-borrow amounts of
principal previously repaid on a credit, it is
almost
always
open-end.
Section
226.2(a)(20) If amounts repaid may not be
re-borrowed, it is closed-end. The fact that
the credit has an expiration date, or that the
creditor may limit future borrowings or
cancel the plan, does not cause the credit to
be closed-end.
Regulation Z imposes certain requirements
on all types of open-end credit. If the credit
line can be accessed with a credit or a
charge card, there are additional credit card
requirements that are not addressed in this
compliance manual. If the credit plan is
secured by the consumer‘s dwelling (a
home-equity plan), there are additional
requirements that are addressed later in this
chapter.
Also, disclosures must reflect the legal
obligations of the plan. If any information
that is necessary for an accurate disclosure
is not known, the disclosure should be
based on the best information available and
must clearly state that such information
provided is an estimate. If, after a disclosure
is given to a customer, there is a change in
the credit plan that causes the prior
disclosure to be inaccurate, a new
disclosure or change-in-terms notice may
be required.
In May 2009, Congress passed the Credit
Card Accountability Responsibility and
Disclosure Act of 2009, commonly referred
to as the Credit CARD Act. The Credit
CARD Act amended the Truth in Lending
Act and established new substantive
disclosure requirements for open-end credit
plans. It impacts all open-end credit plans
in several provisions to Regulation Z,
including home equity lines of credit,
overdraft lines of credit and other personal
lines of credit.
Rules for Open-End Credit (Not Home
Secured). Rules for credit lines not secured
by a consumer‘s dwelling are significantly
different from the rules for credit lines that
are secured by a consumer‘s dwelling. This
is not exactly exciting news, since these
rules are no easier to decipher than those
used in credit lines secured by a dwelling.
Appendix G to the regulation contains
model clauses and forms (which is quite
exhaustive thanks to the Credit CARD Act).
These forms provide suggested language
for many of the required disclosures. These
―safe harbor‖ forms should be used
verbatim whenever they are appropriate for
the circumstances and should be modified
only as much as is absolutely required to fit
other situations. You should familiarize
Account Opening Disclosures for OpenEnd Credit (Other than Home-Equity
Plans). A creditor must generally provide
account-opening disclosures to a consumer
prior to the first transaction under a plan,
and the disclosures must be clear and
conspicuous
and
in
a
reasonably
understandable form. These disclosures
look similar to the credit card disclosures,
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and require a
Section 226.6
similar
tabular
Truth in Lending
Regulation Z
format.
the occurrence of one or more
specific events).
The account-opening disclosures for openend non-home secured credit must tell the
consumer several key pieces of information
in a certain format and font size. There are
strict requirements that certain disclosures
be placed in the table while others must be
located directly below the table. Only those
disclosures or information that are required
or permitted to be in the table may be in the
table; you may not modify the table to
include any other information.
Variable-rate information - If a rate
is variable, the creditor shall
disclose the fact that the rate may
vary and how the rate is
determined. In describing how the
applicable rate will be determined,
the creditor must identify the type
of index or formula that is used in
setting the rate. The value of the
index and the amount of the
margin that are used to calculate
the variable rate shall not be
disclosed in the table. A disclosure
of any applicable limitations on
rate increases or decreases shall
not be included in the table. If the
financial institution does not tie its
variable-rate program to an index
or formula, but merely reserves the
contractual right to change the rate
it charges the consumer from time
to time, the financial institution
must give a ―change-in-terms‖
notice at each adjustment of the
rate.
Additionally, certain disclosures must be in
bold text.
The Federal Reserve has
provided explicit instructions where bolding
is required and where it is not permitted.
You may not use bold text for the amount of
any periodic fee that is not an annualized
amount, or other annual percentage rates or
fee amounts disclosed in the table.
Below are the disclosures with detail on the
location, size, and format requirements of
the disclosures. Keep in mind that the
disclosures should be ―substantially similar‖
to the models in G-17 of Appendix G of
Regulation Z.
Discounted initial rates - If the
initial rate is an introductory rate,
disclose the rate that would
otherwise apply to the account.
Where the rate is not tied to an
index or formula, disclose the rate
that will apply after the introductory
rate expires. The creditor is not
required to, but may disclose in the
table the introductory rate along
with the rate that would otherwise
apply to the account if it also
discloses the time period during
which the introductory rate will
remain in effect, using the term
―introductory‖
or
―intro‖
in
immediate
proximity
to
the
introductory rate. This introductory
rate must be in bold text.
Within the table shall include to the extent
applicable:
1. Rate Information. Required rate
information includes the following
information:
Annual percentage rate - Each
periodic rate that may be used to
compute the finance charge on an
outstanding
balance
for
purchases, cash advances, or
balance transfers, expressed as
an annual percentage rate. When
more than one rate applies for a
category of transactions, the range
of balances to which each rate is
applicable shall also be disclosed.
The Annual Percentage Rate for
purchases disclosed in this section
shall be in at least 16-point type
and in bold text (except for a
penalty rate that may apply upon
Premium initial rate - If the initial
rate is temporary and is higher
than the rate that will apply after
the temporary rate expires,
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disclose the premium initial rate.
The premium initial rate for
purchases must be in at least 16point type. The creditor is not
required to, but may disclose in the
table the rate that will apply after
the premium initial rate expires, if
the creditor also discloses the time
period during which the premium
initial rate will remain in effect. If
the creditor also discloses in the
table the rate that will apply after
the premium initial rate for
purchases expires, that rate also
must be in at least 16-point type
and in bold text.
Regulation Z
disclosure includes a statement
that the annual percentage rate
varies by state or will be
determined based on the
consumer's
creditworthiness
and refers the consumer to the
account agreement or other
disclosure provided with the
account-opening table where
the annual percentage rate
applicable to the consumer's
account is disclosed. A creditor
may not list annual percentage
rates for multiple states in the
account-opening table.
2. Fees and Charges.
Generally,
lenders may not collect a membership
fee
before
account-opening
disclosures are provided. However,
you may collect, or obtain the
consumer‘s agreement to pay a
membership fee or an application fee
that is excludable from finance
charges, provided that if the consumer
objects to the plan, they have no
obligation to pay any such of these
fees.
Penalty rates - If a rate may
increase as a penalty for one or
more events specified in the
account agreement (such as a late
payment or an extension of credit
that exceeds the credit limit), the
creditor must disclose: (1) the
increased rate that may apply; (2)
a brief description of the event or
events that may result in the
increased rate; and (3) a brief
description of how long the
increased rate will remain in effect.
If more than one penalty rate may
apply, the creditor may disclose
the highest rate that could apply,
instead of disclosing the specific
rates or the range of rates that
could apply.
There are a number of fees and
charges that must be disclosed in the
account opening disclosures and
either must be in bold text or cannot
be in bold text. These disclosures
must be placed in the table:
Any annual or other periodic fee in
bold text, that may be imposed for
the issuance or availability of an
open-end plan, including any fee
based on account activity or
inactivity, how frequently it will be
imposed, and the annualized
amount of the fee.
Plans for the purchase of goods
where APRs vary by state or
based on creditworthiness Annual percentage rates that vary
by state or based on the
consumer's creditworthiness on
open-end credit to purchase goods
or services must disclose one of
the following in the accountopening table:
Any non-periodic fee in bold text,
that relates to opening the plan
and the fact that the fee is a onetime fee.
o The specific annual percentage
rate
applicable
to
the
consumer's account; or
o The range
percentage
Truth in Lending
Any fixed finance charge and a
brief description of the charge.
of the annual
rates,
if
the
Any minimum interest charge that
could be imposed during a billing
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cycle, and a brief description of the
charge.
Truth in Lending
Regulation Z
3. Grace Period. The grace period is the
date by which, or the period within
which, any credit extended may be
repaid without incurring a finance
charge due to a periodic interest rate,
and any conditions on the availability
of the grace period. If no grace period
is provided, that fact must be
disclosed. The grace period must be
disclosed in the table.
Any transaction charge imposed
by the creditor for use of the openend plan for purchases in bold
text.
Any fees imposed for a cash
advance or its equivalent in bold
text.
If the length of the grace period
varies, disclose either: (1) the
range of days; (2) the minimum
number of days; or (3) the average
number of the days in the grace
period. Further, the creditor must
identify which of these it is
disclosing.
Any fees imposed for a late
payment in bold text.
Any fees imposed for exceeding a
credit limit in bold text.
Any fees imposed to transfer an
outstanding balance in bold text.
Any fees imposed for a returned
payment in bold text.
For a grace period that applies to
all features on the account, the
phrase “How to Avoid Paying
Interest” shall be used as the
heading for the row describing the
grace period. If a grace period is
not offered on all features of the
account, the phrase “Paying
Interest” shall be used in the table
as the heading for the row
describing this fact.
Any fees for insurance or debt
cancellation
or
suspension
coverage in bold text, if required
as part of the plan, including any
cross reference to any additional
information about the insurance.
If fees are required for the
issuance or availability of credit, or
if a security deposit is required for
the credit, and the total amount of
those required fees and/or security
deposit that will be imposed and
charged to the account when the
account is opened is 15 percent or
more of the minimum credit limit
for the plan, you must disclose the
available credit remaining after
these fees or security deposit are
debited to the account. You will
also have to disclose that the
consumer has the right to reject
the plan and not be obligated to
pay those fees or any other fee or
charges until the consumer has
used the account or made a
payment on the account after
receiving a periodic statement.
This only applies if the fees or
security deposits are debited to the
account.
4. Web Site Reference. For open end
lines of credit (other than home equity
lines) that are accessible by a card,
you have to include a reference to the
Web site that has been established by
the Federal Reserve, along with a
statement that consumers can get
more information on the Web site
about shopping for and using credit
cards. This chapter does not address
requirements
for
credit
cards.
However, for purposes of this
requirement, overdraft lines of credit
that are accessible indirectly by a debit
card that accesses a deposit account
that draws funds from the overdraft
line of credit are considered ―credit
cards‖ and must have this Web site
reference language in the table on the
account opening disclosures.
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Required Disclosures Outside of the
Table. In addition to disclosing the rates,
fees and grace period in the table, there is
other information that must be included in
the disclosures and are not permitted in the
table.
Truth in Lending
Regulation Z
attorney's fees (whether or not
automatically imposed), and postjudgment interest rates permitted by
law are not included;
Taxes imposed on the credit
transaction by a state or other
governmental
body,
such
as
documentary stamp taxes on cash
advances;
Directly Below, but Outside of the
required table, the creditor shall include to
the extent applicable:
Balance Computation Method. The
balance computation method used to
determine the balance on which the
finance charge is calculated for each
feature.
Charges for which the payment, or
nonpayment affect the consumer's
access to the plan, the duration of the
plan, the amount of credit extended,
the period for which credit is extended,
or the timing or method of billing or
payment;
Billing Error Rights. A statement
that information about consumers‘
right to dispute transactions is
included in the account opening
disclosures.
Charges imposed for terminating a
plan;
Charges for voluntary credit insurance,
debt cancellation or debt suspension;
or
Introductory Rates Revoked as a
Result of a Penalty.
If an
introductory rate is disclosed in the
table, a creditor must briefly disclose
directly beneath the table the
circumstances under which the
introductory rate may be revoked and
the rate that will apply after the
introductory rate is revoked.
If the open-end credit plan is
collateralized, you need to include a
statement that you have or will acquire
a security interest in the property
purchased under the plan, or in other
property that has been identified by
either item or type.
In addition to the disclosures that are
required to be placed outside and directly
below the table, the following disclosures
are required to be placed outside of the
table, although not directly below it: (1) the
circumstances under which a charge may
be imposed (including either the amount of
the charge or an explanation of how the
charge is determined); and (2) charges
imposed as part of the plan that are finance
charges (for disclosing finance charges, you
must include both the time at which the
charge begins to accrue and an explanation
of whether a time period exists, within which
any extended credit may be repaid without
incurring the charge). Some examples of
charges imposed as part of the plan are:
Periodic Statements for Open-End Credit
(Other than Home-Equity Plans). The
Credit CARD Act significantly impacted the
delivery
requirements
for
periodic
statements. For all open end credit plans
that have a grace period, periodic
statements must be mailed or delivered to
customers at least 21 days prior to the date
on which the grace period expires.
Note that the regulators don‘t expect
institutions to determine the specific day
that periodic statements are mailed or
delivered.
However, institutions are
required to have reasonable procedures in
place to ensure that the periodic statements
are provided in time to meet the 21-day
requirement. Reasonable procedures must
account for a certain number of days for the
mailing, with an additional 21-day period
added on thereafter. For example, if you
are going to need 3 days after the end of
Charges resulting from the consumer's
failure to use the plan as agreed,
although
amounts
payable
for
collection
activity
after
default,
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Truth in Lending
Regulation Z
the billing cycle to mail or deliver the
periodic statements to your customers, then
you should have procedures in place that
ensure that the end of the grace period (if
applicable) is at least 24 days after the end
of the billing cycle.
a late payment fee, increase the annual
percentage rate as a penalty, or report the
consumer as delinquent to a credit reporting
agency, based on the fact that the
consumer failed to make a payment by the
payment due date.
A ―grace period‖ means a period in which
any credit that was extended to the
customer may be repaid without incurring a
finance charge that results from a periodic
interest rate. Be aware that this refers to a
―finance‖ charge and not a ―late fee‖ charge.
A grace period typically occurs before the
payment due date, although it is not
uncommon for the grace period to expire on
the payment due date.
Since periodic
statements must be provided at least 21
days before the expiration of the grace
period, if you have a grace period that ends
7 days before the payment due date, a
periodic statement must be provided at least
21 days before the expiration of the grace
period. Therefore, the statement must then
be provided 28 days before the payment
due date. However, in the more common
scenario where the grace period expires on
the payment due date, the institution must
have procedures in place to provide the
periodic statement 21 days before the
payment due date, since that is the date on
which the grace period expires.
Like the account opening disclosures, there
are also format, delivery and content
requirements for periodic statements. A
creditor must furnish a consumer with a
periodic account statement for each billing
cycle at the end of which an account has a
debit or credit balance, or on which a
finance charge has been imposed; however,
the statement must be provided no less
than quarterly. Section 226.7 The statement
must include the following:
In contrast, some creditors provide what is
referred to as a ―courtesy period.‖
A
courtesy period is not a grace period. A
courtesy period is an additional period of
time after the due date during which
customers are allowed to make a payment
without incurring a late fee. Sometimes
these are included in the account
agreement, and sometimes they are
provided as an informal policy by the
creditor. Regardless of whether you offer
this or not, the 21-day mailing requirement
does not include any courtesy period.
Any credit to the account during the
billing cycle, including the amount and
the date of crediting. The date doesn‘t
need to be provided if a delay in
crediting doesn‘t result in any finance
or other charge;
The closing dates of the period;
The beginning and closing balances;
An identification of each credit
transaction. Use of the label ―credit‖ is
sufficient, except when the creditor is
using the periodic statement to satisfy
the billing error correction notice
requirement.
Credits may be
distinguished in any way that is clear
and conspicuous (such as debit and
credit columns). A total of the amounts
credited is not required;
Each periodic rate that may be used to
compute the finance charge, the range
of balances to which it is applicable,
and
the
corresponding
annual
percentage rate, using the term
―Annual Percentage Rate.” Disclose
the types of transactions to which the
periodic rates apply. If the plan is a
variable-rate plan, it must be disclosed
that the periodic rate may vary;
What happens if you don‘t provide the
periodic statement 21 days in advance?
Then you may not treat a payment as late
for any purpose, or collect any finance or
other charge imposed as a result of your
failure to provide the statement as early as
required. For example, you cannot assess
If there‘s a promotional rate, disclose it
only in periods in which the offered
rate is actually applied;
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The balance to which a periodic rate
was applied and how the balance was
calculated, using the term “Balance
Subject to Interest Rate.”
If the
balance is determined without first
deducting all credits and payments,
include that fact; the amount of the
credits and payments must also be
disclosed;
Truth in Lending
Regulation Z
Disclose any deferred interest period
(related to a deferred interest or
similar program), which is the date by
which any outstanding balance must
be paid in full in order to avoid finance
charges. This deferred interest date
must be disclosed on the front of each
periodic statement issued during the
deferred interest period, and must
begin with the first periodic statement
issued during the deferred interest
period; and
The amounts of any charges imposed
as part of a plan, grouped together in
proximity to the transactions identified;
The periodic statement must also
include the date by which or the time
period within which the new balance or
any portion of the new balance must
be paid to avoid additional finance
charges. This is sometimes referred
to as the ―grace period.‖
The finance charges attributable to
periodic interest rates, using the term
―Interest Charge.” These charges must
be grouped together under the
heading ―Interest Charged,” and
itemized and totaled by type of
transaction. Also included is a total of
finance charges attributable to periodic
interest rates, using the term ―Total
Interest.”
Total Interest must be
disclosed for the statement period and
calendar year to date;
In addition to the above items required by
the regulation, the model forms in Appendix
G also include the two following items:
The beginning date of the cycle; and
The number of days in the billing
cycle.
Charges attributable to periodic rates
other than interest charges must be
disclosed as a fee. These fees must
be grouped together under the
heading ―Fees,” identified by the type
of fee (such as ―late fee,‖ ―cash
advance fee,‖ or ―balance transfer
fee‖) and itemized for each fee. These
fees must be totaled using the term
―Fees,” which must be disclosed for
the statement period and calendar
year to date;
We recommend that financial institutions
mirror the model forms and include the two
above items in their periodic statements.
Subsequent Disclosures and Change in
Terms Notices for Open-End Credit
(Other than Home-Equity Plans). If a
creditor does not provide the short form
billing error notice on or with its periodic
statements, it must provide a long form
notice at least annually. If a creditor adds a
new credit feature to a plan or provides a
new way to access the credit line, and the
previously disclosed finance charge terms
apply to the new feature or access method,
then that must be disclosed before the first
transaction with the new feature or access
method. If different finance charge terms
apply, then a new disclosure of the
applicable finance charge must be given.
Section 226.9
Disclose an address for notice of
billing errors; or in the alternative, the
address may be placed on the billing
error notice, for which there are model
forms located in Appendix G to the
regulation. The standard, however, is
to preprint the following on the back of
the statement: (1) the short form billing
error notice; (2) a statement of how
the balance on which the finance
charge computed was determined;
and (3) a statement that the periodic
rate may vary;
If a creditor makes a significant change in
account terms of a plan that was required to
be disclosed in the account opening
disclosures, then the creditor must provide
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advance written notice of the change to
each consumer who may be affected. A
―significant change in account terms,‖
means either: (1) a change to a term that is
required to be disclosed in the account
opening disclosure; (2) an increase in the
required minimum periodic payment; or (3)
the acquisition of a security interest.
Truth in Lending
Regulation Z
A statement that the consumer may
find additional information about the
summarized changes, and other
changes to the account, if applicable;
If the creditor is changing a rate on the
account (other than a penalty rate), a
statement that if a penalty rate
currently applies to the consumer's
account, the new rate described in the
notice will not apply to the consumer's
account until the consumer's account
balances are no longer subject to the
penalty rate; and
The advance notice must be provided at
least 45 days prior to the effective date.
The 45-day requirement does not apply
where the consumer has agreed to the
particular change; however, where that
occurs, notice must be given before the
effective date of the change.
If the change in terms being disclosed
is an increase in an annual percentage
rate, also disclose the balances to
which the increased rate will be
applied. If applicable, a statement
identifying the balances to which the
current rate will continue to apply as of
the effective date of the change in
terms.
If the change in terms is either: (1) an
increase in any component of a charge; (2)
an introduction of a new charge; or (3) is not
a significant change in terms, then the
creditor may provide notice by either
complying with the 45-day rule, or providing
the notice (orally or in writing) before the
consumer agrees to (or otherwise becomes
obligated to pay) the charge at a time and
manner that the consumer is likely to notice
the disclosure of the charge.
The change in terms notice also has
formatting specifications. The disclosures
required for a change in account terms must
be in a tabular format (except for a
summary of any increase in the required
minimum periodic payment), with headings
and in a format substantially similar to any
of the account-opening tables found in the
model forms provided in Appendix G-17.
The table must disclose the changed term
and information relevant to the change, if
that relevant information is required in
account opening disclosures. The new
terms must be described in the same level
of detail as required when disclosing the
terms in the account opening disclosures,
using the same tabular format and bolding
requirements as described in the ―Account
Opening Disclosures‖ section in this
chapter.
A change in terms notice for a significant
change in account terms must include the
following disclosures:
A summary of the changes made to
the required terms;
A description of any increase in the
required minimum periodic payment,
as applicable;
A description of any security interest
being acquired, as applicable;
A statement that changes are being
made to the account;
A statement indicating the consumer
has the right to opt out of these
changes (if applicable), and a
reference to additional information
describing the opt-out right provided in
the notice, if applicable;
If a required change in terms notice is
included on or with a periodic statement, the
change in terms notice disclosure
requirements must be disclosed on the front
of any page of the statement. The summary
of changes must immediately follow the
significant account change account terms
information, and must be substantially
The date the changes will become
effective;
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Regulation Z
accordance with any requirements you have
established for making loan payments. If
you do not specify, in writing, any
requirements for making loan payments,
any such payments may be made at any
location where you conduct business, any
time during your normal business hours,
and by cash, money order, draft, or other
similar instrument or by electronic fund
transfer if you and the consumer have so
agreed.
similar to the format shown in the sample
provided in Appendix G-20 or G-21.
If a required change in terms notice is not
included on or with a periodic statement, the
change in terms notice disclosure
requirements must, at the creditor's option,
either be disclosed on the front of the first
page of the notice or segregated on a
separate page from other information given
with the notice. The summary of changes
may be on more than one page. The
creditor may use both the front and reverse
sides, provided that the table begins on the
front of the first page of the notice and
includes a reference on the first page
indicating that the table continues on the
following page. The summary of changes
must immediately follow the significant
account change account terms information,
and be substantially similar to the format
shown in the sample provided in Appendix
G-20 or G-21.
Crediting of Payments for Open-End
Loans. Financial institutions are required to
credit payments to a consumer‘s open-end
account as of the date of receipt, except
where a delay in crediting does not result in
either a finance charge or another type of
charge.
You may, however, specify
reasonable
requirements
(and
we
recommend that you do) for making
payments, as long as the requirements
enable
most
consumers
to
make
conforming payments. Section 226.10
Payment Issues – Open-End
Credit
Reasonable requirements for open-end
credit payments may be such requirements
as:
Credit Balance. The creditor must refund a
credit balance upon the consumer‘s written
request. If the credit balance remains for six
months and the consumer has not requested
it, the creditor must make a good faith effort
to return it. Section 226.11
Requiring
that
payments
be
accompanied by a payment stub or
account number;
Setting reasonable cut-off times for
payments to be received by mail,
electronic means, telephone, and in
person, provided that such cut-off
times are no earlier than 5 p.m. on the
payment due date at the location
specified by the creditor for the receipt
of such payments;
Crediting of Payments. Historically, a
creditor has been required to credit openend payments as of the date of receipt,
unless a creditor specified, on or with the
periodic statement, any requirements for the
consumer to follow in making his or her
payments. The creditor could set a cut-off
time when payments must be received in
order to be credited as of that day. Now,
any requirements that you establish for
consumers to make their loan payments
must be reasonable and in writing. In other
words, it shouldn't be difficult for most
consumers to make conforming payments.
Therefore it‘s important for you to inform
your borrowers of the means by which a
―conforming payment‖ must be made.
Conforming
payment is
Truth in Lending
Specifying that only checks or money
orders should be sent by mail;
Specifying that such payments are to
be made in U.S. Dollars; or
Specifying a particular address for
receiving payments, such as a post
office box.
Although the reasonable requirements do
not have to be in retainable form, they must
be in writing.
A sample conforming
payment notice for open-end credit plans
can be found at the end of this chapter.
Payment. A conforming
one that is received in
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Regulation Z
The disclosures must contain the following
information, to the extent applicable to the
financial institution‘s home-equity plans:
Home-Equity Lines of Credit
If the credit line is secured by the
consumer‘s dwelling, different disclosure
requirements apply. There are also some
limits on the terms of the plan and the
actions that creditors may take. Note that for
the home-equity plan rules to come into
play, the dwelling need not be the
consumer‘s
principal
dwelling.
For
Regulation Z purposes, a dwelling is a 1-4
family residential structure. Accordingly, an
open-end credit line secured by a vacation
home or rental house, if for a consumer
purpose, is a home-equity plan. Likewise, a
credit plan secured by a yacht or trailer is a
home-equity line, if the yacht or trailer is
used as a dwelling.
1. Terms of the Loan. The disclosures
shall include aspects of the terms of
the loan, including a statement that the
consumer should make or otherwise
retain a copy of the disclosures;
Note: The Federal Reserve has
explained that the financial institution
need not make the above disclosure
retention statement to the consumer if
the disclosures are themselves
already “retainable,” that is, if the
disclosures are not on the application
form that has to be returned to the
financial institution in order to apply for
the plan. If they are on a separate
sheet, this disclosure is not applicable.
Application Disclosures for Home-Equity
Plans. Home-equity plan disclosures must
be given to a consumer when the
consumer is given an application for a
home-equity plan.
Thus, when an
application is mailed to a consumer or put in
a financial institution‘s lobby as a brochure,
the required disclosure must accompany it.
In addition to the disclosure, a copy of the
Federal Reserve‘s brochure titled, “When
Your Home is on the Line: What You Should
Know About Home Equity Lines of Credit,”
or a suitable substitute, must be provided to
the consumer at the time an application is
provided.
A statement of the time by which
the consumer must submit his or
her application to obtain the
specific terms disclosed, and an
identification of any disclosed term
that is subject to change prior to
opening the plan; and
A statement that, if a term
disclosed
in
the
statement
changes before the plan is
opened, and the consumer elects
for that reason not to take
advantage of the plan, the
consumer may receive a refund of
all fees he or she has paid in
connection with the application.
In the disclosure, the information disclosed
must be clear, conspicuous, and segregated
from unrelated information. In addition, the
Federal Reserve has determined that
certain disclosures must be given before
others on the statement. That means they
must appear above and/or to the left of the
other disclosures. These ―first‖ disclosures
are the first four items set forth below.
Once these disclosures have been put on
the page, the others may follow in any order
that is not unclear or misleading. We
recommend continuing in the order used in
the regulation unless there is a strong
reason to deviate from that order.
Note: The Federal Reserve has
explained that this provision does not
require the financial institution to
guarantee any terms; however, if a
financial institution chooses not to
guarantee any terms, it must disclose
that all of the terms are subject to
change before the plan takes effect.
A financial institution is permitted to
guarantee some of the terms and not
others; in that case, it has to indicate
which terms are subject to change. A
financial institution may disclose either
a specific date or a time period for
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obtaining the disclosed terms (e.g., “by
July 23, 2010” or “within 20 days from
the date stamped on this disclosure”).
The consumer must be able to
determine from the disclosure the
specific date by which the application
must be submitted to obtain
guaranteed terms.
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Regulation Z
the annual percentage rate that
occur under the contract when the
consumer fails to make payments
on time.
Note: As previously mentioned, the
above disclosures must precede all
other disclosures.
4. Payment Terms. The disclosures
must include the payment terms of the
plan, including the following:
2. Security Interest. A statement that
the financial institution will acquire a
security interest in the consumer‘s
dwelling, and that loss of the dwelling
may occur in the event the consumer
defaults on the credit. The Federal
Reserve has not felt it necessary to
give any explanation of this item.
The length of the draw period and
any
repayment
period
(the
combined length of these two
periods need not be stated). If the
length of the repayment period
cannot be determined because it
depends
on
the
balance
outstanding when the repayment
period begins, the disclosure must
so state. If the length of the plan is
indefinite because, for example,
there is no limit on the period
during which the consumer can
take
advances,
a
financial
institution has to state that fact;
3. Action on the Loan. A statement that,
under certain conditions, the financial
institution may terminate the plan and
require payment of the outstanding
balance in full in a single payment and
impose fees upon such a termination.
This should include the following:
A disclosure that the financial
institution may prohibit additional
extensions of credit or reduce the
credit limit; and as specified in the
initial
agreement,
implement
certain changes in the plan; and
If,
under
the
contractual
documents, a financial institution
retains the right to review a line of
credit at the end of the specified
draw period in order to determine
whether to renew or extend the
draw
period,
the
financial
institution
must
ignore
the
possibility of a renewal or
extension of the draw period for
purposes of this disclosure. This is
true no matter how likely the
extension or renewal is, based on
the financial institution‘s prior
practice
and/or
the
creditworthiness of this particular
consumer;
A statement that the consumer
may receive, upon request,
information about the conditions
under which such actions may
occur; or in lieu of that disclosure,
a statement of the precise
conditions under which such
actions may occur. This item
requires disclosure of fees that the
financial institution imposes if the
institution itself terminates the plan
prior to normal expiration. It does
not require disclosure of fees that
are imposed if the plan expires in
accordance with the agreement or
if the consumer terminates the
plan prior to its scheduled maturity.
It also does not require disclosure
of fees associated with collection
of the debt, such as attorney‘s fees
and court costs, or to increases in
An explanation of how the
minimum periodic payment will be
determined and the timing of the
payments. If paying only the
minimum periodic payments may
not repay any principal, or may
repay less than the outstanding
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balance prior to maturity of the
plan, the financial institution must
state this fact, and state that a
balloon payment may result.
Although this disclosure must
reflect how the minimum periodic
payment is calculated, it only has
to describe the principal and
interest components of that
payment;
Truth in Lending
Regulation Z
recently used annual percentage rate,
showing: (1) the minimum periodic
payment; (2) any balloon payment;
and (3) the time it would take to repay
the $10,000 outstanding balance if the
consumer made only the minimum
periodic payments and obtained no
additional credit under the plan.
The Federal Reserve has said that a
financial institution may assume that
the credit limit (as well as the
outstanding balance) is $10,000 if
such an assumption would be relevant
to calculating the payments (if a
financial institution does not offer any
credit limits as high as $10,000, the
Federal Reserve says to assume
$5,000 instead).
Other charges along with the
balance computation method are
permitted to be disclosed, but are
not required under this provision;
If the plan permits the consumer to
pay part or all of the balance
during the draw period at a fixed
rather than variable rate, and over
a specified period of time, the
financial institution must disclose
this option. The disclosure must
include the rules relating to this
option, including: (1) the period
during which it can be selected; (2)
the length of time over which the
consumer can repay; (3) any fees
imposed on the consumer for
doing so; and (4) the specific rate
(or the index rate and margin) that
the financial institution will apply if
the consumer chooses this option;
and
The example should reflect a payment
composed only of principal and
interest (the financial institution is
allowed to provide an additional
example reflecting the addition of
other charges, although it need not do
so).
The Federal Reserve has also said
that financial institutions may assume
that all months have the same number
of days, and that all payments will fall
due on business days. In plans that
have multiple-payment options within
the draw period or within any
repayment period, the financial
institution may provide representative
examples instead of one for each
payment option.
When a balloon payment is
possible, the financial institution
has to disclose that possibility, no
matter how unlikely it may be. In
programs where it is certain that a
balloon payment will occur, such
as those providing for payments of
interest only during the draw
period and not stating a repayment
period, the disclosures must reflect
that fact (in all Truth in Lending
work, the term ―balloon payment‖
means a payment more than twice
the amount of the regular minimum
payment).
The Federal Reserve has established
three categories of payment options
that institutions may use: (1) interestonly plans; (2) fixed percentage or
fixed fraction of outstanding balance or
credit limit plans; and (3) ―all other‖
types of minimum payment options
(the latter includes plans that require
payment of a specific dollar amount
plus accrued finance charges).
Financial institutions are allowed to
pigeonhole their plans into one of
these three categories even if other
features exist, such as varying the
5. Payment Example. The disclosure
must include an example based on a
$10,000 outstanding balance and a
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length of the draw or repayment
period, including the required payment
of past-due amounts, including late
charges, and including required
minimum dollar amounts.
Truth in Lending
Regulation Z
dwelling is sold, typically by the
consumer‘s estate.
The disclosure requirements vary
depending on whether the plan
provides: (1) a specific period for
advances and disbursements, but
repayment only on the occurrence of
some future event, such as the death
of the consumer; or (2) the plan has
neither a specific period for advances
and disbursements nor a specific
repayment date, and both will be
determined by future events.
A financial institution is allowed to use
a single example within each category
to represent various options within that
category. For example, if the financial
institution permits minimum payments
of varying percentages of the
outstanding balance, the institution
may pick one commonly used
percentage and use it to illustrate that
category.
The
example
used,
however, must be either one
commonly chosen by consumers or a
―typical or representative‖ example.
In case 1, the financial institution
must disclose based on the
assumption that disbursements will
be made until they are scheduled
to end, and that repayment will
occur then, or no later than one
disbursement interval later. The
(single) payment is considered the
―minimum periodic payment‖ under
the regulation for disclosure
purposes. It is not considered a
balloon payment because there is
nothing for it to be more than twice
of. The example used in the
disclosure
of
the
minimum
payment should assume a single
draw in the amount of $10,000.
Separate examples must be given for
the draw and repayment periods
unless the payments are determined
the same way during both periods.
The institution must assume that a
$10,000 advance was taken at the
beginning of the draw period and was
then reduced according to the terms of
the plan. The financial institution must
assume that no additional advances
were taken at any time, including at
the beginning of any repayment
period.
In case 2, the financial institution
may assume that the consumer
will die according to actuarial
tables,
that
draws
and
disbursements will end then, and
that repayment will be required at
that time or no later than one
disbursement interval after that
time. If the terms of the plan will be
determined by events that do not
include the death of the consumer,
the financial institution must give
its disclosures based on the event
it believes is most likely to occur
first.
6. Payment Example for Reverse
Mortgages. Perhaps the ultimate in
negative amortization is the reverse
mortgage or home-equity conversion
mortgage. These programs represent
a small portion of the total home equity
lending industry. Retired people
frequently use them to supplement
their incomes, by realizing some of the
value they have accumulated in their
homes. Typically, the plan will provide
for draws at the consumer‘s option or
disbursements on a periodic (usually
monthly) basis for a fixed period or
until a particular event, such as the
consumer‘s death. Repayment usually
is provided in a single payment of all
principal and interest when the
In either case 1 or case 2, the
financial institution must ignore
any "nonrecourse" terms it has put
in its plans, and disclose as though
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Truth in Lending
Regulation Z
8. Itemization of Lender Fees. An
itemization of any fees imposed by the
financial institution whether assessed
on the opening, use, or maintenance
of the plan. These fees must be stated
as either a dollar amount or a
percentage, and include the time at
which they are payable. This item
includes such items as: application
fees, points, annual membership fees,
transaction fees, fees to obtain checks
for access to the plan, and fees for
converting to a repayment phase
provided for in the original contract.
The fees included here must be
disclosed whether they are retained by
the financial institution or by a third
party.
the consumer were going to be
required to make all payments.
Apparently recognizing that this
worst-case scenario might confuse
the consumers, the Federal
Reserve
has
published
commentary that permits financial
institutions to include a statement
that the disclosures are based on
this assumption even though the
amount the consumer may be
required to repay is limited by the
agreement.
Finally,
there
are
reverse
mortgages that provide for the
financial institution to share in any
appreciation in the value of the
consumer‘s dwelling, subject to
various limits. The financial
institution must disclose all of the
terms
of
such
sharing
arrangements,
including
the
manner in which the institution‘s
share will be determined, any
limits on that share, and the time
at which the institution may obtain
its share.
For example, if the financial institution
requires an annual credit check on the
consumer and requires the consumer
to pay the report fee charged by a
credit reporting agency, that report fee
must be specifically stated either as an
estimated dollar amount (for each fee)
or as a percentage of a typical or
representative dollar amount of a
credit.
7. Annual Percentage Rate. For fixedrate plans, the disclosures must
include both a recent annual
percentage rate imposed under the
plan by the financial institution, and a
statement that the annual percentage
rate does not include any costs except
interest. If the institution offers a
preferential fixed-rate plan in which the
preferential rate will increase a
specified amount upon the occurrence
of a specified event, the financial
institution must disclose the amount by
which the rate will increase if the event
occurs (one of the ways this can occur
is in discounted loan rates to
employees of the institution. Typically
the financial institution will have a
provision in its documents which says
that the rate will rise to some particular
rate or by some particular margin if
and when the employee leaves the
financial institution‘s employment).
Stepped-fee schedules, in which a fee
will increase a specified amount on a
specified date, are permissible. Fees
that are not imposed to open, use, or
maintain a plan need not be disclosed.
Examples include fees for researching
an account or photocopying items
related to the account, late-payment
charges,
stop-payment
charges,
returned-check charges, over limit
charges, or account termination fees.
If closing costs are imposed, they
must be disclosed in full even though
they may be rebated later. A number
of financial institutions have plans in
which closing costs are rebated up to
the amount of interest paid by the
consumer on the plan during the first
year of the plan. The potential rebate
of such fees must be ignored in
disclosing the amount of the fees.
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9. Estimate of Third Party Fees. A
good faith estimate (stated either as a
single dollar amount or range) of any
fees that may be imposed by persons
other than the financial institution to
open the plan.
Truth in Lending
Regulation Z
As with rebates of fees imposed by
the financial institution itself,
rebates of third-party fees are not
allowed to be considered in
disclosing the fees. The full
amount of the fees must be
shown,
regardless
of
any
possibility of rebate.
The consumer must also be given a
statement that he or she may receive
on request, a good faith itemization of
such. If the financial institution
chooses, however, it may give that
good faith itemization of fees along
with the good faith estimate stated
either as a single dollar amount or
range. In that case, the statement that
the consumer may receive an
itemization may be omitted from the
disclosures.
10. Negative Amortization. Negative
amortization occurs when a periodic
payment made by the consumer is
less than the interest that accrued
during the period. The unpaid interest
increases the principal amount the
consumer ultimately will have to pay.
Therefore, because the principal
balance is not reduced at all, interest
accumulates on the full amount of the
principal for the full life of the credit (or
for such shorter period as fluctuating
interest rates may cause negative
amortization). When the minimum
payment specified in the home-equity
plan will not or may not cover the
accrued
interest,
the
financial
institution must include a statement
that negative amortization may occur,
and that if it does, it will increase the
principal balance and reduce the
consumer‘s equity in the dwelling.
Note: This disclosure applies only to
fees commonly called closing costs;
that is, fees to open the credit plan. It
therefore does not require disclosure
of fees imposed at the end of a plan to
obtain release of the mortgage.
The typical fees included in this
disclosure are such things as the
appraisal, the credit report, and
attorney‘s fees. When property
insurance is required by the financial
institution, the institution may either
disclose the amount of the premium or
state that property insurance is
required. As noted, the disclosure
must be either a single dollar amount
or a range. The only exception is that
the total need not include property
insurance premiums if the financial
institution
discloses
that
such
insurance is required. The itemization
of third-party fees provided upon the
consumer‘s request (or supplied
initially by the financial institution to
avoid disclosing that the consumer
may request them) does not have to
include any disclosure about property
insurance. In providing the good faith
estimate of either an amount or range,
it is proper to disclose the estimate as
―$7 per $1,000 of credit,‖ for example.
11. Transaction
Limitations
and
Requirements. Any limitations on the
number of extensions of credit and the
amount of credit that may be obtained
during any time period must be
disclosed. In addition, a disclosure of
any requirements for a minimum
balance to be outstanding or a
minimum draw amount (all stated as
either dollar amounts or percentages)
must be included. The Federal
Reserve has stated that the financial
institution need not disclose a
limitation on the use of automated
teller machines unless that is the only
means by which the consumer can
obtain funds under the plan.
Therefore, unless that is the only
method, the prudential limits imposed
by many financial institutions on the
amount of cash withdrawal permitted
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from ATMs in a given time period
(such as no more than $800 a day)
need not be disclosed under this item.
Truth in Lending
Regulation Z
4. An explanation of how the annual
percentage rate will be determined,
including how the index will be
adjusted to achieve the APR stated
(such as by the addition of a
margin);
12. Tax Implications. The disclosures
must include a statement that the
consumer should consult a tax adviser
regarding the deductibility of interest
and charges under the plan. The tax
advantages of home-equity plans
make them more desirable to
borrowers than many other kinds of
consumer credit. The Federal Reserve
wants financial institutions to advise
consumers to obtain their own
independent tax advice concerning
whether the interest or other charges
on a particular home-equity loan will
be deductible by the consumer. The
possibilities for misleading advertising
(or misleading a particular consumer
in a particular home-equity loan
situation) are significant, and financial
institutions ought to be very careful
with what they say about tax
deductibility in either context.
5. A statement that the consumer
should ask about the current index
value, margin, discount or premium,
and annual percentage rate;
6. A statement that the initial annual
percentage rate is not based on the
index and margin used to make later
rate adjustments, and the period of
time the initial rate will be in effect;
7. The frequency of changes in the
annual percentage rate;
8. Any rules relating to changes in the
index value and the annual
percentage rate, and the resulting
changes in the payment amount;
9. Any annual (or more frequent
periodic) limitation on changes in the
annual percentage rate, or a
statement that no such limitation
exists;
Additional Application Disclosures for
Variable Rate Home-Equity Plans.
A
variable-rate plan is one where the interest
rate ―floats‖ or changes in reference to the
changing value of a published interest rate
such as New York Prime as published in the
Wall Street Journal. The published base
rate is called the ―index‖ and the number of
percentage points between the rate charged
the customer and the index is called the
margin. Section 226.5b(d)(12)
10. The maximum annual percentage
rate that may be imposed under
each payment option;
11. The minimum periodic payment
required when the maximum annual
percentage rate for each payment
option is in effect. The financial
institution should assume there is a
$10,000 outstanding loan balance
for this example. The financial
institution also must state the
earliest date that this maximum rate
may be imposed;
The additional items that must be disclosed,
to the extent applicable, for variable-rate
plans are:
1. The fact that the annual percentage
rate, periodic payment, or term may
change due to the variable-rate
feature;
12. A historical table, based on a
$10,000
extension
of
credit,
illustrating how annual percentage
rates and payments would have
been affected by index value
changes implemented according to
the terms of the plan. This table
must be based on the most recent
2. A statement that the annual
percentage rate does not include
costs other than interest;
3. The index used in making rate
adjustments and a source of
information about the index;
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15 years of index values and must
reflect all significant plan terms; and
Truth in Lending
Regulation Z
the latter option, a financial institution might
state, ―The maximum annual percentage
rate that can apply to your home-equity line
will be seven percentage points above your
initial rate.‖ In this case, the financial
institution must include a statement that the
consumer should inquire about the rate
limitations that are currently available. The
limitations referred to in this item do not
include legal limits such as state usury laws
or state or federal regulations limiting the
amount of interest that may be charged.
13. A statement that rate information will
be provided on or with which
periodic statement sent to the
consumer under the plan.
While some of these items are selfexplanatory, others are not. The Federal
Reserve Board, therefore, published
commentary to explain them. For example,
for the fourth item, the financial institution
need not disclose the specific value for the
margin. A simple statement such as ―Your
annual percentage rate is based on the
index plus a margin‖ is sufficient. Comment
#1 to Section 226.5b(d)(12)(iv)
If there are multiple periodic or maximum
rate limitations currently available, the
financial institution need not disclose each
one separately. Instead, the financial
institution may disclose the range of the
lowest and highest periodic and maximum
rate limitations applicable to its plans. If the
financial institution uses this alternative, it
must include a statement that the consumer
should inquire about the limitations currently
available.
The sixth item, of course, is designed to
help consumers avoid being misled by low
initial or ―teaser‖ rates.
The Federal Reserve Board has stated that
the eighth item requires disclosure of any
preferred rate provisions, such as those for
employees of the financial institution, which
would be canceled if employment were
terminated. That item also requires
disclosure of any options the financial
institution offers the consumer to convert
from a variable to a fixed rate. Comments
#1 and 2 to Section 226.5b(d)(12)(viii)
In calculating the payment example for item
11, any discount or premium initial rates or
periodic rate limitations should be ignored. If
a range is used to disclose the maximum
cap, the highest rate in the range must be
used for the disclosure. The financial
institution need not make disclosures based
on each payment option; however, if it does
not, it must then choose a representative
example within each of the three categories
of payment options on which to base this
disclosure (see the previous section for
details of the three categories). The
financial institution must provide separate
examples for the draw period and for any
repayment period unless the payment is
determined the same way during both
periods. As mentioned in the previous
section, the financial institution normally
must use a $10,000 balance in the example,
but may use a $5,000 balance if the
financial institution does not offer lines as
high as $10,000.
Item 9 has been clarified to state that if the
financial institution bases its rate limitation
on 12 monthly billing cycles, the financial
institution should treat that limitation as an
annual cap. Rate limitations calculated on
less than an annual basis must be stated in
terms of a specific amount of time. Semiannual limitations, for example, must be
expressed as limitations based on a sixmonth time period. Finally, if the financial
institution does not impose periodic limits
(annual or shorter) on increases in the
interest rate, the financial institution must
state that there are no annual rate
limitations under the plan. Comment #1 to
Section 226.5b(d)(12)(ix)
In stating the date or time by which the
maximum rate could be reached, the
financial institution must assume that the
rate will increase as rapidly as possible
Item 9‘s requirement may be satisfied by
stating the limit either as a specific
percentage rate, such as ―22%‖ or as a
specific amount above the initial rate. Using
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Truth in Lending
under the terms of the plan. Here, unlike
most other disclosure situations for homeequity plans, the financial institution is
required to factor in any discounted or
premium initial rate or periodic rate
limitations. This disclosure must be provided
both for the draw phase and any repayment
phase.
Regulation Z
that all payments are made on the last day
of the billing cycle, the billing date, or the
payment due date, as it chooses.
Account Opening Disclosures for HomeEquity Plans. After a financial institution
has supplied the brochure and all
disclosures required at the time at which the
consumer receives an application for a
home-equity plan, it needs to prepare for
the additional disclosures required if the
consumer applies and is approved for such
a
plan.
Certain
home-equity
plan
disclosures that were given in general terms
in the initial or application disclosures must
now be made specific to the particular
home-equity plan agreement. Section 226.6
Without restating all of the details (please
refer to the earlier treatment of each item for
those details) the items are:
The 15-year table required in the item 12
example must present index values and
annual percentage rates for the entire 15
years, and must be based on the most
recent 15 years. Therefore, the disclosure
must be updated annually. If the value for a
particular index used by the financial
institution has not been available for parts of
the previous 15 years, the financial
institution need only go back as far as the
value has been available. In that case, it
may also start the example at the year for
which the index value first became
available.
A statement of the conditions under
which the financial institution may take
certain action, such as terminating the
home-equity plan or changing the
terms of the plan;
The financial institution may use index
values as of any date or period within a
year, so long as the same date or period is
used for each year in the example. Even
though the plan may provide for
adjustments to the interest rate more
frequently than once a year, only one index
value per year need be shown. The financial
institution is entitled to assume, for
disclosure purposes, that the index
remained constant for the full year for
purposes of calculating the example
required by item 12.
The payment information for both the
draw period and any repayment
period;
A statement that negative amortization
may occur;
A statement
requirements;
A
statement
implications;
As in other contexts discussed in the
previous section, the financial institution
should assume that the $10,000 balance
used in the example is an advance that was
taken at the beginning of the first billing
cycle. The financial institution also should
assume that balance was then reduced
according to the terms of the plan, and that
the consumer took no draws thereafter. As
with the interest rate, the payment amount
need only be stated as a single amount for
each year, even though an actual payment
amount might have varied during the year.
The financial institution may assume that all
months have an equal number of days, and
of
any
transaction
regarding
tax
A
statement
that
the
annual
percentage rate does not include costs
other than interest;
The variable-rate disclosures; and
The example based on a $10,000
outstanding balance and a recent
annual percentage rate, showing the
minimum periodic payment, any
balloon payment, and the time it would
take to repay that $10,000 balance if
the consumer made only those
payments and obtained no additional
extensions of credit. The example may
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Truth in Lending
Regulation Z
Subsequent Disclosures and Change in
Terms Notices for Home-Equity Plans.
Section 226.9(c)(1) When either a term
required to be disclosed in the account
opening disclosures is changed, or the
minimum periodic payment is increased, the
creditor is required to provide advanced
written notice either by mail or hand delivery
at least 15 days prior to the effective date of
the change. The 15-day time requirement
does not apply, however, if the change has
been agreed to by the consumer; in this
case, it need only be provided prior to the
effective date of the change. Changes
initially disclosed for example could be:
be omitted if the financial institution
initially provided the application
disclosures in a form the consumer
could keep, and included that
representative example for the
category of payment option that was
chosen by the consumer.
Contract Requirements. In addition to
required Regulation Z disclosures, there are
required disclosures for the creditor‘s
contract with the borrower.
When the
home-equity plan has a variable interest
rate, if the interest rate may increase during
the term of the credit, the financial institution
must include in its contract with the
consumer the maximum interest rate that
may be imposed on the credit. The
commentary to Regulation Z gives several
examples of this rate-cap disclosure that are
sufficiently specific:
Rate increases under a
disclosed variable-rate plan;
properly
A rate increase that occurs when an
employee has been under a
preferential rate agreement and
terminates employment; or
―The maximum interest rate will not
exceed X%.‖
An increase that occurs when the
consumer has been under an
agreement to maintain a certain
balance in a savings account in order
to keep a particular rate and the
account balance falls below the
specified minimum.
―The interest rate will never be higher
than X percentage points above the
initial rate of Y%.‖
―The interest rate will not exceed X%,
or Y percentage points above [a rate
to be determined at some future
time].‖
A creditor need not provide notice when
the change involves a reduction of any
component of a finance charge (or other
charge) or when the change results from an
agreement in a court proceeding.
―The maximum interest rate will not
exceed X% or the state usury ceiling,
whichever is less.‖
Contrast those ―good‖ disclosures with
the following, which have been found
insufficiently specific under the
regulation:
If, however, a creditor either prohibits
additional extensions of credit or reduces
the credit limit, the creditor shall mail or
hand deliver written notice of the action
within three business days, to each
consumer who will be affected. If the
creditor requires the consumer to request
reinstatement of credit privileges, then
notice then shall state that fact.
than X percentage points over the
prevailing market rate.‖
than X percentage points above [a
rate to be determined at some future
point].‖
The change in terms may be provided by
either a complete new set of disclosures
that highlight the content that is changed, or
a disclosure statement may be provided
with a letter indicating the changed terms.
―The interest rate will not exceed the
state usury ceiling, which is currently
X%.‖
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Unavailable Index. If the original index
selected by the financial institution ceases
to be available, Regulation Z permits the
financial institution to select another index
on which to base its annual percentage
rates for home-equity plans. The new index
may be one which by itself is substantially
similar to the old one, or it may be one
which, with a larger or smaller margin added
to it, will generate a substantially similar
annual percentage rate for the financial
institution‘s home-equity plans. In the latter
case, the financial institution is allowed to
change both the index and the margin in
order to achieve the substantially similar
annual percentage rate. The consent of the
consumer is not required for such changes.
Section 226.5b(f)(3)(ii)
Truth in Lending
Regulation Z
Appraisals and Valuation Independence.
It is also important to be aware that the
appraisal and valuation independence rules
under Regulation Z also apply to HELOCs.
For more information on these rules see the
Appraisals and Valuation Independence
section which is addresses later in this
article.
Right of Rescission – Home
Equity Lines
When a financial institution takes a nonpurchase-money security interest in a
person‘s dwelling to secure consumer
credit, the financial institution must consider
the possibility that Regulation Z‘s rescission
provisions are applicable. That‘s exactly
what happens when a home equity line of
credit is secured by a consumer‘s principal
dwelling. Since rescission applies when the
dwelling is the principal dwelling of the
consumer, a home equity line of credit could
be rescindable.
Refund of Fees. As noted previously, the
consumer is entitled to a refund of all fees
he or she paid to anyone (whether the
financial institution or a third party) in
connection with an application for a homeequity plan under certain conditions. Those
conditions are that any term required to be
disclosed has changed before the plan is
opened, and the consumer decides for that
reason not to open the plan. The regulation
and the Federal Reserve Commentary
carve out an exception to this rule for
variable-rate home-equity plans. The
exception applies when the change is
caused by fluctuation of the index rate.
Thus, if the index rate rises, causing
changes in the minimum payment required,
the annual percentage rate imposed, the
number of payments, the rate cap, or any
other terms of the plan, the consumer is not
entitled to a refund of fees if, for that reason,
he or she decides not to open the plan.
Section 226.5b(g)
Business
purpose
loans,
residential
mortgage transactions, and refinancings of
an existing loan already secured by the
consumer‘s principal residence by the same
creditor are exempt from the right of
rescission.
With refinancings, the requirements vary,
depending on whether the loan is open or
closed end. Under the closed-end credit
rescission rules, refinancing transactions
with the same creditor without an advance
of new funds are exempted from the
rescission rules. If new money is advanced,
the new money is rescindable. No such
exemption applies to refinancings of openend credit, however. If you refinance a
home equity line of credit, the entire
refinanced transaction is rescindable. Also,
the refinancing of a loan held by a different
creditor is rescindable for open-end loans,
regardless whether new money is involved.
Another tricky issue with home equity lines
of credit are those that are used for
purchase money of a principal dwelling.
While the funds used for the purchase
money portion are not rescindable, the
funds that become available to be re-drawn
Neither a creditor nor any other person may
impose a non-refundable fee in connection
with an application until three business days
after the consumer receives the required
home equity disclosures and brochure. If
they are mailed, the consumer is considered
to have received them three business days
after they are mailed.
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after the purchase money portion is repaid,
are rescindable. Therefore, at closing, a
financial institution should provide the
proper rescission notice, indicating which
portion of the proceeds are rescindable.
Keep in mind that while any 1-4 family
dwelling can be used to secured a home
equity line, only those lines that are secured
by a principal dwelling have the right of
rescission.
Truth in Lending
Regulation Z
A consumer may exercise the right of
rescission by providing written notice of
rescission to the creditor during the
rescission period. If notice is sent by mail, it
is considered provided when mailed. Thus,
a consumer could place the rescission
notice in the mail at midnight of the third
business day and the rescission would be
effective. If the notice of right to rescind is
not provided, or the proper disclosures are
not given, then the rescission period ends
three years after loan closing.
In a transaction subject to rescission, a
creditor must deliver two copies of the
notice of the right to rescind to each
consumer entitled to rescind. The notice
must be a separate document. It must
identify the transaction and contain the
Before a lender may fund a rescindable
loan, it must wait until the three-businessday rescission period has run. It must also
be reasonably satisfied that the consumer
has not rescinded. To be reasonably
satisfied, a creditor may obtain a written
statement from the consumer that he or she
has not exercised the right of rescission.
Alternately, the creditor may wait not only
the three business days, but also a time
sufficient for a notice that was mailed at
midnight of the third day to arrive. Realize
that if on the fourth business day, a
consumer gives a creditor a written notice
stating that he or she has not exercised the
right of rescission, that notice does not
negate rescission if notice of rescission was
properly given. For example, at midnight of
the third business day, a consumer places a
notice of rescission in the mail; however, the
next day, that consumer gives the creditor a
statement indicating that he or she has not
rescinded and walks away with the loan
proceeds.
Although
the
consumer
―rescinded‖ their rescission, the loan is
treated nonetheless as rescinded.
That the creditor is acquiring or
retaining a security interest in the
consumer‘s principal dwelling;
That the consumer has the right to
rescind the transaction;
How the consumer can rescind the
transaction, together with a form for
that purpose designating the creditor‘s
address;
The effects of rescission; and
The date the rescission period ends.
Unless a consumer waives the right of
rescission, the creditor may not fund the
loan until the rescission period has expired,
and the creditor is reasonably satisfied that
the consumer has not rescinded. A
consumer may exercise the right of
rescission at any time up until midnight of
the third business day (for the purpose of
rescission Saturday is a business day)
following the later to occur of: (1) the
consummation of the loan, that is, signing
the loan documents; (2) delivery of the
rescission notice; or (3) delivery of the
material disclosures. If the notice of right to
rescind or accurate disclosures is not
provided to the consumer, the three-day
right-of-rescission period does not begin to
run.
When a loan is rescinded, the creditor‘s
security interest in the consumer‘s principal
dwelling becomes void. Within 20 days of
rescission, the creditor must release the
security interest and re-pay the consumer
all money the consumer paid or that was
paid on the consumer‘s account in
connection with the transaction. A creditor
must repay not only fees and costs that it
retained, but also fees and costs paid to
third parties such as appraisers. After the
creditor fulfills its obligations, and only then,
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the consumer
proceeds.
must
repay
the
Truth in Lending
Regulation Z
loan
If a consumer has a bona fide personal
financial emergency, the consumer may
waive the right of rescission. Examples of a
bona fide financial emergency are: a roof
blown off of a home by a tornado, or a sick
child in need of medical care. Conversely,
funds for use on a hot technology stock or
for placement on a winning horse do not
qualify. What is considered a bona fide
financial emergency is construed very
strictly. To exercise a waiver of the right of
rescission, a consumer must provide a
creditor with a dated and signed, written
statement that describes the emergency
and waives the right to rescind.
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Truth in Lending
Regulation Z
General Rules for Disclosures. As with
most consumer protection regulations, the
primary purpose of Regulation Z is
disclosure to the consumer of the terms of
the credit that he or she is receiving. The
required disclosures have a very rigid
format so that consumers can more easily
compare apples to apples when they shop
for credit. Three rules apply to all Regulation
Z disclosures for closed-end credit. Number
one, the disclosures must be clear,
conspicuous, in writing, and in a form that
the consumer may keep. Number two, the
required disclosures must be grouped
together, segregated from all other
information, and the segregated information
must not contain any information not directly
related to the required disclosures. Third,
the terms ―finance charge‖ and ―annual
percentage rate,‖ when required to be
disclosed, shall be ―more conspicuous‖ than
any other disclosure other than the
creditor‘s identity. These three requirements
have spawned the famous or infamous ―Fed
Box.‖ Section 226.17
Closed-End Credit
Closed-end credit is a loan where the
borrower does not have the right to reborrow principal that has been paid. A
mortgage is an example of a typical closedend credit plan. Section 226.2(a)(10) If
credit does not fall under the open-end
credit definition, it is by default closed-end
credit. Section 226.2(a)(10)
Most of the trickiest disclosure requirements
for a consumer purpose loan arise when a
dwelling secures the loan. A residential
mortgage transaction is an example of
closed-end dwelling secured loan. It is a
loan secured by a consumer‘s principal
residence where the proceeds of the loan
are used to purchase or finance the initial
construction of the residence. Accordingly, a
home improvement loan is not a residential
mortgage transaction because it is not for
the initial construction of the residence. But
it is a type of dwelling secured consumer
loan. A loan to refinance a purchase money
loan is not a residential mortgage
transaction either because its proceeds
were not used to purchase or construct the
residence. Section 226.2(a)(24) But it too,
is a type of closed-end loan secured by a
dwelling.
Special Application Disclosures for
Adjustable Rate Mortgages. The variablerate or ARM disclosures for a loan with a
term greater than one year secured by the
consumer‘s principal dwelling must be
delivered to the consumer at the time the
consumer is given the loan application. The
ARM disclosure requirement is not
predicated upon the loan being either a
residential mortgage transaction or covered
by RESPA.
Disclosures
The required disclosures for closed-end
credit must be provided to the consumer
prior to consummation of the transaction. In
some variable-rate transactions, certain
disclosures must be given at the time the
application is provided to the customer. In
addition to general disclosure requirements,
other special disclosures may be required,
depending on whether the loan is an
adjustable rate mortgage or whether the
mortgage servicing is to be transferred.
Subsequent disclosures may be required if
subsequent
events
cause
certain
inaccuracies in the initial disclosures. The
timing
requirements
for
the
initial
disclosures, the subsequent disclosures and
special disclosures are discussed in this
chapter.
If a variable-rate loan is secured by a
consumer‘s principal dwelling and has a
term greater than one year, then the
disclosure must state that the loan contains
a variable-rate feature and that the variablerate disclosures have been given earlier.
The ―earlier‖ disclosure, generally referred
to as adjustable-rate mortgage or ―ARM‖
disclosures, must be given at the time a
loan application is provided to a consumer.
There are two parts to the ARM disclosure.
The first part is a booklet published by the
Federal Reserve Board titled ―Consumer
Handbook on Adjustable Rate Mortgages,‖
often referred to as the ―CHARM Booklet.‖
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The second part is a disclosure for each
variable-rate program in which the
consumer expresses an interest. The
disclosure must contain the following, as
applicable:
Truth in Lending
Regulation Z
and payment for a $10,000 loan
(reflecting any discount or premium),
accompanied by a statement that the
payment may increase or decrease
substantially due to changes in the
rate, the maximum interest rate and
payment amount possible under the
program;
The fact that the interest rate,
payment, or term of the loan can
change;
An explanation of how the payments
for a loan amount can be calculated
based on the most recent payment
shown in the historical example;
The index or formula used in adjusting
the interest rate and a source of
information about the index. Unlike an
open-end loan, it is not a requirement
to tie a variable-rate loan secured by a
consumer‘s principal dwelling to an
independent index. The rate may be
adjusted at the creditor‘s discretion. If
that is the case, that fact must be
disclosed;
The maximum interest rate
payment for a $10,000 loan;
and
If the loan program contains a demand
feature, a statement of that fact;
A description of the information that
will be contained in notices of rate or
payment adjustments and the timing of
the notices; and
An explanation of how the interest rate
and payment will be determined,
including the addition of a margin to
the index;
A statement that disclosures are
available for the creditor‘s other
variable-rate programs.
A statement that the consumer should
ask about the current margin and
interest rate;
Early and Closing Truth in Lending
Disclosures for Closed-End Credit. For
many years, the regulation required a
separate set of early good faith Fed Box
disclosures to be provided in connection
with residential mortgage loan transactions.
Those early disclosures were required to be
given within three business days after a
creditor received an application from a
consumer for a loan to either purchase or
construct the borrower‘s principal dwelling
that was to be secured by that dwelling.
Section 226.18
The frequency that the interest rate or
payment may change;
If the initial interest rate will be
discounted (a ―teaser‖ rate), a
statement that it will be and that the
consumer should ask about the
discount;
Any rules relating to changes to the
index, interest rate payment amount
and loan balance, such as limits on
the amount the interest rate may
increase or decrease over a period,
the maximum increase or decrease
over the life of the loan, and similar
limitations;
Effective July 2009, the early good faith Fed
Box disclosures became required for all
closed-end, Regulation Z-covered loans that
are secured by a consumer‘s dwelling
(principal or otherwise) and are RESPAcovered loans. These disclosures must be
provided within three business days after
the creditor receives the consumer‘s written
application, and at least seven business
days prior to consummation. Section
226.19(a)(1)(i) The specific rules for delivery
Either an historical example covering
the most recent 15 years showing how
payments and the loan balance would
have been affected by interest rate
changes implemented in accordance
with the terms of the loan program, or
a statement of the initial rate
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of these early disclosures are described
later in this chapter.
Truth in Lending
Regulation Z
delivered or placed in the mail within three
business days after receipt of the
consumer‘s application. ―Business days‖ for
this three-day timeframe is defined as ―days
on which a creditor‘s offices are open to the
public for carrying on substantially all of its
business functions.‖ Section 226.2(a)(6) If
you are ―substantially open for business‖ on
Saturdays, you would count Saturdays
when calculating the three days allowed to
provide the disclosure. If your institution is
not ―substantially open for business‖ on
Saturdays, then that would not be a day that
you would consider when counting the three
allowable days.
The fundamental requirement of all
disclosures is that they accurately describe
the legal obligation between the parties. In
calculating the annual percentage rate for
the disclosures, some minor discrepancies
may be ignored, such as the occurrence of
a leap year, the fact that months have
different numbers of days, and within limits,
that there is an irregular amount of time until
the first payment is due. If a loan is payable
on demand, the disclosures should assume
a term of one year. If a loan is payable
either on a maturity date or upon demand,
then the disclosures should be based on the
stated maturity date. Because early Fed
Box disclosures are required to be given
before consummation of a loan, all of the
details of the loan may not be known at the
time the disclosures are prepared. In that
case, the disclosures should be prepared on
the best information reasonably available
and the estimated items should be noted as
such by placing ―(e)‖ beside them.
Frequently, if one disclosure is estimated,
that individual estimate will affect other
disclosures. For example, if the finance
charge is estimated, then the APR must be
an estimate also. The (e) may be placed
after each estimated item or after only the
item that was primarily affected.
The early good faith Fed Box must also be
delivered or placed in the mail at least
seven business days prior to the closing of
the loan. The definition of ―business days‖
for this period is different from the one for
the three-day period. For the seven days,
you use ―all calendar days except Sundays
and specified legal public holidays.‖ Section
226.2(a)(6) Here, it does not matter whether
your institution is open for business on
Saturdays; every day counts except for
Sundays and certain public holidays.
If the early good faith Fed Box disclosure
contains an APR that is inaccurate outside
of the tolerance of one-eighth of one
percentage point in a regular transaction, or
one-fourth of one percentage point in an
irregular transaction, the customer must
receive an additional, corrected disclosure
no later than three business days before the
date of closing. If something other than the
APR was wrong, a corrected final disclosure
should be provided prior to closing;
however, since a non-APR correction is
required only for the closing Fed Box
disclosure (and not the early Fed Box
disclosure), no waiting period is required.
Section 226.19
If the early Fed Box disclosures are given to
a consumer and subsequent events make
them inaccurate, then the changed terms
must be re-disclosed before the loan is
closed.
For example, since early
disclosures are given based on the
information available at that time of
disclosure, a term in the loan may change
(such as an additional finance charge that
was unknown at the time of the disclosure)
that requires re-disclosure. If re-disclosure
is required, the subsequent disclosures
must be provided in accordance with the
delivery requirements.
If you provide the revised early Fed Box
disclosure in person, the three-day waiting
period can start as soon as the customer
has received the disclosure.
However,
revised disclosures that are mailed are
assumed to be received by the customer
three business days after they are mailed.
The early good faith Fed Box disclosures
must be provided to the customer before a
fee can be charged, except for a reasonable
credit report fee. The disclosures must be
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Once they are received, the three-day
waiting period to close the loan can start.
Therefore, if you mail the revised
disclosures, you cannot close the loan until
six business days later. For purposes of
calculating the three business days to close
the loan and three business days for mail to
be deemed received, business days include
all calendar days except Sundays and
certain holidays.
Truth in Lending
Regulation Z
providing this disclosure, a creditor
may give the consumer written notice
that the itemization is available and a
space for the consumer to check to
indicate that the consumer requests
the disclosure;
The amount of the finance charge;
The annual percentage rate;
The number, amounts, and timing of
payments scheduled to repay the
obligation;
Like rescission, the new early good faith
Fed Box disclosure timing requirements
may be waived to expedite consummation
of the transaction.
If the consumer
determines that the extension of credit is
needed to meet a bona fide personal
waive or modify the timing requirements for
the disclosures.
The consumer must
provide a dated, written statement
describing the emergency and specifically
waiving
or
modifying
the
timing
requirements, and it must be signed by all of
the borrowers.
Effective January 30, 2011, the
payment schedule was replaced by
the ―interest rate and payment
summary‖ for closed-end transactions
secured by real property or a dwelling.
Section 226.18(s)
For closed-end
transactions not secured by real
property or a dwelling, the rules of
226.18(g) still remain effective (the
specific rules are described later in
this chapter);
The following is the information that must be
contained in early and closing Truth in
Lending disclosures:
The total of payments the consumer
will pay to satisfy the obligation;
If the loan has a demand feature,
must be disclosed. Also, if
disclosures were based on
assumed maturity of one year,
must be disclosed;
The identity of the creditor;
The amount financed. The ―amount
financed‖ is the amount of the loan
minus any prepaid finance charges. A
prepaid finance charge is a finance
charge that is paid by the consumer
prior to or at closing. For example,
interest is a finance charge. Interest
collected at closing is a prepaid
finance charge;
that
the
an
that
If a penalty will be imposed for
prepayment, that must be disclosed.
Additionally, if a consumer will receive
a rebate of any finance charge upon
prepayment of the loan, that must be
disclosed;
An itemization of the amount financed.
The creditor must enumerate the
proceeds of the loan distributed to the
consumer, the amount credited to the
consumer‘s account with the creditor,
amounts paid to third parties by the
creditor on the consumer‘s behalf,
identifying who was paid each amount,
and the prepaid finance charge. In a
RESPA-covered loan, the good faith
estimate can substitute for this
disclosure. Alternatively, rather than
If charges will be imposed for late
payment of an installment, the dollar
or percentage charge that will be
imposed;
If the loan will be secured,
description of the collateral;
a
If credit life or other similar insurance
is being purchased and is excluded
from the finance charge, then there
must be a disclosure of the premium
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and a space for the consumer to
affirmatively request the insurance
coverage;
Truth in Lending
Regulation Z
The effect of an increase; and
An example of the payment terms that
would result from an increase.
If taxes on the transaction, recording
fees, and other similar costs are to be
excluded from the finance charge,
they must be itemized and disclosed;
Payment Table Disclosures
Effective January 30, 2011, the Federal
Reserve Board revised the disclosure
requirements for mortgage loans under
Regulation Z – Truth in Lending Act (TILA).
The revision implements provisions of the
Mortgage Disclosure Improvement Act
(MDIA) and requires new payment
schedules for certain types of transactions.
The payment schedule that we have been
used to for decades has been replaced by
the ―interest rate and payment summary‖ in
the form of a table. For these transactions
only, the payment schedule portion of the
―fed box‖ is changing; the rest of the
disclosure stays the same.
A statement that the consumer should
refer to the loan documents for
information
about
nonpayment,
default, the creditor‘s right to demand
full payment of the loan, and
prepayment penalties and rebates;
In a residential mortgage transaction,
a statement of whether or not a
purchaser of the dwelling will be
allowed to assume the remaining
obligation on its original terms;
If a creditor requires the consumer to
maintain a deposit as a condition of a
transaction (such as a loan secured by
a time deposit), a statement that the
APR does not reflect the effect of the
required deposit. If the account earns
interest at the rate of 5% or more, this
disclosure is not required. An escrow
account is not a deposit for this
purpose; and
The interest rate and payment summary
table rules apply to most closed-end
transactions secured by real property or a
dwelling. Real property means land and all
the things that are attached to it. Anything
that is not real property is personal property
and personal property is anything that isn't
nailed down, dug into or built onto the land.
A house is real property, but a dining room
set is not. Transactions secured by a
consumer‘s interest in a timeshare plan are
not impacted by the interest rate and
payment summary alternate disclosure.
Section 226.18(s) was added to the
regulation to implement the alternate table
disclosures.
The early good faith Fed Box
disclosures must include a warning
indicating, ―You are not required to
complete this agreement merely
because you have received these
disclosures or signed a loan
application.‖ This notice must be in a
conspicuous type size and format.
Section 226.19(a)(4)
The TILA did not previously require
disclosure of the contract interest rate for
closed-end credit. However, the new table
disclosures require financial institutions to
disclose the contract interest rate, regular
periodic payment, and balloon payment, if
applicable. The requirements to use the
interest rate and summary tables apply to
both the ―early‖ and ―final‖ TILA disclosures.
For all other closed-end credit transactions,
it‘s business as usual. Institutions should
continue to provide the standard Truth-in-
If the loan is one in which the APR may
increase after the loan is consummated or
closed, and it is not secured by the
consumer‘s principal dwelling or is so
secured and has a term of less than one
year, then the disclosure statement must
also contain the following information:
The circumstances under which the
rate may change;
Any limitations on the increase;
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Lending disclosure that has been provided
since the inception of the regulation.
Truth in Lending
Regulation Z
Model Forms and Clauses
The information required by this rule must
be in the form of a table and similar to
Model Clauses H-4(E), H-4(F), H-4(G), H4(H), H-4(I), H-4(J), or H-4(K) in Appendix H
of Regulation Z. The sample forms include
shading which can at times undermine the
forms‘ legibility when they are photocopied
or faxed. It is permissible to use the forms
without the shading factor as long as they
are substantially similar to the model forms.
The rules require a minimum 10-point type
size and no unrelated information may be
included in the sample forms. Financial
institutions may make changes to the format
or content of certain model forms without
losing TILA‘s protection from liability for their
use. However, no changes may be made to
model clauses H-4(E), H-4(F), H-4(G) and
H-4(H).
Although most of the table disclosure rules
were effective January 30, 2011, there are
three recent amendments to the rules with
mandatory compliance dates of October 1,
2011. Compliance with those three
amendments is optional between January
30, 2011 and October 31, 2011.
Definitions
The interest rate and payment table
disclosure rules have several terms that
have been specifically defined for this
section.
Adjustable Rate Mortgage. A transaction
which the APR may increase after
consummation.
Step-Rate Mortgage. A transaction which
the interest rate will change after
consummation, and the rates that will apply
and the periods for which they will apply are
known at consummation.
Model H-4(E) – Fixed Interest Rate. This
form typically has four rows and one column
of information that needs to be completed.
The interest rate, principal and interest,
estimated taxes plus insurance escrow, and
the total estimated monthly payment. If an
escrow account is established then the
estimated payment amount for taxes and
insurance (including mortgage insurance)
must be disclosed.
Credit insurance
products such as credit life, credit
suspension or debt cancellation are
excluded.
Fixed Rate Mortgage. A transaction that is
not adjustable rate or step-rate mortgage.
Interest Only. Under the terms of the legal
obligation, one or more periodic payments
may be applied solely to accrued interest
and not to loan principal.
Interest Only Loan. A loan that permits
interest only payments.
Amortizing Loan. A loan in which the
regular periodic payments cannot cause the
principal balance to increase.
Although reverse mortgages are excluded in
the definition of ―negative amortization, they
are not currently excluded from the
requirements under this section of the rules.
Negative Amortization. Regular periodic
payments may cause the principal balance
to increase.
Model H-4(F) – Adjustable Rate or StepRate. There are four rows and three
columns on this form. The rows include the
interest rate, principal and interest,
estimated taxes plus insurance escrow, and
the total estimated monthly payment.
Negative Amortizing Loan. Loan that
permits payments resulting in negative
amortization, but explicitly excludes a
reverse mortgage.
For adjustable-rate or step-rate amortizing
loans, up to three interest rates and
corresponding periodic payments are
required,
including
the
introductory,
Fully Indexed Rate. The interest rate
calculated using the index value and margin
at the time of consummation.
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maximum during first five years and the
maximum possible interest rate and
payment. If payments are scheduled to
increase independent of an interest-rate
adjustment, the increased payment must be
disclosed.
Truth in Lending
Regulation Z
payment at consummation with the payment
itemized to show that the payment is being
applied to interest only; the interest rate and
payment when the interest-only portion; the
maximum interest rate and payment during
the first 5 years; and the maximum possible
interest rate and payments.
The maximum rate is the rate that could
apply during the first five years after
consummation. This rule has recently been
amended to reflect that the maximum rate
that could apply during the first five years
after the first regular payment due date.
The mandatory effective date for this part of
the rules is
October 1, 2011. The
clarification is intended to ensure the
disclosures are consistent with the manner
in which payments are typically structured
for adjustable-rate transactions that are 5/1
ARM loans. Institutions have the option to
include this amendment in their disclosures
prior to the effective date.
For a step-rate mortgage, the financial
institution should disclose the rate that will
apply after consummation. For example,
the legal obligation may provide that the
rate is 6% for the first 2 years following
consummation, and the increase to 7% for
at least the next 3 years. The financial
institution should disclose the maximum rate
during the first five years as 7% and the
date on which the rate is scheduled to
increase to 7%.
For ARM loans with an interest-only option
for each interest rate disclosed, financial
institutions must disclose the earliest date
that the rate may apply and the
corresponding periodic payment. For an
interest-only loan, if the corresponding
payment will be applied to both accrued
interest and principal, the rules require that
the earliest date that such payments will be
required to be disclosed.
The recent
amendments to these rules (*effective
October 2011) would eliminate the potential
conflict from disclosing two different dates in
the same column by clarifying that financial
institutions should disclose the earliest date
that the interest rate becomes effective, or
can change, rather that the date the first
payment is due under the new rate.
Institutions, as noted earlier, have the option
to include this amendment in their
disclosures prior to the effective date.
For ARM loans financial institutions must
take into account any interest rate caps
when disclosing the maximum interest rate
during the first five years. The financial
institution must also disclose the earliest
date on which that adjustment may occur. If
there are no interest rate caps other than
the maximum rate required, then the
financial institution should disclose only the
rate at consummation and the maximum
rate.
On some loans, the payment may increase
following
consummation for
reasons
unrelated to an interest rate adjustment.
For example, an ARM may have an
introductory rate for the first 5 years
following consummation and permit the
borrower to make interest-only payments for
the first 3 years. Under the rules the
financial institution must disclose the first
payment that will be applied to both
principal and interest. In such a case, the
rules require that the financial institution
also disclose the interest rate that
corresponds to the first payment of principal
and interest, even though the interest rate
will not adjust at that time. The table would
show, from left to right: the interest rate and
Model H-4(G) – Mortgage with Negative
Amortization. The definition of negative
amortization was revised to clarify which
transactions are covered by the special
disclosure requirements for such loans.
These disclosures were designed to show
consumers how their periodic payments
would increase over time and to enable
comparison between the consequences for
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Truth in Lending
Regulation Z
consumers of making ―minimum‖ and ―full‖
payments.
increase is scheduled to appear. As it
pertains to payments, the form shall include:
The recent amendments further clarify that
these disclosures apply only to loans where
consumers are allowed to make minimum
payments
that
result
in
negative
amortization. Therefore, the definition of
negative
amortization
excludes
loan
products that do not have a minimum
required payment that results in negative
amortization. This part of the rules goes
into effect October 1, 2011. Institutions
have the option to include this amendment
in their disclosures prior to the effective
date.
The minimum periodic payment
required until the first payment
increase or interest rate increase,
corresponding to the interest rate
disclosed;
The minimum periodic payment that
would be due at the first payment
increase and the second, if any,
corresponding to the interest rate;
A statement that the minimum
payment pays only some of the
interest, does not repay any
principal, and will cause the loan
amount to increase;
There are typically three rows and four
columns in this form. The rows include the
maximum interest rate, full payment option,
and the minimum payment option. The
columns include the introductory rate, date
of first adjustment, date of second
adjustment and the maximum rate.
The fully
amortizing periodic
payment amount at the earliest time
when such a payment must be
made, corresponding to the interest
rate; and
As it pertains to the rate, the form shall
include:
If applicable, in addition to the
payments in this section, for each
interest rate disclosed, the amount
of the fully amortizing periodic
payment, labeled as the ―full
payment option,‖ and a statement
that these payments pay all principal
and interest.
The interest rate at consummation
and, if it will adjust after
consummation, the length of time
until it will adjust, and the label
―introductory‖ or ―intro.‖
The maximum interest rate that
could apply when the consumer
must begin making fully amortizing
payments.
In addition to information disclosed in the
rows and columns, there are special
disclosures that are required to be disclosed
in close proximity to the table:
If the minimum required payment will
increase before the consumer must
begin making fully amortizing
payments, the maximum interest
rate that could apply at the time of
the first payment increase and the
date the increase is scheduled to
occur.
The maximum interest rate, the
shortest period of time in which such
interest rate could be reached, the
amount of estimated taxes and
insurance included in each payment
disclosed, and a statement that the
loan offers payment options, two of
which are shown; and
If a second increase in the minimum
required payment may occur before the
consumer must begin making fully
amortizing payments, the maximum interest
rate that could apply at the time of the
second payment increase and the date the
The dollar amount of the increase in
the loan‘s principal balance if the
consumer makes only the minimum
required payments for the maximum
possible time and the earliest date
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on which the consumer must begin
making fully amortizing payments,
assuming that the maximum interest
rate is reached at the earliest
possible time.
Truth in Lending
Regulation Z
to principal. Special rate and payment
disclosures are required for loans with
negative amortization.
Although the model form is titled, ―FixedRate Mortgage with Interest- Only Interest
Rate and Payment Summary Model
Clause,‖ the table lists columns for
―Introductory Rate‖ and ―Maximum Ever.‖
This is unclear as the rate for a fixed rate
loan, even with one interest-only payment,
will not increase. This only one interest rate
needs to be disclosed. There does not
appear to be a need for the ―Introductory
Rate‖ and Maximum Ever‖ columns and
may be confusing to the borrower.
Reverse mortgages have been excluded
from the definition of ―negative amortization
mortgage‖ because the special interest rate
and payment summary requirements for
negative amortization mortgages would be
especially
unworkable
for
reverse
mortgages and also especially likely to
cause consumer confusion. Most of the
credit being extended for reverse mortgages
is fixed-rate. As a result, under these
requirements, reverse mortgages are to be
disclosed
under
the
relatively
straightforward fixed-rate summary table
requirements.
Model H-4(I) – Introductory Rate
disclosure
for
Adjustable
Rate
Mortgages. For amortizing adjustable-rate
mortgages, if the interest rate at
consummation is less than the fully indexed
rate the rules require that financial
institutions place in a box directly beneath
the required table, the interest rate that
applies at consummation and the period of
time for which it applies. Also a statement
that, even if market rates do not change, the
interest rate will increase at the first
adjustment and a designation of the place in
sequence of the month and year, as
applicable, of such rate adjustment and the
fully indexed rate.
Model H-4(H) – Fixed Rate – Interest
Only. There are typically five rows and two
columns in this form. The rows include the
interest rate, principal payment, interest
payment, estimated taxes and insurance
(escrow) and total estimated monthly
payment.
The columns include the
introductory rate and monthly payment and
the maximum rate.
In an interest only loan, for each interest
rate disclosed financial institutions must
also disclose the corresponding periodic
payment and, if the payment will be applied
to only accrued interest, the amount applied
to interest, labeled as ―interest payment,‖
and a statement that none of the payment is
being applied to principal. If the payment
will be applied to accrued interest and
principal, the earliest date that such
payments will be required and an
itemization of the amount applied to accrued
interest and the amount applied to principal,
labeled as ―interest payment‖ and ―principal
payment‖ respectively.
Model H-4(J) – Balloon Payment. A
balloon payment is defined as a payment
that is more than two times a regular
periodic payment. In such a transaction the
balloon payment is to be disclosed
separately from other periodic payments
disclosed in the table.
If the balloon
payment is scheduled to occur at the same
time as another payment required to be
disclosed in the table, then the balloon
payment must be disclosed in the table.
Model H-4(K) – No Guarantee to
Refinance Statement. Financial institutions
are required to disclose a statement that
there is no guarantee that the consumer can
refinance the transaction to lower the
interest rate or periodic payments. The
If a borrower may make one or more
payments of interest only, all payment
amounts disclosed must be itemized to
show the amount that will be applied to
interest and the amount that will be applied
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statement may be placed inside the ―fed
box.‖
Truth in Lending
Regulation Z
of how it is documented. The advance of
new money is treated as a refinancing and
requires new disclosures. Further, if a
lender agrees to allow a subsequent
purchaser to assume a residential mortgage
transaction and become primarily obligated
for its payment, new disclosures are
required.
Model H-4(E). This form illustrates the
fixed interest rate and payment summary
table required under 226.18(s).
Model H-4(F). This form illustrates the
interest rate and payment summary table
required under 226.18(s) for adjustable rate
or step-rate mortgage transactions.
Adjustable Rate Mortgage Disclosures.
An adjustment to the interest rate on a loan
with a term greater than one year secured
by a consumer‘s principal residence
requires that a disclosure of the changes be
provided to the consumer. The disclosure
must be given at least once each year that
an interest rate change is implemented, and
it must be given not less than 25 days or
more than 120 days before a payment
change is made. The disclosure must state
the following:
Model H-4(G). This form illustrates the
required under 226.18(s) for a mortgage
transaction with negative amortization.
Model H-4(H). This form illustrates the
required under 226.18(s) for a fixed rate,
interest-only mortgage transaction.
Model H-4(I). This form illustrates the
introductory rate disclosure required by
226.18(s)(2)(iii) for an adjustable-rate
mortgage transaction with an introductory
rate.
The current and prior interest rates;
The index values on which the current
and prior rates are based;
Model H-4(J). This form illustrates the
balloon payment disclosure required by
226.18(s)(5) for a mortgage transaction with
a balloon payment term.
The extent to which the creditor has
foregone any increase in the interest
rate; and
The payment that will be due after the
adjustment and the loan balance. If
the payment will not fully amortize the
loan over its term, the disclosure must
state the payment that would amortize
the loan.
Model H-4(K). This form illustrates the noguarantee-to-refinance statement required
by 226.18(t) for a mortgage transaction.
Subsequent Disclosure
Requirements
Mortgage
Transfer
Notice.
This
amendment to Section 226.39 of Regulation
Z implements Section 404(a) of the Helping
Families Save Their Homes Act, and
requires a purchaser or assignee that
acquires a mortgage loan to provide written
disclosures to the borrower no later than 30
days after the date on which the loan was
sold, transferred or assigned, in order to
inform the borrower as to who owns the
loan.
Refinancings. One event that requires redisclosure is a refinancing. A refinancing
occurs when an existing obligation is
satisfied and replaced by a new obligation.
Section 226.20(a) In general, if the
consumer signs a new note, the transaction
is a refinancing and new disclosures must
be given. If, on the other hand, the existing
note is modified and not replaced by a new
note, then the transaction is not a
refinancing and new disclosures are not
required. One exception is a change from a
fixed rate to a variable rate. That change
always constitutes a refinancing, regardless
The requirement applies to principal
dwelling-secured loans, purchase loans and
refinances; home equity loans and home
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equity lines of credit (HELOCs). However,
this notice requirement does not apply to
loans for vacation properties or business
properties.
Truth in Lending
Regulation Z
does not change as a result of the
transfer.
Keep in mind that the Mortgage Transfer
Notice is different from RESPA‘s Mortgage
Servicing Transfer Notice, which deals with
the transfer of the servicing of the loan and
not the sale of the loan itself. Also, the
mortgage servicing transfer disclosure rules
apply only to closed-end, first-lien mortgage
loans covered by RESPA, but do not apply
to junior-lien, closed-end mortgages, nor to
open-end, revolving home equity lines of
credit, regardless of whether secured by a
first- or junior-lien mortgage.
Content of the Disclosures. A creditor
who acquires or purchases a loan must
disclose the following:
The new owner‘s identity, address,
and telephone number;
The date the loan was transferred;
The contact information for agents or
representatives authorized to act on
behalf of the new owner; and
Where the transfer of ownership is
recorded in the public records, or a
statement that the transfer has not yet
been recorded in the public record at
the time the disclosure is provided.
Exceptions. The disclosures need not be
given when:
The purchaser or assignee transfers
or assigns all of its interest in the loan
to another party on or before the 30th
day following the date that person
acquired the loan (but those
subsequent purchasers would have to
comply with the rule and provide the
disclosures);
The owner of the mortgage loan
transfers the legal title in a transaction
that is subject to a repurchase
agreement; the disclosures are not
required if the transferor is obligated to
repurchase the loan (if the transferor
does not repurchase the mortgage
loan, the acquiring party must make
the disclosures within 30 days after
the date that the transaction is
recognized as an acquisition on its
own books and records; or
The purchaser or assignee only
acquires a partial interest in the loan,
and the party who is authorized to
resolve consumer payment issues on
the loan or receive the rescission
notice on behalf of the current owner
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Truth in Lending
Regulation Z
consumer‘s ability to repay the loan. A
creditor is presumed to have met this
requirement if it: (1) adequately
verifies the borrower‘s income (under
the guidelines set out in the next
requirement); (2) assesses the
consumer‘s repayment ability based
on the highest scheduled payment of
principal and interest in the first seven
years of the loan (taking into account
the
consumer‘s
present
and
reasonably expected future income
and the current and reasonably
expected obligations); and (3) takes
into account the borrower‘s overall
debt to income ratio or the income that
he or she will have remaining after the
payment of his or her debt obligations
in assessing the borrower‘s ability to
repay the loan. A lender may not rely
on the presumption where the periodic
payments during the first seven years
of the loan would cause the principal
balance to increase, such as through
negative
amortization.
The
presumption is also not available for
loans with a term of less than seven
years where, in the aggregate, the
regular periodic payments do not fully
amortize the outstanding principal
balance. For example, a lender could
not rely on the presumption in making
a five year loan with a balloon
payment to demonstrate that the
borrower had the ability to repay the
loan. In addition, to show that a lender
violated this prohibition, a consumer is
not required to show that the lender
engaged in a "pattern or practice." As
a result, each lender will be held
responsible for demonstrating, on
each higher-priced mortgage loan
made, that the borrower had the ability
to repay the loan.
Higher-Priced Mortgage
Loans
Section 226.35 of Regulation Z defines a
category of protected loans, called "higherpriced mortgage loans‖ or ―HPMLs.‖ A
higher-priced mortgage loan is a consumer
credit transaction secured by a consumer‘s
principal dwelling with an annual percentage
rate (APR) that exceeds the average prime
offer rate for a comparable transaction as of
the date the interest rate is set by:
1.5% or more for loans secured by a
first lien on a dwelling, or
3.5% or more for loans secured by a
subordinate lien on a dwelling.
The Federal Reserve has created an index,
the average prime offer rate, to be used to
determine which loans are ―higher-priced‖
mortgages.
‗‗Higher-priced mortgage loans‖ do not
include transactions to finance the initial
construction of a dwelling, a temporary or
bridge loan with a term of twelve months or
less (such as a 12 month loan that a
consumer plans to repay when he or she
sells
a
current
dwelling),
reversemortgages, or home equity lines of credit. A
creditor cannot structure a home-secured
loan as an open-end plan to evade the
requirements of a higher-priced mortgage
loan.
Prohibited
Acts
or
Practices
in
Connection with Higher-Priced Mortgage
Loans. Under the rules for ―higher-priced
mortgage loans,‖ creditors are prohibited
from engaging in certain practices. Section
226.35(b)(1) and (2)
Lenders are prohibited from making a
loan without regard to a borrower‘s
ability to repay the loan from income
and assets other than the value of the
collateral. The analysis must include
casualty insurance, private mortgage
insurance (PMI), property taxes,
homeowners association dues and
any similar charges in calculating the
Lenders are prohibited from relying on
unverified income or assets to
determine
repayment
ability.
Verification of income and/or assets
must be documented through the
consumer‘s Internal Revenue Service
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Form W-2, tax returns, payroll
receipts, financial institution records,
or other third-party documents that
provide reasonably reliable evidence
of the consumer‘s income or assets.
Regulation Z
Escrow accounts do not need to be
established for loans secured by
shares in a cooperative; and
If the principal dwelling is a
condominium and the condominium
association has an obligation to the
condominium unit owners to maintain
a master policy insuring condominium
units, the homeowner‘s insurance
premiums do not need to be
escrowed.
Lenders are also banned from
imposing any prepayment penalty
unless all of the following are met:
i.
Truth in Lending
The penalty is allowable under
other law, including HOEPA if
applicable;
A creditor or servicer may permit a
consumer to cancel the required escrow
account only in response to a consumer‘s
dated written request to cancel the escrow
account that is received no earlier than 365
days after consummation.
ii. The prepayment penalty will not
apply after the two-year period
following consummation;
iii. The penalty will not apply if the
source of prepayment is a
refinancing by the institution or
affiliate; and
Section 32 Mortgages
iv. The amount of the periodic
payment of principal, interest or
both cannot change during the
first
four
years
post
consummation.
Section 226.32 of Regulation Z defines
high-rate, high-fee mortgages, which are
often referred to as ―Section 32 mortgages‖
or ―HOEPA loans.‖
The rules impose
additional disclosure requirements for these
types of loans. A Section 32 mortgage is a
closed-end mortgage that is secured by the
consumer‘s principal dwelling and either:
Escrow for First Lien Higher-Priced
Mortgage Loans. Lenders are required to
establish an escrow account for any higherpriced mortgage loan on which the lender
has a first lien on the principal dwelling.
There is an exception for those mortgage
loans considered to be ―jumbo mortgages.‖
The exception permits a lender to waive
escrow on a jumbo loan where the APR
exceeds the average prime offer rate by
1.5% provided it does not exceed the
average prime offer rate by 2.5%. If it did,
the lender would be required to escrow at
that point. The lender can ignore this
exception and require escrow for all loans
exceeding the 1.5% threshold.
1. The annual percentage rate exceeds
by more than 10 percentage points on
subordinate-lien loans or 8% on firstlien loans the yield on Treasury
securities having similar periods of
maturity as of the 15th day of the
month preceding the month in which
the application is received, or
2. The total points and fees payable by
the consumer at or before loan closing
exceed the greater of $400 or 8
percent of the total loan amount. For
example, on a $10,000 mortgage the
points and fees could be $800 and the
loan would not trigger the Section 32
requirements. (The $400 figure was
enacted in 1994, and is tied to the
Consumer Price Index. For 2010, the
figure is $579. For 2011, the figure is
$592. Watch for changes annually.)
The escrow account must include payment
of property taxes, homeowner‘s insurance
premiums,
premiums
for
insurance
protecting against default or credit loss, and
premiums for other mortgage related
insurance. Section 226.35(b)(3). If you are
required to escrow, the regulation provides
two instances where you get a pass:
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Truth in Lending
Regulation Z
―You are not required to complete the
agreement merely because you have
received these disclosures or have
signed a loan application. If you obtain
this loan, the lender will have a mortgage
on your home. You could lose your
home, and any money you have put into
it, if you do not meet your obligations
under the loan.‖
Points and fees are defined as all finance
charges (except interest or time-price
differential) and compensation paid to
mortgage brokers, and all fees paid in
transactions secured by real property. A
charge may be excluded, however, if it is
reasonable, if the creditor receives no
compensation, direct or indirect, from the
charge, and if the charge is not paid to an
affiliate of the creditor. The included fees for
Section 32 purposes need not be fees
included in the finance charge. For
example, an appraisal fee for an appraisal
performed by financial institution personnel
is not a finance charge, but is an included
fee for Section 32 purposes. Amounts paid
at closing for optional credit life, accident,
health, or loss-of-income insurance, and
any other debt-protection products written in
connection with the loan are also included.
With the addition of these costs to the fees
that determine whether a loan is covered,
many more loans will be deemed Section 32
loans, particularly if the borrower is
purchasing single premium credit life
insurance.
The annual percentage rate must be
disclosed in these ―early‖ disclosures. The
amount of the monthly (or periodic) payment
must also be disclosed. If the plan is a
variable-rate transaction, a statement that
the interest rate may increase is also
required, along with the amount of the
maximum single monthly payment, based
on the maximum interest rate.
Disclosures for Section 32 mortgages must
be provided to the consumer at least three
business days prior to consummation of the
transaction. This waiting period may be
modified or waived if the consumer can
show the credit is needed to meet a bona
fide personal financial emergency, such as
foreclosure of the home. A detailed
statement must be written by the consumer
to avoid the delay. (Preprinted forms are
forbidden.) In addition, new disclosures
must be given, if, before consummation, the
creditor changes any term that makes the
disclosures inaccurate.
Refinancing a Section 32 loan into another
Section 32 loan to the same borrower within
12 months of closing is prohibited. The
regulation treats loan modifications as
refinancings, unlike the practice under other
parts of Regulation Z, such as section
226.20.
The disclosures for a refinancing must
include the ―amount borrowed,‖ which is
different from the TIL-critical term ―amount
financed.‖
Confusion is almost certain,
relieved only by the fact that Section 32
borrowers, like most consumers, almost
never read the disclosures!
―Amount
borrowed‖ means the face amount of the
note, so it includes all charges that are
financed, regardless of whether they are
finance charges under Regulation Z. Where
the amount borrowed includes charges for
optional
credit
insurance
or
debtcancellation coverage that fact must be
stated near (and ―grouped with‖) the amount
borrowed. A tolerance of $100 is allowed
for inaccuracies in the amount borrowed,
Section 32 does not apply to residential
mortgage transactions (see definition),
reverse mortgages, and open-end homeequity lines. To prevent evasion of the rules,
a financial institution is prohibited from
structuring a Section 32 loan as an openend line of credit if there is ―no reasonable
expectation‖ that repeated draws will occur.
Disclosures.
The disclosures required
under Section 32 must be given at least
three business days before consummation
of a closed-end transaction. The disclosures
must include the following statement in
exactly the words shown. Section
226.32(c)(1)
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Truth in Lending
Regulation Z
consumer‘s ability to repay the loan. A
creditor is presumed to have met this
requirement if it (1) adequately verifies
the borrower‘s income (under the
guidelines set out in the next
requirement), (2) assesses the
consumer‘s repayment ability based
on the highest scheduled payment of
principal and interest in the first seven
years of the loan (taking into account
the
consumer‘s
present
and
reasonably expected future income
and the current and reasonably
expected obligations), and (3) takes
into account the borrower‘s overall
debt to income ratio or the income that
he or she will have remaining after the
payment of his or her debt obligations
in assessing the borrower‘s ability to
repay the loan. A lender may not rely
on the presumption where the periodic
payments during the first seven years
of the loan would cause the principal
balance to increase, such as through
negative
amortization.
The
presumption is also not available for
loans with a term of less than seven
years where, in the aggregate, the
regular periodic payments do not fully
amortize the outstanding principal
balance. For example, a lender could
not rely on the presumption in making
a five year loan with a balloon
payment to demonstrate that the
borrower had the ability to repay the
loan. In addition, to show that a lender
violated this prohibition, a consumer
no longer needs to demonstrate that it
is part of a "pattern or practice." As a
result, each lender is held responsible
for demonstrating, on each Section 32
loan made, that the borrower had the
ability to repay the loan.
and that tolerance passes through to the
disclosure of the monthly (or other periodic)
payment on a pro-rata basis.
Proceeds of a Section 32 loan are not
allowed to be paid to a contractor under a
home-improvement plan, unless they are
paid jointly to the consumer and the
contractor. Further, a lender may not sell or
assign a Section 32 mortgage unless the
following statement is furnished to the
purchaser or assignee:
―Notice: This is a mortgage subject to
special rules under the federal Truth in
Lending Act. Purchasers or assignees of
this mortgage could be liable for all claims
and defenses with respect to the mortgage
that the borrower could assert against the
creditor.‖
The simplest way to be certain such
language is furnished to a loan buyer is to
include it in the mortgage itself, and we
believe most Section 32 lenders will follow
that course of action.
Prohibited Practices.
Lenders are
prohibited from including any ―demand‖ or
―call‖ provision that would permit the lender
to accelerate the loan absent fraud or
payment default by the borrower, or some
action or inaction by the borrower that
adversely affects the lender‘s security or
rights in the collateral.
Historically, there has been a prohibition on
making it a practice to grant Section 32
loans without regard to the borrower‘s ability
to repay the loan. Lenders are prohibited
from not only this practice but additional
practices for Section 32 mortgages. Section
226.32(d)(6) and (7)
Lenders are prohibited from making a
loan without regard to a borrower‘s
ability to repay the loan from income
and assets other than the value of the
collateral. The analysis must include
casualty insurance, private mortgage
insurance (PMI), property taxes,
homeowners association dues and
any similar charges in calculating the
Lenders are prohibited from relying on
unverified income or assets to
determine
repayment
ability.
Verification of income and/or assets
must be documented through the
consumer‘s Internal Revenue Service
Form W-2, tax returns, payroll
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Truth in Lending
receipts, financial institution records,
or other third-party documents that
provide reasonably reliable evidence
of the consumer‘s income or assets.
which includes mortgage brokers and loan
officers, based on the terms or conditions of
the loan other than the loan amount. The
rule also prohibits any person other than the
consumer from paying compensation to a
loan originator in a transaction where the
consumer pays the loan originator directly,
and prohibits the loan originator from
―steering‖ the consumer to a more
expensive loan in order to increase
earnings.
Lenders are also banned from
imposing any prepayment penalty
unless all of the following are met:
–
The penalty is allowable under
other law;
–
The prepayment penalty will not
apply after the two-year period
following consummation;
–
Regulation Z
Means of Compensation. The rule
prohibits the following methods of
compensating loan originators:
The penalty will not apply if the
source of prepayment is a
refinancing by the institution or an
affiliate;
•
The amount of the periodic
payment of principal, interest or
both cannot change during the first
four years post consummation;
and
Payments to the loan originator that
are based on the loan‘s interest rate
or other terms. Compensation based
on a fixed percentage of the loan
amount is permitted;
•
At consummation, the consumer‘s total
monthly debts (including amounts owed
under the mortgage) do not exceed 50% of
the consumer‘s verified monthly gross
income.
Payments to a loan originator
directly from a consumer, if the loan
originator
is
also
receiving
compensation from the creditor or
another person; and
•
Steering‖ a consumer to a lender
offering less favorable terms in order
to increase the loan originator‘s
compensation.
–
Prohibited Acts or Practices
for Dwelling-Secured ClosedEnd Loans
The rule defines ―loan originator‖ as ―a
person who for compensation or other
monetary gain, or in expectation of
compensation or other monetary gain,
arranges, negotiates, or otherwise obtains
an extension of consumer credit for another
person.‖
This includes the creditor‘s
employees, if they meet that definition.
However, ‗‗loan originator‘‘ includes the
creditor only if the creditor does not provide
the funds at closing from the creditor‘s own
resources.
All closed-end loans that are secured by a
principal
dwelling
receive
additional
protections. These rules apply regardless
of lien status, and do not have exceptions
(such as the exceptions for construction
loans or residential mortgage transactions
that apply to other consumer protection
provisions of Regulation Z).
Loan Originator Compensation
The rule defines ‗‗compensation‘‘ to include
salaries, commissions, and ―any financial or
similar incentive‖ provided to a loan
originator that is based on any of the terms
or conditions of the loan. Compensation
can include an annual or other periodic
Section 226.36 applies to closed-end
transactions secured by any dwelling.
Effectively
minimizing
―yield
spread
premiums‖ as an accepted practice of
compensation, the amendment generally
prohibits payments to loan originators,
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bonus or awards of merchandise, services,
trips, or similar prizes.
Truth in Lending
Regulation Z
amount.
Other permissible means of
compensation include payments that are
fixed in advance for each originated loan
and compensation that accounts for a loan
originator‘s fixed overhead costs. A creditor
may pay a loan originator, based on the
percentage of loan applications that result in
consummated loans. Also, a creditor may
pay a mortgage broker, who relieves the
creditor of certain overhead costs relating to
the loan origination, more than the creditor
pays its own loan officers, whether as a
certain dollar amount on each loan or as a
fixed percentage of the loan. Similarly, a
creditor may pay some of its loan officers
more than others, so long as that difference
is not based on a term or condition of the
loan.
Compensation that is based on the terms or
conditions of the loan includes the following:
The interest rate;
The annual percentage rate;
The loan to value ratio;
The existence of a prepayment
penalty; or
A proxy for one of the loan terms,
such
as
the
payment
of
compensation, whose amount is
based on the annual percentage
rate, which is in turn based on the
borrower‘s credit score.
In addition, compensation that includes
amounts the loan originator retains from a
loan fee is considered compensation based
on a loan term or condition. When it comes
to charges by third party settlement service
providers, the regulation considers as
compensation those amounts the loan
originator keeps, but does not consider
those amounts the originator receives as
payment for bona fide and reasonable thirdparty charges, such as title insurance or
appraisals. In some cases, amounts that
the loan originator receives for payment for
third-party charges may exceed the actual
charge because, for example, the originator
may not always be able to determine with
accuracy what the actual charge will be
before closing. In that case, the difference
the loan originator keeps is not deemed
compensation if the third-party charge
imposed was bona fide and reasonable. If
the loan originator marks up or ―upcharges‖
the third-party charge, and the loan
originator keeps the difference between the
actual charge and the marked-up charge,
the amount the loan originator keeps that is
above the actual charge is considered
compensation based on a loan term or
condition.
The regulation contains examples of
permissible compensation that is not based
on a loan‘s terms and conditions. This
includes compensation based on:
Loan originator compensation may be
based on a fixed percentage of the loan
Quality of the loan originator‘s loan
files
(e.g.,
accuracy
and
Loan originator‘s overall loan volume
(i.e., total dollar amount of credit
extended or total number of loans
originated), delivered to the creditor;
Long-term performance
originator‘s loans;
of
the
Hourly rate of pay to compensate
the originator for the actual number
of hours worked;
Whether the consumer is an existing
customer or a new customer;
A payment that is fixed in advance
for every loan the originator
arranges for the creditor (e.g., $600
for every loan arranged for the
creditor, or $1,000 for the first 1,000
loans arranged and $500 for each
additional loan arranged);
The percentage of applications
submitted by the loan originator to
the
creditor
that
result
in
consummated transactions;
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Truth in Lending
completeness
of
the
loan
documentation) submitted to the
creditor;
Regulation Z
In order to determine whether directing a
consumer to close on a more expensive
loan product is ultimately in the consumer‘s
interest the rule states that the loan
transaction ―must be compared to other
possible loan offers available through the
originator, if any, and for which the
consumer was likely to qualify, at the time
that transaction was offered to the
consumer.‖
Commentary to Section
226.36(e)(1)
A legitimate business expense, such
as fixed overhead costs;
Compensation that is based on the
amount of credit extended.
As you can see, the rule does not prohibit a
creditor from basing compensation on an
originator‘s loan volume, whether by the
total dollar amount of the loan or the total
number of loans originated over a given
time period, although the Federal Reserve
recognized that such a compensation
arrangement could create ―incentives for
originators to deliver loans without proper
regard for the credit risks involved.‖
The rule provides a safe harbor to creditors
if:
The consumer is presented with loan
offers for each type of transaction in
which the consumer expresses an
interest (that is, a fixed rate loan,
adjustable rate loan, or a reverse
mortgage); and
Source of Compensation.
If a loan
originator receives compensation directly
from a consumer in connection with a loan,
the loan originator may not receive, either
directly or indirectly, any compensation from
anyone else in connection with that loan.
However, if the mortgage broker company
or creditor pays a salary or hourly wage, to
its employee handling the loan, but the
salary or wage is not tied to the specific loan
transaction, there is no violation of the
regulation, even if the consumer directly
pays a loan originator a fee in connection
with that loan.
The loan options presented to the
consumer include the following:
Interestingly, for RESPA covered loans,
where a ―yield spread premium‖ is paid by a
creditor to the loan originator and is
disclosed on the GFE as a ‗‗credit‘‘ applied
to reduce the consumer‘s settlement
charges and origination fees, Regulation Z
considers these not received by the loan
originator directly from the consumer for
purposes of Section 226.36(d)(2).
–
The lowest interest rate for
which
the
consumer
qualifies;
–
The lowest points
origination fees; and
–
The lowest rate for which the
consumer qualifies for a loan
with no risky features, such
as a prepayment penalty,
negative amortization, or a
balloon payment in the first
seven years.
and
Appraisals
and
Valuation
Independence – Closed-End
Loans
Context.
The Dodd-Frank Wall Street
Reform and Consumer Protection Act (DFA)
contains a section to clean up the valuation
and appraisal problems suffered by the real
estate lending industry in recent years. The
DFA added Section 129 to the Truth in
Lending Act, which in turn mandated that
the Federal Reserve add Section 226.42,
replacing similar language on appraisals in
Anti-Steering. The rule does not allow the
loan originator to direct or ―steer‖ a
consumer to close on a loan product, whose
costs would increase the amount of
compensation that the loan originator would
receive unless that loan is in the consumer‘s
interest.
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Section 226.36. Most of what it outlaws,
however, was already forbidden for many
years by other laws.
A few of the
prohibitions in the DFA did not already apply
to lenders other than regulated financial
institutions, so applying them to unregulated
entities was a small positive step.
Truth in Lending
Regulation Z
interest in the property appraised.
It
prohibits a lender from lending when it has
knowledge that either of those two violations
has occurred, and requires all creditors and
service providers to report any appraiser
who commits either of those two violations.
It also requires reporting of anyone who fails
to report as well, because that‘s a violation
itself, and of anyone who fails to report on
someone who failed to report, and … well,
you get it. The report of a violation must be
sent to the appropriate state licensing
agency.
Applicability. Section 226.42 applies to
any consumer credit transaction that is
secured by the consumer‘s principal
dwelling. Vacation cottages and other nonprimary residences are not covered, only
principal dwellings. Lien status does not
matter; both first and junior liens are
covered. Whether the credit is open- or
closed-end does not matter either; both are
covered. That is a small expansion of the
2008 HOEPA Appraiser Independence
rules, which did not cover open-end credit.
In addition to this section, the Federal
Reserve also added a new comment
(226.5b-7) to the HELOC section to remind
readers that HELOCs are covered by these
rules.
Minor mischaracterizations of the value of a
property are not forbidden.
To be
prohibited, the mischaracterization must be
material. The Federal Reserve defines
material as ―likely to significantly affect the
value.‖ 226.42(c)(2)(i). It does not define
―likely‖ or ―significantly,‖ thus preserving its
ability to determine what was or was not
material on a case-by-case basis after the
fact.
Conflicts of Interest. As mentioned above,
Section 226.42 also prohibits conflicts of
interest. Conflicts of interest occur when
the person performing the valuation or
valuation management services has a direct
or indirect interest in the property or the
transaction. Situations involving an interest
in the property are fairly straightforward, but
those involving an interest in the transaction
can get complex. The rule provides one
safe harbor exception for creditors with
assets of $250 million or less in either of the
past two calendar years and another for
creditors that do not meet that test.
In
other words, there is a safe harbor
exception for small creditors, those being
creditors with assets of less than $250
million in the either of the two past
calendars years, and for large, creditors
those being creditors with assets of more
than 250 million for both of the past two
calendar years, there is a different safe
harbor exception.
It is very similar to the
breakpoint for small bank status under the
Community Reinvestment Act.
Coverage Differences. Section 226.42‘s
provisions apply to formal appraisals that
comply with the Uniform Standards of
Professional
Appraisal
Practice.
Evaluations also are covered, as are any
other methods used to establish the value of
the property for the purpose of the credit.
(Purely automated models, however, are
exempted.) However, while section 226.42
applies to appraisals, evaluations and other
methods used to determine value, the
compensation and reporting-of-violations
rules apply only to appraisals and
appraisers. Other types of less formal
valuations and their providers are exempt
from the compensation and reporting-ofviolations rules.
Prohibitions. Section 226.42 prohibits the
use of coercion, bribery, collusion, and
similar actions in an attempt to influence a
person who provides valuation services
concerning the value s/he arrives at for the
property. It also forbids an appraiser or
appraisal management company from
having a direct or indirect financial or other
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Small Creditors. In addition to the assets
threshold discussed above, to get the small
creditor exception, an employee or affiliate
of the lender performing valuations or
valuation management services must meet
two
conditions:
compensation
and
safeguards. The compensation condition is
that the person‘s compensation is not based
on the value arrived at for the property. The
safeguards condition is that the employee,
officer, or director of the lender who orders,
performs, or reviews a valuation for the
lender must abstain from participating in any
decision on that loan.
Truth in Lending
Regulation Z
other services in the transaction. So the
effort to comply with the several conditions
described above may not be justified by the
porous safe harbor you may get.
Exceptions to Prohibitions.
Section
226.42 permits some actions a lender or
consumer might want to take regarding a
particular valuation, saying they are not
coercion and therefore are allowed. Asking
that the valuation provider consider
additional appropriate property information,
requesting further detail, substantiation, or
explanation for the value conclusion, and
asking that errors in the report be corrected,
are
all
permissible.
To
avoid
misunderstandings later, however, we
recommend that all such communications
be in writing.
Large Creditors. To get the large creditor
exception, there are three conditions that
have to be met: compensation, reporting,
and selection. The compensation condition
is that the person‘s compensation is not
based on the value arrived at. Interestingly,
the Federal Reserve says something
contradictory in describing its thoughts here.
It says that it believes that whether the loan
closes depends on the conclusion of value.
That is obviously true. It then says that
―therefore‖, the rule prohibits basing the
appraiser‘s compensation on the conclusion
of value, but does not prohibit basing his
compensation on whether the loan closes.
Covered People.
The people who are
subject to these prohibitions include most,
but not all, of the usual suspects who might
want a fudged appraisal: the lending
institution and its personnel, and any
settlement service provider, such as a title
insuror, real estate sales person, or
mortgage broker.
Oddities. The DFA directed the Federal
Reserve to promulgate interim final rules on
this topic. The agency took that to mean it
did not have to allow public comment before
the rules took effect, and so, it did not. The
interim rules went into effect immediately
upon publication. Comments on the interim
rules were then accepted until late 2010,
and a definitive (i.e. not interim) final rule
may be forthcoming at some unspecified
future time.
The reporting condition for large creditors is
that the person who orders, performs, or
reviews a valuation for the lender must
report to a person who is not part of the loan
production function or whose compensation
is not based on the closing of the loan. The
selection condition requires that the
employees, officers, and directors in the
loan production function not be directly or
indirectly involved in selecting the person
(1) to perform the valuation, or (2) to be
included in or excluded from a list of
approved appraisers or providers of
valuations.
Similarly odd is the rule‘s exception to the
prohibition of the property appraiser or
valuation provider having an interest,
financial or otherwise, in the transaction.
The exception allows the lender to complete
the transaction in such a case if the lender
has used reasonable diligence to determine
that the valuation does not materially
misstate the value of the property. Think
about that for a minute. We find out that the
seller and the appraiser are brothers, but we
Despite the above superstructure, the
regulation clearly says that it is not per se a
conflict of interest to be an employee or
affiliate of the creditor and also perform the
valuation. Similarly, it is not per se a conflict
of interest to perform the valuation and
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can go ahead and lend to the buyer if we
use reasonable diligence to find that the
value is not misstated by a lot. What is the
purpose of the prohibition, if not to avoid
that very situation? What is a lender
supposed to do under the heading of ―due
diligence‖ here, hire a second appraiser?
The Federal Reserve tells us no, but what
else could satisfy the due diligence test?
Perhaps you have alternative sources of a
figure for the property‘s value that, if not
much different from the number in the
compromised valuation could constitute the
required
diligence?
Tax
values,
computerized valuation services, other
sources? The agency will not say, so no
one knows.
Truth in Lending
Regulation Z
who may be bribed or coerced. Bribery or
coercion of the human being running such a
system is a question left for another day, but
until it is clarified, we recommend against
trying it.
The HVCC. The Home Valuation Code of
Conduct was a product of the late 2008
settlement among Fannie Mae, Freddie
Mac, and the Attorney General of New York.
Among other things, it regulated the process
of selecting and communicating with
appraisers and forbade the use of an
appraisal tainted by a conflict of interest.
The DFA says the HVCC shall have no
effect after the effective date of the interim
Section 226.42.
Compensation.
Section 226.42 also
requires that an appraiser be paid a
reasonable fee for the work done. The rule
provides
two
presumptions
of
reasonableness.
First, the fee will be
presumed reasonable if it is reasonably
related to recent rates paid for appraisals in
the geographic market where the property is
located and, in setting the fee, the lender
has taken into account the following factors:
Another oddity is that the consumer buyer
and the consumer seller are excluded from
the covered persons who are forbidden to
bribe or coerce an appraiser into giving an
unjustified value for the property. Either of
them may do so under the new rules, as
may some person who will reside in the
house with the consumer. Guarantors and
similar secondarily-liable parties are also
excluded.
The appraiser‘s experience, record,
and qualifications;
A person doesn‘t have to be trying to raise
the value assigned to the property, either.
Using bribery, coercion, and similar means
to hold a property‘s valuation down is a
violation, as well.
Clearly, safety,
soundness, and earnings of lending
institutions were not the only concerns on
the minds of Messrs. Dodd and Frank.
The property type;
The time in which the work was
needed;
The quality of the appraiser‘s work;
and
The scope of the work.
One of the comments to Section 226.42
clarifies that a loan originator may not
coerce a loan underwriter to alter an
appraisal report to increase the value shown
for the consumer‘s dwelling. That was
already illegal. Making false entries in the
books and records of an insured depository
institution has been a federal felony for
generations.
The lender must not have engaged in any
anticompetitive acts that affect the fee, such
as price-fixing or restricting others from
entering the market. Those acts have
carried prison terms and enormous fines for
years under the Sherman Antitrust Act since
1890.
Alternatively, the fee will be
presumed reasonable if the lender sets it by
relying on rates set by third parties, such as
the Veteran‘s Administration appraisal fee
schedule or reports and surveys from
independent third parties. The reports and
Automated Models. The Federal Reserve
believes that it‘s impossible to bribe or
coerce an electronic model or system, so it
excludes them from the definition of those
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Regulation Z
mortgage transactions, and refinancings of
an existing loan already secured by the
consumer‘s principal residence by the same
creditor are exempt from the right of
rescission.
surveys used must not include fees paid by
appraisal management companies.
Notice that we have shifted away from the
use of the term ―evaluations‖ now that we
are discussing the compensation rules. In
composing this portion on the regulation,
the Federal Reserve said it was constrained
by the statutory language, which does not
allow the broader coverage present in the
other portions of the law. Therefore the
provisions on compensation apply only to
state-licensed or state-certified appraisers
or entities that employ them and are
compensated for their services.
As
mentioned above in the second paragraph
under ―Applicability,‖ other types of
valuations and the people who perform
them are exempt from Section 226.42‘s
rules on compensation and reporting of
violations. This portion of the regulation
does not prohibit withholding payment from
an appraiser who has rendered substandard
performance or failed to perform his/her
contractual obligations.
Refinancing transactions with the same
creditor without an advance of new funds
are exempted from the rescission rules. If
new money is advanced, the new money is
rescindable. Also, the refinancing of a loan
held by a different creditor is rescindable for
closed end loans, regardless whether new
money is involved.
In a transaction subject to rescission, a
creditor must deliver two copies of the
notice of the right to rescind to each
consumer entitled to rescind. The notice
must be a separate document. It must
identify the transaction and contain the
That the creditor is acquiring or
retaining a security interest in the
consumer‘s principal dwelling;
That the consumer has the right to
rescind the transaction;
Additional Information. More information
on appraisals is available in the Appraisal
and Appraiser Standards article in the
Loans section of this Manual.
How the consumer can rescind the
transaction, together with a form for
that purpose designating the creditor‘s
address;
Right of Rescission – ClosedEnd Credit
The effects of rescission; and
When a financial institution takes a nonpurchase-money security interest in a
person‘s dwelling to secure consumer
credit, the financial institution must consider
the possibility that Regulation Z‘s rescission
provisions are applicable. Rescission
applies when the dwelling is the principal
dwelling of the consumer. If the dwelling is a
second home, vacation cottage, or the like,
the rescission provisions of Regulation Z
are not applicable.
The date the rescission period ends.
Unless a consumer waives the right of
rescission, the creditor may not fund the
loan (other than into escrow) until the
rescission period has expired, and the
creditor is reasonably satisfied that the
consumer has not rescinded. A consumer
may exercise the right of rescission at any
time up until midnight of the third business
day (for the purpose of rescission Saturday
is a business day) following the later to
occur of: (1) the consummation of the loan,
that is, signing the loan documents; (2)
delivery of the rescission notice; or (3)
delivery of the material disclosures. If the
notice of right to rescind or accurate
disclosures is not provided to the consumer,
In a consumer credit transaction in which a
creditor will acquire or retain a security
interest in a consumer‘s principal dwelling,
each consumer whose ownership interest is
subject to the security interest has the right
to rescind the transaction. Section 226.23
Business
purpose
loans,
residential
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the three-day right-of-rescission period does
not begin to run.
Truth in Lending
Regulation Z
retained, but also fees and costs paid to
third parties such as appraisers. After the
creditor fulfills its obligations, and only then,
the consumer must repay the loan
proceeds. In other words, the creditor must
pay over money that it may not have
retained and cannot obtain reimbursement
of, and it then may have an unsecured note
to collect.
A consumer may exercise the right of
rescission by providing written notice of
rescission to the creditor during the
rescission period. If notice is sent by mail, it
is considered provided when mailed. Thus,
a consumer could place a notice of
rescission in a mail box at midnight of the
third business day and the rescission would
be effective. If the notice of right to rescind
is not provided, or the proper disclosures
are not given, then the rescission period
ends three years after loan closing.
If a consumer has a bona fide personal
waive the right of rescission. Examples of a
bona fide financial emergency are: a roof
blown off of a home by a tornado, or a sick
child in need of medical care. Conversely,
funds for use on a hot technology stock or
for placement on a winning horse do not
qualify. What is considered a bona fide
financial emergency is construed very
strictly. To exercise a waiver of the right of
rescission, a consumer must provide a
creditor with a dated and signed, written
statement that describes the emergency
and waives the right to rescind.
Before a lender may fund a rescindable
loan, it must wait until the three-businessday rescission period has run. It must also
be reasonably satisfied that the consumer
has not rescinded. To be reasonably
satisfied, a creditor may obtain a written
statement from the consumer that he or she
has not exercised the right of rescission.
Alternately, the creditor may wait not only
the three business days, but also a time
sufficient for a notice that was mailed at
midnight of the third day to arrive. Realize
that if on the fourth business day, a
consumer gives a creditor a written notice
stating that he or she has not exercised the
right of rescission, that notice does not
negate rescission if notice of rescission was
properly given. For example, at midnight of
the third business day, a consumer places a
notice of rescission in the mail; however, the
next day, that consumer gives the creditor a
statement indicating that he or she has not
rescinded and walks away with the loan
proceeds.
Although
the
consumer
―rescinded‖ their rescission, the loan is
treated nonetheless as rescinded.
Reverse Mortgages
A ―reverse mortgage‖ is a nonrecourse
transaction in which a consumer receives
periodic payments from the creditor. To be a
reverse mortgage, the mortgage must be
secured by the consumer‘s principal
dwelling
and
repayment
must
be
conditioned on the homeowner‘s death or
permanent move from or transfer of the
dwelling.
Disclosures for Reverse Mortgages. The
disclosures required for these plans must
contain a good faith projection of the total
cost of the credit to the consumer by means
of a table of annual interest rates. The
interest rate used in this calculation must be
called ―total annual loan cost rate,‖ so as not
to be confused with the annual percentage
rate, or APR. This total annual loan cost
rate must be disclosed for at least three
projected
home
appreciation
rates
(determined by the Federal Reserve Board
to be zero percent, 4 percent, and 8
percent) as well as for at least three credit
When a loan is rescinded, the creditor‘s
security interest in the consumer‘s principal
dwelling becomes void. Within 20 days of
rescission the creditor must give the
consumer a release of the security interest
and pay to the consumer an amount equal
to all money that the consumer paid or that
was paid on the consumer‘s account in
connection with the transaction. A creditor
must repay not only fees and costs that it
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Regulation Z
interest rates, fees, default and late
payment costs, repayment terms, eligibility
requirements, and cost estimates, including
an example of the total cost of a loan based
on the maximum interest rate the creditor
can charge.
The customer must also
receive information about alternatives to
private education loans, the customer‘s right
to have 30 days to accept the terms of the
loan and a self-certification form. Section
226.46(d)(1) and Section 226.47(a)
transaction periods (two years, the
consumer‘s actuarial life expectancy, the
consumer‘s actuarial life expectancy
multiplied by 1.4, and, at the creditor‘s
option, one-half of the consumer‘s actuarial
life expectancy). All costs and charges to
the consumer must also be disclosed. All
costs to the consumer must be disclosed,
whether or not the costs can be defined as
―finance charges.‖ Model forms and
instructions for these calculations are
included in the regulation. Section 226.33
Approval Disclosures. The second set of
disclosures must be given with the approval
of the loan. The approval disclosures must
include information about the rate, fees and
other terms of the loan; fees and late
payment costs; estimates of total repayment
amount based on both the current interest
rate and the maximum interest rate that may
be charged; the monthly payment at the
maximum rate of interest; alternatives to
private education loans; and customers‘
rights regarding acceptance of the loan.
Disclosure for reverse mortgages must also
be provided to the consumer at least three
business days prior to consummation of the
transaction, or, in the case of an openended reverse mortgage, at least three
business days before the first transaction.
Private Education Loans
Although closed-end loans for education
have
historically
fallen
within
the
requirements of Regulation Z, there are
specific disclosure requirements for private
education loans. The required provisions
went into effect in September 2009, and
became mandatory on February 14, 2010.
Private education loans are defined as
closed-end loans made expressly for
expenses incurred due to attending an
institution of higher education, even if only
part of the loan proceeds are for that
purpose.
They are covered under
Regulation Z even if the loan amount
exceeds $25,000.
However, open-end
credit, real-estate secured loans or any
federal loans covered under Title IV of the
Higher Education Act of 1965 are not
included. As a result, lenders should pay
close attention if an applicant applies for a
closed-end loan that is unsecured or is
secured by something other than real estate
where any portion of the proceeds will be
used for higher education expenses, such
as college tuition for the applicant‘s child.
For 30 calendar days after the customer
receives the disclosures, the terms of the
loan and the rates may not change. One of
the few changes that are allowed is a rate
change due to a change in the index used
for rate adjustments on the loan. The
borrower is allowed to accept the terms at
any time during the 30 day period. Section
226.46(d)(2) and Section 226.47(b)
Final Disclosures. The last set of
disclosures must be provided after the
customer accepts the loan.
The final
disclosures are similar to the ones provided
when you approved the loan. In addition,
you must disclose to the consumer their
three-day right to cancel.
Borrowers have up to three business days
after closing to cancel the transaction.
Much like the right of rescission for principal
dwelling-secured
loans,
the
private
education loan cannot be funded until the
three-day cancellation period has passed.
However, unlike rescission, there is no
ability to waive this three-day period.
Application Disclosures. The first set of
disclosures that must be provided to the
private education loan applicant must be
provided on or with the application. The
disclosures must contain information about
The consumer is also required to complete
a self-certification form.
This form will
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include information about the cost of
attendance at the school that the student is
or will be attending. The form will include
information about the availability of federal
student loans, the student‘s cost of
attendance at that school, the amount of
any financial aid, and the amount the
consumer can borrow to cover any gap.
You must obtain a signed self-certification
form from the customer before you can
close the loan.
Section 226.46(d)(3) and
Section 226.47(c)
Truth in Lending
Regulation Z
the rules for crediting payments on openend loans, a financial institution may set
reasonable requirements using the same
examples provided in this chapter for openend loans. Any payments that do not
comply with your established requirements
must be credited within 5 days of receipt of
the payment. Section 226.36
If your institution doesn‘t specify reasonable
requirements, then borrowers may make
payments at any location. Payments may
be made during normal business hours;
therefore, if your branch is open for normal
business hours until 6 p.m., then payments
must be credited as of the date it was
received, as late as 6 p.m.
Payment Issues
Credit Balance. If there is a credit balance
on an account the creditor must refund it
upon the consumer‘s written request. If the
balance remains for six months, the creditor
must make a good faith effort to return it.
Section 226.21
If your institution provides reasonable
requirements, the commentary in Section
226.36 of the regulation does provide an
example of a reasonable cut-off time of 5
p.m. for mailed checks.
However, the
Federal Reserve has indicated that as long
as payments aren‘t solely accepted within a
time span of only one hour, then a
reasonable cut-off time could also be as
early as 4 p.m. Additionally, if institutions
are open on Saturdays for deposits only,
payments may be limited to the days in
which loan operations are conducted, e.g.
Monday – Friday.
Crediting of Payments.
A creditor is
required to credit open-end payments as of
the date of receipt, unless a creditor
specified requirements for the consumer to
follow in making his or her payments, and
the consumer did not follow those
requirements.
Conforming Payment.
A conforming
payment is received in accordance with any
requirements established for making loan
payments. If you do not specify, in writing,
any requirements for making loan
payments, payments may be made at any
location where you conduct business, any
time during your normal business hours,
and by cash, money order, draft, or other
similar instrument or by electronic fund
transfer if you and the consumer have so
agreed. Open-end credit and closed-end
credit each have their own particular
requirements for the prompt crediting of
payments. Section 226.10 and Section
226.36
Reasonable requirements should be
provided on or with a loan statement. A
sample conforming payment notice for
closed-end credit plans can be found at the
end of this chapter.
Late Fees. The lender is not allowed to
pyramid late fees. A late fee may not be
charged where the only delinquency is
attributable to late fees on earlier payments,
and the payment is a full payment for the
applicable period and is paid on the due
date or within the applicable grace period.
Payoff Statements. Lenders are required
to provide a pay-off statement within a
reasonable period after receiving a request.
It is reasonable to provide the statement
within five business days of the request.
§226.36(c)(1)(iii) Commentary
Crediting of Payments for Closed-End
Loans.
Under the October 1, 2009
changes to Regulation Z, payments on
closed-end loans must be made credited on
the date received for loans secured by a
consumer‘s principal dwelling. Similar to
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Regulation Z
finance charge disclosure is accurate if it
does not understate the actual finance
charge by more than one percent of the
loan amount.
Tolerances, Errors and
Corrections
The regulation requires that a creditor make
all disclosures accurately using the best
information reasonably available. It also
establishes tolerances for the accuracy of
the ―finance charge‖ and the ―annual
percentage rate.‖
An anomaly occurs if the borrower raises
the right of rescission as a defense to a
foreclosure action. In that event, the finance
charge disclosure tolerance drops to $35.
Assume a financial institution made a
consumer loan of $50,000 secured by the
consumer‘s principal dwelling and the
finance charge disclosure is understated by
$50. As long as the consumer pays the
loan, there is not a right of rescission; the
disclosure is within the $250 tolerance level
for that loan. But the consumer stops paying
and the financial institution files for
foreclosure. Bingo. The disclosure tolerance
drops to $35, the loan is rescinded, and
there is nothing left to foreclose on. The
consumer wins. In other words, the
consumer is rewarded for failing to meet his
or her obligation. In any event, a financial
institution‘s
pre-foreclosure
procedure
should include a finance charge check if the
loan is less than three years old.
Finance Charge Tolerance. The general
rule is that a finance charge disclosure
is considered
accurate if the
amount
disclosed is not more than $10 above or
below the exact finance charge in a
transaction involving an amount financed of
more than $1,000 or not more than $5
above or below the exact finance charge in
a transaction involving an amount financed
of $1,000 or less. Section 226.18(d)
For a closed-end transaction secured by
real estate or a dwelling, a finance charge
disclosure shall be considered accurate if it
does not understate the actual finance
charge by more than $100. Accordingly, for
this class of transactions, an overstated
finance charge disclosure or a disclosure
that understates the finance charge by $100
or less is considered accurate. Recognize
that this greater tolerance is available only
for transactions secured by real estate or a
dwelling. The finance charge disclosure for
a loan secured by an automobile, for
example, falls under the old $10/$5 rule. On
that same automobile loan, if real estate or
a dwelling is added as additional collateral,
the new rule applies. Note also, the real
estate can be any category of real estate
and the dwelling need not be the person‘s
principal dwelling. Section 226.48(e)
Annual Percentage Rate Tolerance. The
general rule is that an APR disclosure is
accurate if the APR disclosed is within oneeighth of one percent of the actual APR in a
regular transaction or within one-quarter of
one percent of the actual APR in an
irregular transaction. This remains the rule
for transactions not secured by real estate
or a dwelling. For transactions secured by
real estate or a dwelling, the law increasing
the finance charge tolerance also increased
the tolerance for ―other disclosures affected
by any finance charge,‖ which includes the
APR. Accordingly, if the maximum finance
charge tolerance produces an APR that
varies from the actual APR more than the
normal APR tolerance, a disclosed APR that
falls within the expanded range shall be
treated as accurate. For example, assume a
$100,000 regular loan secured by real
estate with an actual finance charge of
$20,000 and an actual APR of 8 percent. A
finance charge disclosure of $19,900 (using
the new $100 tolerance) is treated as
accurate. Assume that a $19,900 finance
For the purpose of rescission, the tolerance
is even greater. One of the triggers that start
the three-day rescission period ticking is
delivery of accurate disclosures to the
customer. For this purpose, the finance
charge disclosure is accurate if it does not
understate the actual finance charge by
more than one-half of one percent of the
amount of the loan. If the loan is a refinance
and no new funds are being extended, the
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charge would produce an APR of 7 5/8
percent. In that case, any APR disclosed of
7 5/8 percent or higher would be treated as
accurate even though it exceeded the
normal 1/8 tolerance. Additionally, because
any over disclosure of the finance charge is
acceptable, any over disclosure of the APR
is also acceptable. Section 226.22
Truth in Lending
Regulation Z
Some of these errors are likely to be
isolated events, affecting only one
customer. Others may be repeated many
times, affecting many customers. The latter
situation could be the basis for a class
action. In that instance, it would be all the
customers affected by, say, an error in the
preprinted parts of a form, or an error
arising
from
a
financial
institution
employee‘s misunderstanding of the law
and Regulation Z. Penalties are discussed
earlier in this chapter.
Correcting Violations. The fact that a
financial institution committed a Truth in
Lending violation can come to the financial
institution‘s attention in various ways: the
examiners may find it during an
examination; the financial institution‘s own
compliance officer, auditor, or other staffer
may catch it; the customer may phone or
come in to talk about it; or the customer (or
the customer‘s lawyer) may write or file suit.
In all but the last of these cases, the
financial institution can fix the error and
avoid liability under TILA if it moves quickly.
15 U.S.C. 1640
The ways to defuse both the individual
action and the class action are similar. In an
individual case, by definition, the financial
institution will know which of its customers is
affected. As a precautionary measure,
however, the financial institution may wish
to do a file search of customers whose
accounts might have been affected by a
similar error. (What at first appears to be an
individual case may actually be a potential
class action.) In any event, the financial
institution must move quickly to find out:
Section 130(b) of the Truth in Lending Act
creates this escape hatch. That section
says the financial institution must make
whatever adjustments are necessary to the
appropriate accounts to assure that the
borrower will not have to pay an amount in
excess of the charge actually disclosed or
the dollar equivalent of the annual
percentage
rate
actually
disclosed,
whichever is lower. If the financial institution
does so, it will not be liable for any penalties
to the customer or for the customer‘s
attorney fees.
What caused the errors;
Which customers were affected; and
How much money is involved.
Then the financial institution must:
Write a letter to each affected
customer identifying the error;
Send corrected disclosure forms; and
Refund or otherwise credit any
charges in excess of those on the
original (erroneous) disclosure.
Truth in Lending violations can be of several
types:
An error in what form is used;
If these steps are accomplished within 60
days after the financial institution discovers
the violation, the financial institution is
granted immunity from liability to the
customer. The law defines ―discovering‖ the
error to include:
An error in the preprinted portions of a
form;
An error in entering figures;
An error in calculation (even with
correct input);
Finding it through the financial
institution‘s own procedures;
An error in what words are entered in
blanks on a form; and
Write-up of the violation by financial
institution examiners in their final
written report of examination; and
Failure to give the customer a form
(such as a rescission notice).
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Regulation Z
compliance publications for reports of
developments that might affect those forms.
There are many good compliance
publications on the market today. No one
publication will catch all significant
developments in time to allow a financial
institution to react promptly, but if the
financial institution receives several of the
good publications, it probably will be kept up
to date.
An administrative enforcement notice
and restitution order to the financial
institution from its regulator, based on
the financial institution‘s error in
disclosing APR or finance charges.
In addition, if a customer brings the violation
to the financial institution‘s attention orally,
without giving the financial institution written
notice or filing suit, the financial institution
also may correct the violation.
Calculation tools should be tested
periodically by the financial institution‘s
compliance officer or auditor to be sure that
annual percentage rates, finance charges,
and other critical quantitative disclosure
items are being computed correctly under
Regulation Z‘s procedures and tolerances.
So long as the correction, including a notice
to the customer and the appropriate refund
or credit, is accomplished within 60 days
after the financial institution discovers the
error and before the financial institution
receives written notice from the customer or
a lawsuit is started, the financial institution is
relieved of further liability. And if one
customer gives the financial institution
written notice of a violation or sues just on
his or her sole behalf, the financial
institution still may correct the error as to
other customers and cut off potential
liability to them. (The financial institution will
not be able to avoid liability to the particular
customer who has given such notice or filed
such a suit.)
The financial institution‘s lending officers
and other staff must be trained and
retrained in this and other compliancerelated disciplines, and failures must be the
subject of serious corrective actions. There
are a number of courses offered by some of
the same financial institution trade
associations and private providers who
publish newsletters and loose-leaf services
on compliance. Many financial institutions
have internal counsel and compliance
officers who are adept at training. All these
resources must be brought into play in the
effort to prevent TILA violations. Then, in
those few instances in which a violation
occurs despite all the best efforts described
above, the financial institution may fall back
to section 130(b).
Violation Prevention. Preventive maintenance
of compliance procedures can prevent virtually
all Truth in Lending Act violations. A financial
institution must ensure that its forms are
reviewed by counsel and compliance
officers periodically because the law and
particularly Regulation Z are often subject to
changes. In fact, the best preventive
maintenance is accomplished when a
financial institution has one or more
compliance personnel and/or attorneys who
have as part of their position descriptions
the job of knowing what the financial
institution‘s forms say and are intended to
do, and who then watch the incoming
Record Retention. All good regulations
require that a creditor maintain records as
evidence of their compliance. Regulation Z
requires that those records be retained for
two years. Section 226.25
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Regulation Z
Regulation Z ARM Disclosure Checklist
(Section 226.19(b))





1. CHARM booklet provided in all cases, plus the items listed below, as applicable.






6. An explanation of how the index is adjusted, such as by adding a margin.
2. The fact that the interest rate, payment, or term can change.
3. The index or formula for rate changes.
4. A source of information about the index or formula.
5. An explanation of how the interest rate and payment will be determined, including item
6, below.
7. Statement that consumers should ―Ask about the current margin and index rate.‖
8. The fact that the interest rate will be discounted.
9. Statement that consumers should ―Ask about the amount of the interest rate discount.‖
10. The frequency of interest rate and payment changes.
11. Any rules about changes in the index, interest rate, payment amount, and outstanding
loan balance (including for example, interest rate and payment limitations, negative
amortization, and interest rate carryover).
12. At the option of the creditor, choose either A or B below:

(A) A historical example of a $10,000 loan over the most recent 15 years of index
values reflecting all significant loan terms such as negative amortization, interest rate
carryover, rate discounts, and rate and payment limitations. If the particular program is
for less than 15 years, start at the oldest year and stop ―short.‖

(B) An illustration of the maximum interest rate and payment for a $10,000 loan
originated at the initial interest rate (reflecting any discount or premium) assuming the
maximum periodic increases in rates and payments under the program and the initial
interest rate and payment of the loan accompanied by a statement that the periodic
payment may increase or decrease substantially due to changes in the rate.
13. An explanation of how the consumer may calculate payments for a $10,000 loan.
Creditor may choose either A or B below based on how question 12 above was
answered:


(A) The most recent payment shown in the historical example in 12 (A) above; or
(B) The initial interest rate used to calculate the maximum interest rate and payment in
12 (B) above.


14. The fact that the loan contains a demand feature.

16. Statement that ―Disclosure forms are available for the creditor‘s other variable-rate loan
programs.‖
15. The types and timing of information the financial institution will provide the customer in
notices of adjustments.
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Regulation Z
Regulation Z Consumer Closed-End Loan Disclosure
Checklist (Section 226.18)
 1.
 2.
 3.
Identity of lender.
 4.
Alternative to 3: ―You have the right to receive a written itemization of the amount
financed. Initial here if you want it: ______‖ and consumer does not initial.
 5.
 6.
 7.
―Finance charge‖ (―the dollar amount the credit will cost you.‖)
 8.
For variable-rate loans of more than a year secured by consumer‘s principal dwelling:
(a) the fact that the loan contains a variable-rate feature;
(b) a statement that variable-rate disclosures have been provided earlier.
 9.
The number, amounts, and timing of payments scheduled to repay the loan. In
addition, there are three additional cases where special rules apply:
(a) for true demand loans (no alternate maturity) disclose the timing of any scheduled
interest payments in first year;
(b) when the transaction involves a series of payments which vary because a finance
charge is applied to the unpaid principal balance, disclose the dollar amounts of the
largest and smallest payments and refer to the variations in the other payments
(c) for closed-end transactions secured by real property or a dwelling, the rules require
the disclosure of the contract interest rate, regular periodic payment, and balloon
payment, if applicable. These disclosures apply to;
Fixed Interest loans
Adjustable Rate or Step-Rate
Mortgage with Negative Amortization
Interest Only

―Amount financed‖ (―the amount of credit provided to you or on your behalf.‖)
Itemization of amount financed (unless transaction is subject to RESPA and a GFE was
given):
(a) proceeds directly to consumer;
(b) proceeds credited to consumer‘s account with lender;
(c) amount paid to third parties by lender on behalf of consumer.
―Annual percentage rate‖ (―the cost of your credit as a yearly rate.‖)
For variable-rate loans: (i) not secured by consumer‘s principal dwelling; or (ii) secured
by consumer‘s principal dwelling but having a term of one year or less:
(a) the circumstances under which the rate may increase;
(b) any limits on the increase;
(c) the effect of an increase;
(d) an example of the payment terms that would result from an increase.
10. Total of payments (―the amount you will have paid when you have made all scheduled
payments.‖)
 11. Demand feature. (If true, assume one year maturity for calculations.)
 12. For precomputed finance charge, whether a prepayment penalty is imposed or not.
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Regulation Z



13. If finance charge includes other than item 12, state whether or not rebatable.

16. The fact that offered credit life, accident, health, or loss-of-income security interest
insurance is not required.



17. The premium for the initial term of item 16 insurance coverage.

20. The premium for the initial term of any item 19 insurance the consumer will obtain
through the lender (and the term of it, if less than the loan term).

21. Taxes and fees prescribed by law that actually are or will be paid to public officials for
searching for, perfecting, releasing, or satisfying a security interest.


22. Alternative to 21: insurance in lieu of (and for no greater charge than) the item 21 fees.

24. In a residential mortgage transaction, whether a subsequent purchaser from the
consumer may assume the mortgage on its original terms.

25. ―The APR does not reflect the effect of the required deposit.‖ (May omit if deposit earns
5 percent or more).

26. If the disclosure is an early good faith Fed Box disclosure, a statement indicating ―You are
not required to complete this agreement merely because you have received these
disclosures or signed a loan application‖ in conspicuous type size and format.
14. Any late charge other than a deferral or extension fee.
15. ―The financial institution will acquire a security interest in: [the property purchased as
part of this transaction] and/or [other property (identified by type)].‖
18. Consumer‘s signature (or initials) requesting item 16 insurance.
19. The fact that property damage and liability insurance may be obtained from a person of
the consumer‘s choice.
23. ―Refer to the [note/mortgage/etc.] for information about nonpayment, default, right of
acceleration, and prepayment rebates/penalties.‖ Optional: include further information
on security interest.
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Regulation Z
Sample Conforming Payment Notices
Sample Conforming Loan Payment Notice for Open-End Credit Plans
All loan payments must be accompanied by the account number or payment coupon provided.
Loan payments must be sent to: [name of your institution], P.O. Box 123 or Street Address, City,
State, Zip Code. Loan payments may also be made in person to personnel at any of our branch
locations. Payments must be received by 5 p.m. [include time zone] Time, Monday - Friday,
except bank holidays, to be credited as of that date. All other payments received will be
credited as of the next business day or as otherwise permitted by law.
Sample Conforming Loan Payment Notice for Closed-End Credit Plans
All loan payments must be accompanied by the account number or payment coupon provided.
Loan payments must be sent to: [name of your institution], P.O. Box 123 or Street Address, City,
State, Zip Code. Loan payments may also be made in person to personnel in any of our branch
lobby locations. Our hours of operation for receiving loan payments are 9 a.m. – 4 p.m.,
Monday – Friday [include time zone] Time, except bank holidays. All other payments received
will be credited as of the next loan operations business day or as otherwise permitted by law.
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Unfair or Deceptive Acts or Practices
Regulation AA
define purpose, to differentiate between a
consumer and a business purpose for
credit, the commentary suggests using the
factors listed in the commentary to
Regulation Z. Note that Regulation AA
does not contain a $25,000 cut-off as
Regulation Z generally does so for any
credit over $25,000 not secured by real
property or a principal dwelling, Regulation
Z may not apply but Regulation AA will.
Unfair or Deceptive Acts
or Practices
Common name: Regulation AA
Introduction
The Credit Practices Rules of Regulation
AA were promulgated by the Federal
Reserve Board to implement portions of the
Federal Trade Commission Improvement
Act. The regulation governs the activities of
all financial institutions that are either
national banks, members of the Federal
Reserve, or insured by FDIC. In general,
the rule prohibits three courses of conduct:
Confession of Judgment. A confession of
judgment is a clause in a contract (e.g., a
promissory note) in which the borrower
consents in advance to allow the lender to
obtain a judgment against the borrower
without giving the borrower notice or an
opportunity to appear or be heard in court.
Section 227.13(a) This does not prohibit a
negotiated settlement after default or an
agreed judgment after suit has been filed.
Unfair provisions in credit contracts
Not only may you not have a confession of
judgment in a consumer credit obligation,
you may not even have a reference to it. For
example, you may not have a confession of
judgment in a consumer credit note with an
explanation that it only applies in businesspurpose loans. If a loan is to an individual
for a covered loan, the note may not contain
any reference to a confession of judgment.
Unfair or deceptive practices involving
cosigners
Unfair late charges
Unfair Provisions in Credit
Contracts Section 227.13
It is an unfair act or practice for a financial
institution to enter into or enforce a
consumer credit obligation that contains any
of the following provisions:
Waiver of Exemption. All states grant
various
property
exemptions
from
attachment or execution to satisfy a
judgment. Typical exemptions are for a
home, household goods, clothing, tools, and
farm animals. The regulation prohibits the
existence of a clause in a consumer credit
contract waiving any of those exemptions.
Section 227.13(a) The only exception is
when the waiver applies solely to the
property given as security for the obligation.
For example, a waiver of the homestead
exemption on a person‘s home, in
connection with a home equity loan secured
by the home, does not violate the rule,
because the home is being given as
security for the loan.
Confession of judgment
Waiver of exemption
Assignment of wages or
A non-possessory security interest in
household goods
Consumer Credit Obligation. For the
purposes of Regulation AA, a consumer is a
natural person who seeks or acquires
goods, services or money for family or
household use other than for the purchase
of real property. Section 227.12(a) Loans to
corporations and partnerships are not
covered. Also, loans for the purchase of
real estate are not covered; but, real estatesecured loans such as home equity loans
are covered. While the regulation does not
Assignment of Wages. An assignment of
wages is a pledge by a debtor of future
wages to a creditor as security for a debt.
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Typically, in the event of a default, the
creditor presents the assignment to the
debtor‘s employer and the employer pays
the debtor‘s wages to the creditor in
accordance with the assignment. This
differs from a garnishment in that a
garnishment requires a final court order.
There are three exceptions to the
assignment of wages prohibition. Section
227.13(c) They are:
Regulation AA
Antiques (must be over 100 years old)
Jewelry
A financial institution may take a valid nonpossessory security interest in any nonincluded items.
Unfair or Deceptive Practices
Involving Cosigners
For Regulation AA purposes, a cosigner is
considered to be a natural person who
assumes liability for the obligation of
another consumer without receiving goods,
services or money in return for the
obligation or, in the case of an open-end
credit obligation, without receiving the
contractual right to obtain extensions of
credit under the account. Section 227.12(b)
A cosigner is given the protection of the
regulation regardless of when in the credit
process the signature is obtained. A person
who cosigns a note so that a financial
institution will forbear collection has the
same protection as a person who cosigns at
the time the note is signed. There are three
requisites for cosigner protection:
An assignment that is revocable at
any time by the borrower
A payroll deduction plan commencing
at the time of the transaction, whereby
the borrower authorizes a series of
wage deductions as a method of
making the payments
An assignment that applies only to
wages or earnings already earned at
the time of the assignment
Security Interest in Household Goods. It
is permissible to take a non-possessory
security interest in household goods as
collateral for a loan only when the
household goods were purchased with the
loan proceeds such as in a purchase money
mortgage. Section 227.13(d) The regulation
allows a security interest to be retained
when a purchase money mortgage is
refinanced or consolidated with other debts
of the consumer. Absent a purchase money
situation, a financial institution may not hold
a security interest in household goods. The
one exception is if the financial institution
wants to take physical possession of the
household goods. The regulation only
forbids non-possessory security interests.
That is the reason you may hock your TV
set at a pawnshop; they take possession.
The cosigner must be a natural
person, not an artificial entity such as
a corporation, partnership, etc.
The debt must be a consumer credit
obligation
(see
discussion
of
―Consumer Credit Obligation‖ above)
and
The cosigner is not a spouse whose
signature is needed to perfect a
security interest pursuant to state law
Before a cosigner becomes obligated, the
financial institution must inform the cosigner
of the nature of the cosigner‘s liability, and
the
financial
institution
may
not
misrepresent the nature or extent of the
cosigner‘s liability to anyone. Section
227.14(b) The obligation on the part of the
financial institution is both affirmative and
prohibitive. It must inform the cosigner of
the nature and extent of the liability, and it
must not misrepresent the cosigner liability.
Household goods include clothing, furniture,
appliances, and personal effects. Section
227.13(d) They do not include:
Works of art
Electronic entertainment equipment
(other than one TV and one radio)
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Prior to becoming obligated, a cosigner
must be given a notice in writing. The notice
need not be in a form the cosigner can
keep, though that is the recommended
practice. The cosigner is not required to
sign the notice, though that is also
recommended. The cosigner notice may be
contained in another document, such as a
credit application or a guarantee. The
notice, however, must be clear and
conspicuous. While Regulation AA does
not define clear and conspicuous, it does
provide sample ―Notice to Cosigner‖
language. If the notice is contained in
another document, then it should be
highlighted in some manner. The best policy
is to have the cosigner sign the disclosure
and keep a copy of it in the loan file.
Regulation AA
Unfair Late Charges
Another prohibition of Regulation AA is the
levy or collection of unfair late charges. A
financial institution may not charge a
delinquency charge when the only
delinquency is the nonpayment of
previously
assessed,
but
unpaid,
delinquency charges. Section 227.15(a) The
rule does not prohibit imposing multiple late
fees on a payment delinquent for more than
one period (though some states have laws
prohibiting this practice). The rule also does
not address (and, therefore, does not
prohibit) charging interest on late fees,
however, many states have laws prohibiting
this practice as well. The regulation requires
that all payments on an obligation be
applied to required payments before any
amount is applied to accrued late fees. For
example, assume that a loan has a required
$40 monthly payment and that there is $5 in
accrued but unpaid late fees. The current
monthly payment of $40 is made timely. The
entire payment must be applied to the
current requirement. No part of it may be
applied to the past-due late fee, thereby
causing a shortage in the current payment
and triggering an additional late fee.
If the language of the prescribed notice is
contrary to the law of your state or the terms
of the cosigner‘s liability, the notice should
be changed to reflect the applicable law and
or liability obligation.
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Regulation AA
Sample Notice
Notice to Cosigner
You are being asked to guarantee this debt. Think carefully before you do. If the borrower
doesn‘t pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you
want to accept this responsibility.
You may have to pay up to the full amount of the debt if the borrower does not pay. You may
also have to pay late fees or collection costs, which increases this amount.
The financial institution can collect this amount from you without first trying to collect from the
borrower. The financial institution can use the same collection methods against you that can be
used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in
default, that fact may become a part of your credit record.
This notice is not the contract that makes you liable for the debt.
I acknowledge receipt of a copy of this notice.
Date
Cosigner
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Community Reinvestment Act (CRA)
Regulation BB
wholesale or limited-purpose financial
institution, each institution will be evaluated
based on its performance within its
―assessment area.‖ Each financial institution
must define its own assessment area. The
defined assessment area must consist of
whole ―geographies,‖ meaning whole
census tracts or Block Numbering Areas
(BNAs). BNAs were established for those
areas that were not already divided into
census tracts, so urban areas are typically
divided into census tracts while rural areas
are divided into BNAs. The old method of
drawing a circle around the financial
institution will not meet the technical
requirements for defining an assessment
area. Rather, the assessment area should
consist of one or more Metropolitan
Statistical Areas (MSAs) or one or more
political subdivisions (i.e., counties, cities,
and states). An assessment area cannot
split census tracts or BNAs and must
encompass the areas in which a financial
institution has its main office, any branches,
and any deposit-taking remote service
facilities (e.g., ATMs). Mobile branches and
ATMs must be included in the assessment
area, but loan production offices are not
considered branches unless they are
approved as branches by the regulators.
Community
Reinvestment Act (CRA)
Common name: Regulation BB
Introduction
Congress
passed
the
Community
Reinvestment Act (CRA) in 1977 to require
financial institutions to serve the needs of
the entire community in which they are
located, not excluding low- and moderateincome (LMI) areas. The CRA and its
implementing
regulations
place
an
extensive obligation on financial institutions
to be proactive in meeting the credit needs
of their communities.
To help address the many issues of CRA,
the
regulators
periodically
publish
―Interagency Questions and Answers
Regarding
Community
Reinvestment‖
(Q&A) which can be helpful.
The regulators‘ enforcement powers are
different under CRA than under most
regulations. CRA does not empower the
regulators to invoke civil money penalties
for problem institutions. This may sound
good at first, but CRA comes with a punch
of its own. CRA ratings are made public,
and branch applications or mergers can be
blocked based on CRA ratings. Community
groups aggressively pursue this course on
many large financial institution merger
applications, regardless of how the
institution was rated in its last CRA
examination.
As long as an institution meets the technical
requirements in defining an assessment
area, there will be no ―reasonableness‖
rating for the size and appropriateness of
the area. Of course, the assessment area
still must not arbitrarily exclude LMI areas or
reflect illegal discrimination. Additionally,
financial institutions will be questioned if
there are unusual, disproportionate lending
gaps within certain areas. This possibility,
however, does not mean that an institution
must lend in all areas throughout its
assessment area. This is quite a departure
from the old rules, where a financial
institution was required to step up
ascertainment and marketing efforts in any
area within its defined community where
lending was not active. Factors such as
competition,
economic
conditions
throughout the area, and the financial
Assessment Methods
Assessment Area. The regulation is
expressly designed, the regulators say, to
emphasize
performance
instead
of
paperwork. It is intended to be objective in
its evaluations of institutions. At the same
time, the agencies wanted to preserve a
strong element of ―examiner judgment.‖
Whether a large, small, intermediate small,
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institution‘s ability to lend will all be taken
into consideration in determining the
reasonableness of the financial institution‘s
lending activities throughout the community.
Regulation BB
information. Rather, loans should be
analyzed based on their distribution among
borrowers of varying income levels. To
facilitate this analysis, financial institutions
must maintain adequate records of
applications so that the applicant‘s income
information is available.
Income Levels. Large, small, and
intermediate small institutions will be
evaluated under CRA based on their
lending to borrowers of various income
levels. The defined income levels are: (1)
low-income -- less than 50% of the area
median income (AMI); (2) moderate-income
-- at least 50% and less than 80% of AMI;
(3) middle-income -- at least 80% and less
than 120% of AMI; and (4) upper-income -120% of AMI or more. The same
percentages are also used in determining
the income level of a particular census tract
or BNA. Income information is collected by
the Census Bureau every ten years, and
HUD applies an update to these figures
each year. You may obtain this information
by contacting the Census Bureau or HUD
(800-245-2691). Also, you can obtain (at no
charge) a list of the 2010 Census Bureau
data and HUD‘s annually updated numbers
by calling the Federal Financial Institutions
Examination Council‘s (FFIEC‘s) HMDA
Help Line at (202) 452-2016 or reviewing its
Web site at http://www.ffiec.gov. You may
also order income-level information for each
census tract or BNA as a percentage of a
particular MSA or non-MSA from the FFIEC.
There are three methods by which the vast
majority of institutions will be judged under
the new CRA rules: three-pronged, small,
and strategic plan. Other methods are
provided for intermediate small, wholesale
and limited-purpose institutions.
The Three-Prong Method
The three-prong method will be applied
unless an institution qualifies as small or
intermediate small or elects to use the
strategic plan method. The three prongs (or
tests) are lending, investment, and service.
Section 228.21
The Lending Test. Section 228.22 On the
lending prong, a financial institution will be
evaluated on its loan originations and loan
purchases that help meet the credit needs
of its assessment area. Loans outstanding
will not be considered, except as
background information for an examiner to
learn more about an institution. The
categories of loans considered are:
Home mortgage loans. These loans
include all HMDA-reportable loans:
home purchase, home improvement,
and refinancings of both. Being
exempt from HMDA does not exempt
a financial institution from this part of
the lending test. Regulators will
sample the types of loans that would
have been reported had the financial
institution not been exempt from
HMDA.
Loan Distribution. As part of the lending
review for all financial institutions,
examiners will assess the distribution of the
institution‘s loans among geographies (loan
location) and borrower characteristics
(income levels and size of business). In
many cases, a geographic distribution
analysis is meaningless because the loan‘s
location in no way indicates the income
level of a borrower. This is frequently the
case in rural areas and small towns where
income levels vary greatly with no
geographical division between high- and
low-income residents. When conducting a
self-analysis, therefore, institutions should
not waste time on a geographical analysis
which does not provide meaningful
Small-business and small-farm loans.
CRA specifically refers to the Call
Report, Schedule RC-C definitions of
small-business and small-farm loans.
This category of loans really should
be referred to as ―small loans to
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businesses and farms.‖ Any business
loan that is $1 million or less is a
small-business loan, regardless of the
size of the business; any farm loan of
$500,000 or less is a small-farm loan.
Collateral securing a loan must be
nonresidential, commercial, or farm
real estate in order to meet the
definition of small-business or smallfarm loans. So if a financial institution
makes a loan to a small business that
is secured by the owner‘s residence
only, the loan would not be
considered under the small-business
category. Credit cards that are issued
for small-business purposes are
considered small-business loans if
they meet the Call Report definition.
Regulation BB
community will not be included as
community development loans.
Community development loans that also fit
the category of home mortgage, small-farm,
or small-business loans will be considered
under those categories rather than as
community
development
loans.
For
instance, a loan made to a builder for single
family housing development in low-income
areas must be reported under HMDA rather
than in the community development
category. Multifamily dwelling loans are the
only type of loans that may be counted as
both home mortgage loans and community
development loans. Even if the financial
institution is not required to report home
mortgage loans under HMDA, or smallbusiness and small-farm loans under CRA,
these loans will still be considered under
these categories by the regulators if the
loans would have fit had the financial
institution been a reporting institution.
Community development loans. This
category includes loans for affordable
housing, community service facilities,
and economic development or
revitalization projects, provided each
loan is directed at the needs of LMI
people or geographies. Indirect loans
may also count as community
development loans. For example,
loans originated or purchased by a
financial
institution
through
a
Community Development Corporation
(CDC), loan consortium, or similar
third party usually fall under this
category. Community development
loans may be counted even when
made outside of the financial
institution‘s assessment area, as long
as the program under which the loan
is made serves the institution‘s
assessment area as well as a broader
regional area. So if a financial
institution joins a statewide loan
consortium and has defined one
county of the state as its assessment
area, the financial institution may
report as a community development
loan any loan it participates in
throughout the state. Loans that have
some temporary benefit but no longterm stabilizing effect on a distressed
Consumer loans (optional). A financial
institution may choose to have one or more
of the following types of consumer loans
evaluated: motor vehicle, credit card, home
equity (not reported under HMDA), other
secured, and other unsecured. A financial
institution may choose to have all of its
consumer loans considered or may only
have its motor vehicle or credit card loans
considered. Any variation in between is
completely at the discretion of the
institution. The only catch is that the
financial institution must follow the data
collection and reporting requirements
described later in this article for any type of
consumer loans it chooses to have
reviewed. Although the agencies will
typically review consumer loans only when
requested by an institution, in cases where
consumer loans make up a ―substantial
majority‖ of the financial institution‘s overall
lending, the agencies will review those
loans.
The Investment Test. Section 228.23 Here
the examiners evaluate a financial
institution‘s record of helping to meet the
credit needs of its assessment area through
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qualified
investments,
deposits,
memberships, or grants that have
―community development‖ as their primary
purpose. Community development means
affordable housing (especially multifamily
rental housing) for LMI individuals,
community services targeted to LMI
individuals, activities that promote economic
development by financing small businesses
or farms, and activities that revitalize or
stabilize
LMI
geographies.
These
investments must benefit the financial
institution‘s assessment area or some larger
area that includes the assessment area.
Out-of-area investments do not count.
Regulation BB
programs, homeless centers, soup kitchens,
health-care facilities, battered women‘s
centers, and alcohol and drug recovery
centers
would
qualify.
Charitable
contributions will qualify only when made to
an organization that has community
development as its primary purpose.
Investments by a financial institution‘s
affiliates will be considered upon request, if
the investment is not claimed by any other
institution. Activities covered by the lending
or service tests will not be considered under
the investment test. One of the favored
―investments‖ is the giving (or otherwise
making available on below-market terms) of
a branch to a minority or women‘s
depository institution. To qualify, however,
the branch must be located in a
predominantly
minority
neighborhood
(oddly, even if it is given to a women‘s
financial institution).
In evaluating an investment, the regulators
will
consider
its
dollar
amount,
innovativeness, complexity, responsiveness
to community credit and development
needs, and the degree to which the qualified
investments are not routinely provided by
what the regulation contrasts as ―private‖
investors. Section 228.23(e)
Many
investments that you might expect to qualify
under this test will be disregarded because
they are not considered innovative or the
investment does not have community
development as its primary purpose. For
instance, mortgage-backed securities and
municipal bonds generally are not qualified
investments. Additionally, most municipal
bonds will not qualify because they serve a
broad area rather than focusing primarily on
the needs of a low-income area.
Investments need not be housing-related in
order to be counted, however. Municipal
bonds to fund a community facility or park or
to provide sewer services will be counted if
they are part of a plan to redevelop an LMI
neighborhood. Otherwise, they will not be
counted. ―Investments‖ in (really permanent
contributions to) organizations such as
CDCs, loan consortia, and small-business
investment companies will qualify under this
test as long as the organization lends
primarily to LMI individuals or promotes
economic development by financing small
businesses.
Facilities
that
promote
community development either in LMI areas
or for LMI individuals, such as youth
The Service Test. Section 228.24 This test
evaluates a financial institution‘s system for
delivering retail financial services to its
assessment area and the ―extent and
innovativeness‖
of
its
community
development services. Again, only services
in the financial institution‘s assessment area
or some larger area that includes that
assessment area will be considered.
Affiliate services will be included on request,
provided they are not double-counted. The
federal government will look at the
distribution of the institution‘s branches in
geographies with different income levels.
Regulators will review the institution‘s
record of opening and closing branches,
with emphasis on branches in, or serving,
low and moderate income (LMI) areas.
Alternative systems of retail financial
institution service delivery will be considered
too, principally in the context of serving LMI
people.
Community involvement and leadership do
not, in and of themselves, contribute to a
more favorable rating under the service test.
Certain ascertainment activities that were
valued highly under the old rules will benefit
the financial institution under the service
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test only if they meet the definition of
community development and are related to
the provision of financial services. To
illustrate the difference, involvement in a
low-income neighborhood cleanup or a
Habitat for Humanity weekend building
project would not be counted under this test.
Some examples of activities that do
constitute
―community
development
services‖ include serving on the board of
directors of an organization that helps meet
affordable
housing
needs,
providing
financial counseling to LMI members of the
community,
and
educating
small
businessmen and small farmers on financial
issues. While there is no law prohibiting
financial
institutions
from
charging
customers or non-customers for cashing
government checks, a financial institution
will receive credit under this section if it
increases access to LMI people by cashing
those checks at no charge. Additionally,
financial institutions will receive credit for
providing low-cost access to LMI residents
who will be receiving their government
benefits electronically.
Regulation BB
it has hit the threshold for two consecutive
years, it will need to choose intermediate
small or large.
A large institution is
considered to have more than $1.122 billion
in assets as of December 31, 2010.
Small Banks
Small financial institutions have the option
of being evaluated under the three-pronged
method or under the small performance
standards. Under the true small test the
regulators consider the financial institution‘s
loan-to-deposit
(LTD)
ratio,
with
adjustments for any seasonality that exists.
The regulators evaluate the financial
institution‘s other lending activities, such as
originations of loans for sale in secondary
markets. They also consider any community
development loans and similar investments
the financial institution has made.
The examiners evaluate the proportion of
the institution‘s total lending to borrowers in
its assessment area and the distribution of
its loans among people of different income
levels, and among businesses and farms of
different sizes. The geographic distribution
of loans within the financial institution‘s
assessment area will be factored in as well.
The examiners also review the financial
institution‘s responses to any consumer
complaints that have been received by the
financial institution.
Asset Size
Financial institutions are broken down into
three asset size groups for purposes of
CRA.
The asset size of a financial
institution is important for CRA as it
determines how an institution will be graded
for
its
community
reinvestment
performance. The asset size is adjusted
annually each year for the following year so
that a financial institution knows how it will
be judged, and how it should report its data,
if required. There are three asset sizes;
small, intermediate small and large.
The Uniform Bank Performance Report
(UBPR) is a useful report for purposes of
learning a financial institution‘s quarterly
loan-to-deposit ratio and loan mix. Since
this report is sent to financial institution
presidents, CRA officers frequently are not
privy to the report unless they specifically
ask for it or they obtain it from the UBPR
section of the FDIC‘s Web site. The
examiners will use the UBPR to calculate a
financial institution‘s loan-to-deposit ratio by
adding the quarterly loan-to-deposit ratios
since the last examination and dividing the
total by the number of quarters reviewed.
While no specific loan-to-deposit ratio is
used in determining reasonableness, you
are likely to be questioned about an LTD
If an institution is small, its asset size is less
than $280 million as of December 31, 2010.
It is considered small unless its asset size
has exceeded the threshold for small
institutions for two consecutive years. At
that time, the institution will be moved up a
category and has the choice to report as
either a large institution or it can report as
an intermediate small institution. But once
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Regulation BB
ratio of less than 80%. The same is true
with regard to lending within your
assessment area, although a ―majority‖ of
your loans is needed for a satisfactory rating
under one criterion, anything less than 80%
of your loans within your assessment area
will likely raise questions. Factors the
examiners consider in determining the
reasonableness of the LTD ratio and
lending activity include demographic and
economic factors present in the assessment
area, your institution‘s capability to lend,
and lending opportunities in the area.
goes through a multi-step process, dictated
by the regulation, to develop and obtain
federal approval for a plan. Once the plan
has been approved, it will be the standard
against which the institution will be
evaluated. The steps are:
To a large extent, financial institutions are
graded based on a comparison with the
lending activity of other financial institutions
in the community. So, if Institution A‘s LTD
ratio falls well short of the LTD ratios of its
competitors, Institution A should be
prepared to explain its lower LTD ratio.
Therefore it is important to know what the
examiners will know before their arrival at
your financial institution. Since Call Report
information is made public (the FDIC
publishes the information on its Web site),
financial institutions should compare
themselves to the other financial institutions
in the community and be able to explain any
major differences. Additionally, examiners
conduct ―community contacts‖ with various
―leaders‖ in the community to determine
how well financial institutions are serving
the area. The types of people typically
contacted for this information include church
leaders, realtors, city planners, county
extension officers, housing
authority
personnel, and public officials. While
ascertainment efforts are no longer
evaluated as part of CRA, it would certainly
behoove financial institutions to know
firsthand what type of information these
community
contacts
would
provide
examiners.
Revise the plan as appropriate, based
on the comments received.
Informally
seek
the
public‘s
suggestions during the initial drafting
of the plan.
Publish notice of the plan and solicit
written comments from the public for
at least 30 days.
Submit the plan, and the prior draft
the public commented upon, to the
institution‘s principal federal regulator,
along with a description of the
institution‘s informal efforts to obtain
public input to the drafting process
and the written comments received
from the public, and ask for approval
of the plan as revised.
Wait for word from the agency. The
new regulation says the plan will be
deemed approved if the agency does
not disapprove it or extend the
timeframe ―for good cause‖ within 60
days. Based on agency practice under
similar
seemingly
self-executing
timelines in the context of mergers,
acquisitions, and branching, we do not
believe a financial institution ought to
count on that 60-day automatic
approval provision.
Intermediate Small
A financial institution may choose to be
judged under the large institution criteria
even though it fits the criteria for
intermediate small. Many institutions have
made exactly that choice, because it will be
more difficult, perhaps much more difficult,
to attain an overall rating of ―satisfactory‖ as
an intermediate small institution. The reason
is that an intermediate small institution must
get at least a ―satisfactory‖ rating on both
Strategic Plan. Section 228.27 Originally,
many in the industry hoped this method
might be widely usable by financial
institutions. That has not proven to be the
case, however. Few plans have been
allowed. Under this method, an institution
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Regulation BB
regulators indicate that it is possible to do
well by engaging in any one or two of these
activities.
the lending and community development
tests, Section 228.26(a)(2) while a large
institution can get an overall ―satisfactory‖
CRA rating if it has a ―satisfactory‖ on the
lending test alone. The definition of
―community development‖ for all financial
institutions was simultaneously revised to
focus on underserved rural areas.
How Ratings Will Be
Determined
Three-Prong Test.
The regulators have published matrices
which identify the points needed for certain
ratings, using name grades: outstanding,
satisfactory, needs to improve, and
substantial noncompliance. A point system
is used to determine which rating is
assigned to a financial institution:
Wholesale and Limited
Purpose Institutions
A financial institution wishing to be
evaluated as a wholesale or limited purpose
institution must file a written request with its
federal regulator at least three months
before the proposed effective date of the
designation. If granted, the designation will
remain in effect until the earlier of:
The institution‘s request to revoke the
designation, or
One year after the agency notifies the
institution that the agency has
revoked the designation.
Points Received
Rating Assigned
20+
11-19
5-10
0-4
Outstanding
Satisfactory
Needs to Improve
Substantial
Noncompliance
To determine exactly how many points to
grant to a financial institution, the regulators
use yet another table. We reproduce it
below, with our own addition of the last
column, ―Total Points Possible,‖ which
simply adds up the maximum possible
points from each of the three prongs
(lending, service, and investment).
These designated institutions will be
evaluated
under
the
community
development test discussed earlier, based
on their community development lending,
qualified
(community
development)
investments, or community development
services. They need not engage in all three
of these categories of activities. The
Examiner’s Rating on
Particular Component (“Prong”)
Outstanding
High Satisfactory
Low Satisfactory
Needs to Improve
Substantial Noncompliance
Maximum Points per Prong
Lending
Service Investment
12
6
6
9
4
4
6
3
3
3
1
1
0
0
0
Note several things about these two
matrices. First of all, the regulators created
a fifth category of rating in the matrix
immediately above by splitting ―satisfactory‖
into
―high
satisfactory‖
and
―low
satisfactory.‖ The agencies said they did
this to accord special recognition to those
Total Points
Possible
24
17
12
5
0
financial institutions that are almost good
enough for an ―outstanding‖ grade. It is,
however, purely an intermediate step in the
rating process. The CRA rating ultimately
awarded will be phrased only as
―satisfactory,‖ without ―high‖ or ―low‖ as
modifiers.
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Secondly, the points will be ―adjusted‖ to be
certain that no financial institution receives a
―satisfactory‖ rating overall unless it
receives at least a ―low satisfactory‖ on the
lending test. To accomplish this end, a
financial institution will not be allowed a
higher rating than that generated by
multiplying its lending score by three.
Regulation BB
deposit ratio and ―reasonable‖ distribution of
loans among different income levels of
people and different sizes of businesses
and farms.
As a small financial institution, you will be
asked by the regulators whether or not you
want to be considered for an ―outstanding‖
rating. Believe it or not, this is not a trick
question. A small financial institution may
qualify for an outstanding rating based on
lending activity alone. If not, the regulators
will review (at your option) the financial
institution‘s performance in making qualified
investments and providing services that
enhance credit availability.
Thirdly, the regulators removed the matrices
from the regulation. The proposal to
automatically award a rating of ―substantial
noncompliance‖ if an institution‘s prior two
ratings were ―needs to improve‖ or lower
was dropped from the final regulation. The
government says it will consider the
institution‘s efforts to improve in determining
what rating to grant.
Wholesale or Limited Institutions. To
obtain an ―outstanding‖ rating requires a
―high‖ level of this, ―extensive‖ use of that,
and ―excellent‖ the other, while a
―satisfactory‖ grade requires only an
―adequate‖ level of this, ―occasional‖ that,
and ―adequate‖ the other.
Finally, look at the ultimate standards an
institution must meet under each of the
three prongs in order to be awarded an
―outstanding‖ or ―high satisfactory‖ or ―low
satisfactory‖ or other rating. They are in
Appendix A to the regulation. To be
awarded an ―outstanding‖ rating under the
lending
prong,
an institution
must
demonstrate ―excellent‖ responsiveness to
the credit needs of its assessment area. For
a ―high satisfactory,‖ it must demonstrate
―good‖ responsiveness to those needs. If it
demonstrates
only
―adequate‖
responsiveness to those needs, it will
receive a ―low satisfactory‖ rating. ―Poor‖
responsiveness will get a ―needs to
improve,‖ while ―very poor‖ responsiveness
will get a ―substantial noncompliance.‖ All of
the standards to be used by the examiners
in grading financial institutions are just that
vague and undefined: excellent, good,
adequate, poor, very poor, high, small,
extensive, significant, occasional, and so
on. There are no objective standards, no
measures, and no guidance. How will an
institution know when it has demonstrated
―excellent‖ or ―good‖ responsiveness?
When the examiner says so.
Strategic Plan. The proposed plan itself will
be graded as either ―satisfactory‖ or
―outstanding‖ based on its stated goals.
Then, the financial institution‘s actual
performance toward those goals will be
graded. If a financial institution ―substantially
achieves‖ its goals under a ―satisfactory‖
plan, it will be awarded a ―satisfactory‖
rating. If it ―fails to meet substantially‖ those
goals, then it will receive either ―needs to
improve‖ or ―substantial noncompliance‖
depending upon ―the extent to which it falls
short.‖ Where will the line be drawn? The
government has not said.
Data Collection and Reporting
Large financial institutions are required to
collect and report data annually on their
small-business and small-farm loans, home
mortgage
loans,
and
community
development loans. Section 228.42 This
reporting must reflect only loans originated
and purchased, not loans outstanding. The
regulators have made software available to
handle the reports and have set up a CRA
Assistance line at (202)872-7584. Our
Small Institutions. Similar lack of precision
exists in these standards. A small financial
institution will receive a ―satisfactory‖ rating
if it demonstrates a ―reasonable‖ loan-to-
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experience has been that this line is readily
accessible and provides quick responses.
Regulation BB
outside of an MSA altogether. The
aggregate number and amount of
community development loans originated or
purchased must also be reported annually.
Except for multifamily loans, a financial
institution cannot report any loans as
community development when they could
also fall under another category (i.e., smallbusiness, small-farm, or home mortgage
loans). This limitation significantly reduces
the number of community development
loans that may be reported for many
financial institutions.
For small-business and small-farm loans,
large financial institutions must collect and
maintain information that is not going to be
reported annually but is going to be
reviewed during CRA examinations. The
required information is (1) a number or
symbol that identifies the loan, (2) the loan
amount at origination, (3) the loan‘s
location, and (4) an indicator whether the
loan was to a business or farm with gross
annual revenues of $1 million or less.
There are no requirements that a financial
institution maintain or report information on
consumer loans. However, if the financial
institution does not maintain data on these
loans, the examiners will not consider them
(except as noted under the lending test).
There are five types of loans under the
consumer lending category that examiners
consider if your financial institution collects
and maintains information similar to that
maintained for small-business and smallfarm loans: motor vehicle, credit card, home
equity (not reported under HMDA), other
secured, and other non-secured. To have
any type of consumer loans considered, you
must maintain a unique identifier, the loan
amount, the loan location, and the gross
income of the borrower for each loan of that
type. The result of this recordkeeping is that
each financial institution will report all loans
or no loans under each type, depending on
whether or not the financial institution wants
that type of loan considered by the
examiners.
Additionally, a financial institution must
annually report to the regulators the
aggregate number of small-business and
small-farm loans in each census tract or
block numbering area in which the financial
institution originated or purchased such
loans. Remember to look to the size of your
loans, not the size of the businesses and
farms, in determining whether the loans are
considered small-business and small-farm
loans. The annual report must break down
the aggregate loans as follows:
Number and amount of loans with
original amounts of:
$100,000 or less,
$100,001 to $250,000,
Over $250,000.
A separate indicator for the number
and amount of loans to businesses
and farms with gross annual
revenues of $1 million or less. (If the
financial institution did not determine
and rely on the gross annual
revenue for a business in making the
credit decision on a loan, the loan
should not be reported under this
category.)
When determining the gross revenues or
income of a borrower, a financial institution
should use the amount relied upon in
making the credit decision. For instance, if a
financial institution makes a loan to
Company A, which is owned by Company
B, but relies solely on the income of
Company A in making the credit decision,
then the financial institution would report the
loan using the revenues of Company A only.
If the income of the holding company was a
factor in the decision, however, then the
Large financial institutions meet the home
mortgage
reporting
requirements
by
submitting the HMDA-LAR each year. CRA
adds a twist by requiring financial
institutions to report the loan location even
for those loans that are made outside of an
area in which the institution has a branch or
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income of Company B should be added to
the income of Company A in determining
the figure. The loan amount for lines of
credit is reported as the full amount that is
approved at origination, or the amount of
the increase only for lines that are later
increased. The appropriate loan amount to
report for small-business or small-farm
loans that the financial institution purchases
is the amount of the loan at origination, not
at the time of the purchase. This rule to
report the origination amount rather than the
purchase amount is designed to be in line
with the Call Report provisions. Under the
lending test, examiners look at purchase
amount only. When a financial institution
makes multiple loans to the same business,
each loan should be reported separately.
Multiple credit lines issued to a company‘s
employees, however, should be reported (if
appropriate under Call Report instructions)
as one loan with an amount equal to the
total of the credit limits opened on a
particular date.
Regulation BB
Home mortgage loans - where the
home is located.
Small-business and small-farm loans at the institution‘s discretion, either
where the main business facility or
farm is located or where the borrower
says the loan proceeds will be put to
use.
When a financial institution has its affiliate‘s
lending considered under the institution‘s
CRA evaluation, these data collection and
reporting requirements apply equally to the
affiliate lending. Additionally, the financial
institution must report any third-party
lending (such as a loan consortium) that it
wishes to have included in the CRA
evaluation.
The regulation provides an opportunity for
financial institutions to submit other lending
activity for review as well. Therefore, be
certain to maintain documentation on any
loans that you would like to have considered
even though these loans do not specifically
fall into one of the required reporting
categories.
Just like HMDA, CRA requires reporting of
loans that are refinanced, but not of loans
that are merely renewed or extended. A
refinancing occurs when an existing
obligation is satisfied and replaced by a new
obligation. When changes to an existing
obligation are accomplished solely through
a modification agreement, with the existing
note remaining intact, a refinancing does
not occur and the transaction is not
reportable. On the other hand, when a new
note is used (which satisfies the existing
note) to simply extend the maturity of a
loan, a reportable refinancing has occurred.
Reporting requirements may change
significantly for a financial institution due to
a merger. For example, two small
institutions may be involved in a merger that
increases their assets above the small
threshold. In this case, the surviving
financial institution remains a small financial
institution until the total assets at year-end
have exceeded the small threshold for two
consecutive years. When a large institution
acquires a small institution, however,
information on the small institution‘s loans
must be collected beginning with the year
following the merger. The acquiring financial
institution has the option of reporting or not
reporting loans from the small institution
originated during the year of the merger.
When two large financial institutions merge,
loan information for both institutions must be
submitted for the year of the merger. For
that first year only, these data may be
submitted by the surviving financial
When the proceeds of a small-business
loan are used at a variety of locations, the
financial institution should report the
location of the loan as either the
headquarters of the business or the location
where the greatest portion of the proceeds
were used (as indicated by the borrower). A
loan‘s location is:
Consumer loans - where the borrower
resides.
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institution in a consolidated report or in two
separate reports.
Regulation BB
number and amount to borrowers and
census tracts having different income levels.
The public file must be maintained at one
office in each state in which an institution
has an office. Each branch must have a
copy of the institution‘s public CRA
evaluation and a list of services provided at
that branch. The public file must be updated
as of April 1 of each year, except for items
that are given different updating schedules
in the regulation, such as the disclosure
statement.
Disclosure Statement and
Public File
The regulators will prepare the institution‘s
CRA disclosure statements based on the
information reported for each year.
Section 228.43 These statements are made
publicly available at central depositories on
individual financial institutions and show
aggregate information by MSA and each
non-MSA portion of a state. Each institution
is required to put a copy of its own
disclosure statement into its CRA public file
within three business days after it receives
the statement from the regulator. The public
file must also contain the financial
institution‘s most recent CRA Performance
Evaluation from its primary regulator (within
30 business days of receipt) and the HMDA
Disclosure
Statement
(if
applicable)
prepared by the FFIEC for the prior two
calendar years (within three business days
of receipt).
If an institution has elected to be judged as
intermediate small, it will also need to keep
records of the number and amount of
community development loans, the number
and amount of qualified investments, the
extent to which the financial institution
provides community development services,
and
the
financial
institution‘s
responsiveness (through those activities) to
community
development
lending,
investment, and service needs. Section
228.26(c)
CRA Notices
Each institution will still have to keep a map
of its assessment area in its public file. It will
have to have a list of the census tracts or
BNAs in its area with the map, but those
geographies need not be marked on the
map. The public file must contain a list of
the services offered at the financial
institution‘s branches, the address of each
branch and the geographies it serves, and a
list of all branches opened and closed by
the financial institution during the current
year and the two prior calendar years. A
small institution‘s public file must state the
institution‘s loan-to-deposit ratio for each
quarter of the prior calendar year and, at the
institution‘s option, additional information on
the loan-to-deposit ratio. All of an
institution‘s ATMs need not be listed.
Appendix B to the regulation contains two
model forms of CRA notices. One form is for
a financial institution‘s main office, and, if
the financial institution operates in more
than one state, at least one branch in each
state. The other form is for all other branch
offices.
Recommendations
Based on our reading of the regulation and
the material that accompanied it, together
with the public statements we have seen
from some of those involved in drafting it,
and the Q&A released in the intervening
years,
we
have
the
following
recommendations for your consideration:
Forget about getting CRA credit for
anything you do outside your
assessment area (or some larger area
that includes your assessment area).
You will receive points for it only if you
are found to have already ―adequately
If an institution has elected to be graded on
a category of consumer loans, it will be
required to put into its public file the number
and amount of those loans made inside and
outside of its assessment area and the
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addressed‖ the credit needs of your
own area. We do not believe any of
the regulators will say that about an
institution.
Regulation BB
only if consistent with safe and sound
operations.‖
―Where a portion of a line of credit is
reported under HMDA and another portion
meets the definition of either a ‗small
business loan‘ or a ‗consumer loan,‘ the full
amount of the line of credit should be
reported as a small business loan or
collected as a consumer loan as
appropriate, and the agencies will also
consider as a home mortgage loan the
portion of the credit line that is reported
under HMDA.‖
Get to know the competition. The
agencies have explicitly said they will
compare your financial institution to
your competitors locally (and to your
―peers,‖ on a national basis) to
determine your level of performance.
The
community
institution
that
competes with a local branch of a
super-regional needs to know what
that branch has in its arsenal (and
vice versa).
―An institution is not expected to lend evenly
throughout or to every geography in its
assessment area.‖
Save the preamble to the regulation. If you
have a problem, there is language there that
just may help. We have produced portions
of it below.
―The appropriate inquiry regarding service
to particular racial or ethnic groups and men
and women is whether the institution is
operating in a nondiscriminatory manner.‖
Potentially Useful Statements
in the Preamble to the CRA
Regulation
―The focus of the service test . . . remains
on an institution‘s current distribution of
branches, and the test does not require an
institution to expand its branch network or
operate unprofitable branches.‖
―Activities that create, retain, or improve
jobs for low- or moderate-income persons to
stabilize or revitalize low- or moderateincome areas also qualify as community
development, even if the activities are not
located in low- or moderate- income areas.‖
―An institution‘s branches and other service
delivery systems need not be accessible to
every part of an institution‘s service area.‖
―The rule does not require institutions to
provide basic financial services or low-cost
checking accounts.‖
―Home equity loans that are not reportable
under HMDA are consumer loans if they
otherwise meet the definition.‖
―A small institution is not expected to lend
evenly throughout its service area; rather,
loan distribution will be evaluated within the
context of an institution‘s capacity to lend,
local economic conditions, and lending
opportunities in the assessment area.‖
―Institutions are in the better position to
know their communities, and it is neither
appropriate nor feasible for the agencies to
prepare a detailed assessment of the credit
needs of an institution‘s community.‖
―The agencies will not consider whether
community
organizations
unanimously
support [an institution‘s strategic] plan, but
whether the institution made an appropriate
investigation to determine the needs of its
community, and whether the goals of the
plan serve those needs.‖
―The agencies firmly believe that institutions
can and should expect lending and
investments encouraged by the CRA to be
profitable.‖
―The agencies permit and encourage an
institution‘s use of flexible underwriting
approaches to facilitate lending to low- and
moderate-income individuals and areas, but
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―The final rule eliminates the equidistance
principle as a required part of the
delineation of an assessment area.‖
Regulation BB
area is within an institution‘s assessment
area, the institution must lend to that census
tract or block numbering area.‖
―The agencies do not expect that, simply
because a census tract or block numbering
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Availability of Funds
Regulation CC
what kinds of accounts are covered by the
regulation. It includes all transaction
accounts, such as checking accounts,
negotiable order of withdrawal (NOW)
accounts, and automatic transfer service
(ATS) accounts, but it expressly excludes
money market deposit accounts (MMDAs)
and savings accounts (statement or
passbook) even though those accounts do
have some limited transaction capability.
Common name: Regulation CC
Introduction
Regulation CC was promulgated by the
Board of Governors of the Federal Reserve
System to implement the provisions of the
Expedited Funds Availability Act. The
regulation contains rules regarding when a
financial institution must make deposited
funds available to its customers and rules
regarding the prompt collection and return
of checks through the banking system.
Regulation
CC
became
effective
September 1, 1988.
Business Day. Section 229.2(g) A calendar
day other than Saturday or Sunday and
other than a holiday specified and observed
by Federal Reserve Banks.
Banking Day. Section 229.2(f) A business
day on which an office of a financial
institution is open to the public for carrying
on substantially all of its banking functions.
A financial institution may set a cut-off hour
of its banking day for the receipt of deposits
not earlier than 2:00 P.M., or 12:00 P.M. for
ATMs or off-premise facilities. Even though
the financial institution remains open past
then, deposits taken after the cut-off time
are attributed to the next banking day.
Regulation CC is the most technical of all of
the Federal Reserve Board Regulations.
Virtually every rule has an exception and
there are exceptions to the exceptions. The
time frame within which a financial
institution must make funds from a deposit
available to its customers depends on the
nature of the item deposited, when the
deposit was made, where the deposit was
made, to whom the deposit was made, the
size of the deposit, and the particulars of the
account(s) to which it was made.
Note: Even though a financial
institution may be open, if it is not a
business day, (e.g., Saturday), it is not
a banking day.
Local Check. Section 229.2(r) A check
payable by, at, or through a financial
institution located in the same geographic
region served by an office of a Federal
Reserve Bank for purposes of its checkprocessing activities as the branch or ATM
of the financial institution in which the check
was deposited. As of February 27, 2010,
there will be only one check-processing
region for purposes of Regulation CC.
Regulation CC prescribes the maximum
length of time that a financial institution may
withhold the availability of funds deposited
by its customers. There are no regulations
prohibiting a financial institution from
making funds available sooner than the
regulation requires.
Summary of Regulation CC
The time when a financial institution must
make funds from a deposit available to its
customer is measured from the time that
the deposit is deemed to have been
received by the institution.
Section
229.19(a)
Even for a summary of Regulation CC a few
terms must be defined. Other terms used
are defined in the glossary at the end of this
article, but generally have the meaning
normally attributed to them.
Generally, a deposit made at a staffed teller
station, received by mail, placed in an ATM
or a lobby depository, or transferred
Account. Section 229.2(c) This is the key
term for much of Regulation CC. It defines
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electronically is deemed made when
received by the financial institution or put in
the machine. A deposit in a nighttime
depository is generally considered made on
the day on which the deposit is removed
from the depository. Deposits received on a
day other than a banking day or after a
financial institution‘s cut-off hour are
generally considered made the next banking
day. After the time that a deposit is deemed
made is determined, the time that it must be
made available for withdrawal by the
institution‘s
customer
is
determined
primarily by the nature of the item
deposited.
The requirements of the notices that a
financial institution must give to its customer
under Regulation CC are extensive. A
disclosure of the institution‘s funds
availability policy must be provided in writing
to each new customer, posted in each
location where employees accept deposits
to consumer accounts, and provided to
anyone who requests it. Section 229.17 All
deposit slips must have a notation that
deposits may not be available for immediate
withdrawal, and a similar notice must be
posted at all ATMs. Section 229.18 If a
financial institution extends the time for
funds availability on a case-by-case basis
from its normal availability schedule, or if it
places an exception hold on an item, it must
notify its depositor of the extension. Section
229.16(c)
The balance of the proceeds of local checks
must be made available on the second
business day following the banking day on
which the deposit was received. Section
229.12
The civil liability for violations of Regulation
CC can be severe. Section 229.19(a)
A financial institution may make exceptions
to its funds availability policy for:
When Funds Are Considered
Deposited Section 229.19(a)
New accounts Section 229.13(a)
over
$5,000
Section
Staffed Teller Station. Funds are
considered deposited when received by the
teller.
Checks that have been returned and
redeposited Section 229.13(c)
ATM. Funds are considered deposited
when placed in the ATM. There is an
exception for ATMs that are not serviced
more than twice per week. If a financial
institution puts a notice on the ATM that
funds deposited may not be considered
received on the day of the deposit, then
such funds are considered deposited on the
day they are removed from the ATM.
Customers with repeated overdrafts
Section 229.13(d)
Checks that a financial institution has
reasonable cause to believe are
uncollectible Section 229.13(e)
Emergency
229.13(f)
conditions.
Regulation CC
If a financial institution invokes any
exception other than the new account
exception, it must provide a notice to its
customers. Section 229.13(g) Additionally
(with the exception of new accounts), if an
exception is invoked, a financial institution
may only extend the time to make funds
available by a reasonable time beyond the
maximum funds availability schedule. A
reasonable time is usually not more than
five days for local checks. Section 229.13(h)
Cash, electronic payments, government
checks, bank checks, on-us checks, and the
first $100 of the aggregate deposit of local
checks must generally be made available
on the business day following the banking
day that the deposit is received if the
deposit was made in person to an employee
of the financial institution. If it was not, the
availability can be delayed to the second
business day (except for checks drawn on
the U.S. Treasury). Section 229.10
Deposits
229.13(b)
Section
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Mail. Funds mailed to a financial institution
are considered deposited on the banking
day they are received by the institution.
Regulation CC
the deposit is not made in person to an
employee of the financial institution, then
the funds must be available not later than
the second business day after the banking
day on which the cash is deposited. No
exceptions apply to cash deposits.
Night Depository. Funds placed in a night
depository are considered deposited on the
banking day the deposit is removed and the
contents are available for processing.
(Some businesses may deposit their funds
in a locked bag and return to the financial
institution the following day to open the bag.
In these cases, the funds are not
considered deposited until the bag is
opened.)
Electronic Payment. Section 229.10(b) A
financial institution shall make funds
received by electronic payment (ACH or
wire transfer) available not later than the
business day after the banking day it
receives information on the account, the
amount to be credited and payment in
actually and finally collected funds. No
exceptions apply to electronic payments.
Daytime Depository. Some financial
institutions have a deposit box in their lobby
that is accessible only during regular
banking hours. Funds deposited in a lobby
box are considered deposited when placed
in the box, unless the financial institution
puts a notice on the box informing the
customer to the contrary, and then the
daytime depository may be treated as a
nighttime depository.
Treasury Checks. A check drawn on the
U.S. Treasury and deposited in an account
of a payee of the check must be made
available not later than the business day
after the banking day of deposit. If the
account is a new account, the first $5,000 of
the check must be made available as
normal. The balance of the check must be
made available not later than the ninth
business day following the banking day of
deposit. If a Treasury check is endorsed by
the payee and deposited in an account that
is not held by the payee, then the funds it
represents must be made available the
second business day following the day of
deposit. If the account is not a new account,
all exceptions can apply.
Lockbox. Funds deposited in a lockbox
arrangement (post office box) are
considered deposited on the day the deposit
is removed from the lockbox.
A deposit, no matter how received, that is
not received on a banking day (even though
the financial institution may be open, such
as on a Saturday) or is received after the
institution‘s cut-off hour for deposits, may be
considered made on the next banking day.
Other Government Checks. Section
229.10(c) Funds represented by a check
drawn on a Federal Reserve Bank or a
Federal Home Loan Bank, a state or unit of
a local government in which the financial
institution is located, or a U.S. Postal
Service money order must be made
available on the business day after the
banking day of deposit if deposited in an
account held by a payee of the check and in
person to an employee of the institution.
Additionally, as to state and local
government checks, a financial institution
may require the use of a special deposit slip
or envelope. If the deposit does not meet
the requirements, then it is treated as a
General Availability
Requirements
The following is a description of when funds
must be made available based on the type
of instrument deposited. The exceptions
referred to are defined later in this article.
Cash. Section 229.10(a) A financial
institution must make funds deposited in
cash available not later than the business
day after the banking day on which the cash
is deposited, if the deposit is made in
person to an employee of the institution. If
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local check. If the account is a new account,
the first $5000 of the check must be made
available as normal. The balance of the
check must be made available not later than
the ninth business day following the banking
day of deposit.
Regulation CC
the banking day of deposit. The balance of
the funds must be made available the
second business day following the banking
day of deposit. Section 229.12(b)
All
exceptions can apply to the balance of
funds from local checks, whether or not the
account is a new account. In either case, a
financial institution may also extend the time
that funds are available for withdrawal by
cash or similar means (cashier‘s check,
electronic transfer, etc.) by one business
day, provided that it makes $400 (in addition
to the $100 described above) available by
5:00 P.M. on the day on which the funds
would otherwise be available.
Cashier’s, Certified or Teller’s Checks.
Section 229.10(c) Funds represented by
Cashier‘s, Teller‘s or Certified Checks
deposited in person to an employee of the
financial institution in an account held by the
payee of the check must be made available
on the business day after the banking day
on which the funds are deposited. As with
state and local government checks, a
financial institution may require the use of a
special deposit slip or envelope. A cashier‘s,
teller‘s or certified check not deposited in
accordance with the above rules is treated
as a local check. If the account is a new
account, the first $5000 of the check must
be made available as normal. The balance
of the check must be made available not
later than the ninth business day following
the banking day of deposit. If the account is
not a new account, all exceptions can apply.
Note: If a deposit is made at a
nonproprietary ATM and all or part of the
deposit would otherwise have availability
the first business day following the
banking day of deposit, the availability
may be delayed to the second business
day following the banking day of deposit.
When the regulation provides that a deposit
must be available for withdrawal on a
business day, the funds must be available
by the later of 9:00 A.M. or the time the
financial
institution‘s
teller
facilities
(including ATMs) are available for
withdrawals. Section 229.19(b) Anything to
the contrary notwithstanding, the regulation
does not:
On-us Checks. Section 229.10(c) Funds
represented by a check drawn on the same
or another branch of the same financial
institution if both branches are located in the
same state or the same Federal Reserve
check-processing region must be made
available on the first business day after the
banking day of deposit. (Note: For the
purpose of this definition only, deposits at
off-premises ATMs or remote depositories
are not considered deposits made at a
branch. A deposit at an off-premises ATM is
considered made when the ATM is next
serviced following the deposit.) All
exceptions can apply, even if the account is
a new account.
Require a financial institution
accept a check for deposit
to
Require a financial institution to open
on a given business day
Supersede a financial institution policy
that limits the amount of cash a
customer may withdraw from its
account in one day (e.g., ATM
withdrawal limits)
Supersede cash withdrawal limits
made in person to an employee of a
financial institution if the limit is
applied without discrimination to all
customers and is related to security,
Local Checks. Section 229.10(c) All checks
deposited by a person (whether into one or
more accounts) on a banking day may be
aggregated, and the lesser of the amount of
the aggregated deposit or $100 must be
made available the next business day after
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operating, or bonding requirements of
the institution
Regulation CC
customer was overdrawn, or would have
been overdrawn if checks or charges to the
account had been paid on six or more
banking days during the last six months, or
if the overdraft did or would have exceeded
$5,000 on two or more banking days within
the last six months, the customer may be
considered
repeatedly
overdrawn.
Thereafter, for a period of six months from
the last overdraft, a financial institution may
extend for a reasonable length of time (as
defined above) the availability of funds from
local checks deposited to that customer‘s
account.
Dictate the hours a financial institution
must remain open. Section 229.19(c)
Exceptions
The regulation describes six circumstances
in which a financial institution may invoke an
exception to the general rule of funds
availability and delay the availability of funds
beyond the time normally required.
Recognize that all exceptions do not apply
to all types of deposits. Refer to the specific
deposit to see which exceptions apply.
Note: The repeat overdraft exception is
not calculated on the number of overdraft
items honored or returned, but on the
number of days the account was or
would have been in an overdraft position.
New Accounts. Section 229.13(a) An
account is a new account if any customer
on the account has not, within 30 days of
when the account is established, had a
transaction account with the financial
institution. An account retains its new
account status for 30 days after it is
established.
Reasonable
Cause
to
Doubt
Collectibility. Section 229.13(e) If a
financial institution has a reasonable cause
to believe that a check is uncollectible from
the paying financial institution, it may treat
the check as an exception.
Large Deposits. Section 229.13(b) If the
aggregate deposit of checks (including
government checks, cashier‘s checks, etc.)
by a customer on any one banking day
exceeds $5,000, a financial institution may
invoke the large deposit exception to the
amount of the deposit in excess of $5,000.
For the purpose of this exception, a financial
institution may aggregate all of the deposits
made on all of the accounts of the
customer, even though the customer is not
the sole holder of the accounts and not all of
the holders of the accounts are the same.
Emergency Conditions. Section 229.13(f)
If a financial institution experiences
emergency conditions which are: an
interruption of communications or computer
or other equipment failure; a suspension of
payments by another financial institution; a
war; or an emergency condition beyond the
control of the institution, then it may declare
an exception for all items deposited to which
an exception can apply.
Redeposited Checks. Section 229.13(c) A
check that has been returned and
redeposited may be treated as an exception
unless the return was for a missing
endorsement and the check is redeposited
after the endorsement has been obtained,
or because the check was postdated when
originally deposited and was no longer
postdated when redeposited.
When a financial institution invokes an
exception, it must give its customer notice
Section
229.13(g)
(see
―Notice
of
Exceptions‖) and may extend the time
period for the availability of funds only a
reasonable length of time. A five-day
period for local checks and similar items is
deemed reasonable. If a financial institution
delays availability beyond that time
period, the burden of proof is on the
institution to demonstrate reasonableness.
Repeat Overdrafts. Section 229.13(d) If
any account or combination of accounts of a
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The exception to the reasonableness rule is
for new accounts. Where the new account
exception applies, there is no requirement
of reasonableness on the length of time a
financial institution may delay funds
availability. Section 229.13(h)
Regulation CC
category to which a particular deposit
or check belongs, and when each
category will be available for
withdrawal (including a description of
the institution‘s business days and
when a deposit is considered
received);
A financial institution need not invoke
exceptions uniformly. It may invoke the new
account exception for some accounts and
waive it for others. It may invoke the large
deposit exception for a customer one day
and not invoke it for the same customer‘s
deposit the next day. The application of the
allowable exceptions is at the sole
discretion of the institution on an item-byitem basis.
A description of any of the exceptions
that may be invoked, when funds will
generally be available if an exception
is invoked, and that the financial
institution will provide the customer
notice if an exception is invoked;
If the financial institution makes funds
available
from
deposits
at
nonproprietary ATMs later than
deposits at proprietary ATMs, then a
description of how a customer can
differentiate between the two;
Disclosures Section 229.15
A financial institution must provide a
potential customer a written disclosure of its
availability policy prior to opening an
account and prior to accepting a deposit if
the account has not yet been opened. If,
however, a customer opens an account by
mail or telephone, the disclosure is sufficient
if mailed to the customer on the first
business day following the banking day that
the request was received. The disclosure
policy must be posted in a conspicuous
place at each location where an institution's
employees receive deposits to consumer
accounts and must be available to anyone
on request.
If the financial institution has a policy
of making funds available sooner than
required by the regulation but extends
the time for withdrawal on a case-bycase basis, then the institution must
state:
That the time when deposited
funds will be available can be
extended, and if so, the latest time
that funds will be available
following a deposit;
That the financial institution will
notify the customer if the general
policy will not be followed; and
The disclosure must reflect the policy for
funds availability generally followed by the
financial institution and any longer delays
the institution may impose on a case-bycase basis or any exceptions it may invoke.
As applicable, the following items must be
set out in the disclosure:
That customers should ask if they
need to be sure about when a
particular deposit will be available
for withdrawal.
Additionally, a financial institution must
include on all preprinted deposit slips
Section 229.18(a) and post or provide at all
ATM locations Section 229.18(c), a notice
that funds deposited may not be available
for immediate withdrawal. If it is an ATM
that is serviced not more than two times per
week, there must also be posted a
A summary of the financial institution‘s
availability policy;
A description of any categories of
deposits or checks used by the
financial institution when it delays
availability, how to determine the
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disclosure of the days on which deposits
made at the ATM will be considered
received.
Regulation CC
extend the availability was not made at the
time the deposit was taken. In either of the
latter two cases, notice must be mailed or
delivered to the customer the first business
day following the banking day the deposit
was made. The financial institution does not
have to give the customer any reason for
the extension.
Notice of Exception Hold. Section
229.13(g) If a financial institution invokes
any of the permitted exceptions to the basic
availability requirements of the regulation
(other than the new account exceptions), it
must provide a notice to its customer setting
out the customer‘s account number, the
date of the deposit, the reason the
exception was invoked, and the day the
funds will be available for withdrawal. If the
exception is because the financial institution
has reasonable cause to doubt collectibility,
the notice must also contain the reason the
institution believes that the check is
uncollectible. A financial institution must
retain for two years a record of each notice
of reasonable-cause exception and a brief
description of the facts on which the
institution based its judgment.
Overdraft Charges
If a financial institution invokes an exception
or delays availability on a case-by-case
basis and does not give its customer proper
notice, it may not charge an overdraft or
returned-check charge if the overdraft or
returned check would not have occurred but
for the availability delay and the deposit
delayed was paid by the paying financial
institution. Alternatively, in such a case, a
financial institution may assess the charge,
but it must notify its customer that the
customer may be entitled to a refund if the
check subject to the delay was paid, and
also tell the customer how to obtain the
refund. Section 229.16(c)(3)
If a deposit is made in person to an
employee of a financial institution and an
exception is invoked, the notice must be
given to the person at the time the deposit is
made. If the deposit is not made in person
to an employee of the financial institution or
if the facts on which the determination to
invoke the exception are not known to the
institution at the time the deposit is made,
notice must be given by the later of the
business day following the banking day of
the deposit or the business day following
the day the facts become known.
Compliance and Liability
Regulation CC is one of the few regulations
in which the regulation itself mandates that
a financial institution establish procedures to
ensure that it complies with the regulation,
and must provide affected employees
education as to the requirements of the act
and the procedures applicable to their
duties. Section 229.19(f) If an institution fails
to comply with the provisions of the
regulation, the potential liability to an
individual customer is the actual amount the
customer was damaged plus $100 up to
$1,000. In a class action suit, the amount
increases to the lesser of $500,000 or 1
percent of the net worth of the financial
institution. Section 229.21
Notice of Case-by-Case Exceptions.
Section 229.16(c) If a financial institution
has a general policy of making funds
available sooner than required by the
regulation, it may extend availability to the
limits of the regulation provided it gives the
depositor notice. The notice must contain
the account number, the date and amount
of the deposit, and the day the funds will be
available. The notice must be given at the
time the deposit was made, unless the
deposit was either not made in person to an
employee of the institution or the decision to
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Regulation CC
region that is consistent with the routing
number shown in the MICR band at the
bottom left of the checks in question. It may
select one of its own offices in that region,
or it may contract with another institution or
with the Federal Reserve. Finally, the
paying financial institution and the
presenting financial institution may agree
between themselves that SDS items will be
presented at an alternate site, which may be
outside the processing region consistent
with the routing number.
The Same-Day Settlement
Rule
Regulation
CC
requires
banks
to
accomplish same-day settlement (SDS) for
certain items that are presented by certain
methods. Section 229.36(f) of Regulation
CC provides that a paying financial
institution (the institution that has the
account the checks are drawn on) must
settle for, or return, checks if they are
presented for payment before 8:00 A.M.
local time at the place of presentment on a
business day. Section 229.36(f) The
settlement must be by credit to the
presenting financial institution‘s account, or
another account designated by the
presenting institution, at a Federal Reserve
Bank.
The
settlement
must
be
accomplished before the close of Fedwire
(6:30 P.M. Eastern Time) that same day.
For the second item, the payor institution is
entitled to specify a particular night
depository. It also may require that the SDS
items be sorted and packaged separately
from other items being presented to it, such
as return items and other (non-SDS)
forward collection checks.
Once the presenting institution has
presented the SDS checks at the
designated location in accordance with the
reasonable delivery requirements, it is
entitled to settlement for (or return of) each
of those items by the close of Fedwire on
the same day. That settlement, however,
will not be final under the Uniform
Commercial Code, and may be revoked by
the paying institution until midnight of the
next banking day. But if a paying financial
institution does not settle for or return an
SDS item by the close of Fedwire on the
day of presentment, it will not be allowed to
return it the next day. It will have become
―accountable‖ for the item because of its
lack
of
action.
Furthermore,
any
adjustments must be handled directly with
the presenting bank, not through the Fed.
What the SDS Rule Does Not Affect. The
rule does not require changes to procedures
or the timing of actions for members of a
clearing house acting within their clearing
house. Nor does it change how items are
cleared through the Federal Reserve. Its
purpose is to remove any excuse for a
financial institution to refuse to settle at par,
on the same day, for items that are
presented to it early in the morning by
another financial institution. Also note that
checks presented between 8:00 A.M. and
2:00 P.M. continue to be governed by the
existing deadlines under the Uniform
Commercial Code. They do not require
same-day settlement.
SDS Procedure. A financial institution that
wants to present checks directly to a
particular payor institution for same-day
settlement will contact that payor institution
well in advance to learn at least two things:
FRB services. To facilitate compliance with
the SDS rules, and for other reasons, the
Federal Reserve has instituted three
services:
The payor institution‘s designated
presentment location(s) for same-daysettlement (SDS) items; and
1. Limited presentment point services for
payor banks that wish to designate the
Fed as a presentment point
The payor institution‘s ―reasonable
delivery requirements‖ for SDS items.
For the first item, the payor institution may
select any location in the check-processing
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2. Limited information processing and
reporting services for checks that are
not collected through the Fed
Regulation CC
post those checks on the morning they are
presented, and return any that are drawn on
closed accounts or against insufficient
funds, or that have similar problems, by the
close of Fedwire that same day. While a
large financial institution, with larger cash
management customers, will not find such a
highly manual process economical, a
smaller financial institution probably will.
3. A Fedwire product code (―CKS‖) to
identify check-settlement messages.
The Federal Reserve has sent detailed
descriptions of these services to every
financial institution in the United States, so
we will not repeat them here.
Recommendations
Small and Medium-Sized Financial
Institutions. The Federal Reserve has
maintained from the beginning that there
ought to be little or no effect on small and
medium sized financial institutions from the
SDS rule, and we can see the Fed‘s point.
In most cases, the volume of checks drawn
on any one such institution and presented
through any other single institution probably
will not support the effort and expense
required to transport the checks for direct
presentment. It probably will not be costeffective for most presenting financial
institutions to obtain same-day settlement in
those situations. There is one possible
exception, however. When there are only
two financial institutions in a town, and
those institutions have been fierce
competitors for years, either (or both) may
decide to avail itself of the SDS rules, if only
to inconvenience its opponent. Of course,
because each has the power to do it to the
other, they may conclude there is no profit
to starting this particular fight.
Based on your financial institution‘s
own situation (volumes of items it
presents to particular institutions and
the reverse of that flow) determine
whether your financial institution is a
good candidate either to use the SDS
rules or to have another financial
institution use them with respect to
items drawn on your institution.
If neither appears likely, simply
monitor the situation, and keep your
people who might receive other
financial institutions‘ requests for your
institution‘s delivery requirements
alerted to inform you if any financial
institution makes such a request.
If it appears likely that another
financial institution will avail itself of
the SDS rights, consult with your
institution‘s deposit operations staff to
develop the required reasonable
delivery
requirements‖ (including
separate packaging of SDS checks)
and determine where your institution‘s
presentment point(s) will be. Reduce
them to writing and be prepared to
hand them out, mail them, or fax them
as required. Put an effective date and
a revision number on the document
and make a list of the financial
institutions you give the document to.
(The details will change over time,
and you will want to send the
revisions to all financial institutions
that got the prior version.)
Small and medium sized financial
institutions that do find themselves faced
with SDS items to process can do one of
two things. First, they can do what the large
financial institutions will do, which is to settle
for all those items, run the items that night,
and revoke settlement for the very few ―bad‖
items by midnight of the next banking day.
As noted above, financial institutions that do
settle
same-day
have
this
right.
Alternatively, they can take advantage of
their smaller size, and the concomitant
smaller number of SDS checks they will
receive. In this alternative, they will memo-
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Regulation CC
Make arrangements for transportation
of the SDS checks from the
presentment point(s) to the place
where they will be processed.
checks payable by, through, or at a financial
institution, not just DDAs and NOW
accounts, as is the case in the rest of
Regulation CC.
If your financial institution presents
enough checks (outside of a clearing
house
association
or
similarly
exempted situation) to a single
financial institution so that you believe
it would be to your advantage to
obtain same-day settlement from that
institution, contact that institution and
request its ―reasonable delivery
requirements‖ and the location of its
presentment
point(s).
Adopt
procedures to comply with those
requirements.
Risk-Shifting. The rule relieves the drawee
financial institution (where the customer
who supposedly authorized the check has
his or her account) of the risk of these
checks being unauthorized. It places that
risk on the institution where the con artist or
other person who originated the check has
his or her account. The Fed says it will
―create an economic incentive for depository
banks to perform the requisite due diligence
on their customers,‖ and so it may. Thus, if
your customer claims one of these checks
was not authorized, you, his financial
institution, have a warranty claim against
the financial institution that presented it to
you. That institution has a similar claim
against the institution that presented the
item to it, and so on until the items comes to
roost at the financial institution that first
injected the bad item into the collection
process.
Remotely Created Checks
Context. Paper drafts that bear the words
―Authorized by your depositor‖ or some
similar phrase where a drawer‘s signature
normally would appear have been a sore
point for bankers for years. Many such
drafts were not, in fact, authorized by the
owner of the account they were drawn
against, and the financial institution that had
that account was forced to reimburse the
account owner for them.
Disappointment.
Despite strong public
pressure, however, the Fed declined to
make these items returnable through the
check collection process after the expiration
of the normal ―midnight deadline,‖ so the
warranty claim will have to be made outside
that process, perhaps through the courts. If
a single financial institution is found to have
let a large number of such items into the
collection system, a class action lawsuit
could be brought against that institution
unless a judge decides that class action
status is not available for these claims.
Then the economics will be prohibitive for
suing over the typical mid-three-figure draft.
Amendments. Effective July 1, 2006, the
Fed amended Regulation CC to address
these items, which it calls ―remotely created
checks. Section 229.2(fff) The term means
a check that was not created by the paying
financial institution, and that does not bear a
signature applied or purported to have been
applied by the accountholder. They added
a new saying that when an institution
transfers or presents such a check, it
warrants to subsequent financial institutions
in
the
collection
chain
that
the
accountholder authorized the issuance of
the check in the amount and to the payee
shown on the check.
Additionally, the
definition of the ―accounts‖ to which this
warranty applies includes any credit or other
arrangement that allows a person to draw
Defenses. The financial institution that first
accepted the item for deposit can defend
against a claim of no authorization in two
ways. First, it may prove that the customer
did, indeed, authorize the check.
The
primary way it can do so is by a tape
recording made under the Federal Trade
Commission‘s Telemarketing Sales Rule.
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The other defense is that the accountholder
is legally precluded from asserting the
claim. That defense usually arises when he
fails to assert the claim for over a year.
Regulation CC
Automated Teller Machine (ATM).
Section 229.2(c) An electronic device
at which a person may make deposits
to an account by cash or check and
perform other account transactions.
Customers. The warranties are not made
by the customer who first deposits the
check, (the con artist in the bad situations)
so if your financial institution allows
customers to deposit such items into
accounts with you, you will want to have
your lawyer add a special provision to your
account agreements. The provision should
have your customer expressly making those
warranties to your financial institution and
agreeing to indemnify your institution
against, and hold it harmless from, any and
all such claims.
(Obviously, if your
customer is a con artist, no such provision
will provide any real protection for your
institution. It may help in the case of an
honest mistake.)
Available For Withdrawal. Section
229.2(d) Funds in an account
available to a customer for actually
and finally collected funds pursuant to
the account agreement, such as for
payment of checks, certification of
checks,
electronic
payments,
withdrawal by cash, and transfers
between accounts.
Bank. Section 229.2(e) Generally, an
insured bank, mutual savings bank or
savings bank; an insured credit union,
a savings association; an agency or a
branch of a foreign bank.
Banking Day. Section 229.2(f) That
part of any ―business day‖ on which
an office of a financial institution is
open to the public for carrying on
substantially all of its banking
functions.
Non-Consumer Accounts.
Oddly, the
amendments are not limited to items drawn
on consumer accounts. They apply equally
to remotely-created checks drawn against
business, trust, charitable organization,
government and other entity accounts, as
well. We haven‘t heard of any frauds
committed using those items on nonconsumer accounts, but we see no
objection to preventing whatever fraud may
be occurring in them by these means. Any
state laws that are inconsistent with the new
rule will be preempted.
Note: Even though a financial
institution may be open, if the day is
not a business day (i.e., Saturday), it
is not a banking day.
Business Day. Section 229.2(g)
Monday through Friday, except
January 1, the third Monday in
January, the third Monday in
February, the last Monday in May,
July 4, the first Monday in September,
the second Monday in October,
November 11, the fourth Thursday in
November, or December 25. If
January 1, July 4, November 11, or
December 25 falls on a Sunday, then
the next Monday is not a business
day.
Glossary of Terms
Account. Section 229.2(a) For almost
all purposes of the regulation, an
account means a regular checking
account or NOW account (demand
deposit account). The regulation does
not apply to savings accounts, moneymarket accounts or time deposits.
(But see ―Remotely Created Checks,‖
above for exceptions.)
Note: If your financial institution
recognizes holidays other than those
listed, the day is still a business day,
even though you are not open.
Automated Clearing House (ACH).
Section 229.2(b) A facility that
processes debit and credit transfers
under Federal Reserve or an ACH
association rules.
Cash. Section 229.2(h) United States
coins and currency.
Cashier’s Check. Section 229.2(i) A
check that is drawn on a financial
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institution, signed by an officer or
employee of the financial institution on
behalf of the institution as drawer, as
a direct obligation of the institution
and provided to a customer of a
financial institution or acquired from
the institution for remittance purposes.
Check. Section 229.2(k) A negotiable
demand draft drawn on or payable
through or at an office of a financial
institution, drawn on a Federal
Reserve Bank or a Federal Home
Loan Bank, drawn on the Treasury of
the United States, drawn on a state
government or unit of general local
government that is not payable
through or at a financial institution, a
U.S. Postal Service Money Order, or a
travelers check drawn on or payable
through or at a financial institution.
Regulation CC
financial institution in which the check
was deposited.
Teller’s Check. Section 229.2(gg) A
check provided to a customer of a
financial institution or acquired from a
financial institution for remittance
purposes, that is drawn by the
financial
institution
on
another
financial institution or is payable
through or at another financial
institution.
Unit of General Local Government.
Section 229.2(kk) A city, county,
parish, town, village, or other general
purpose political subdivision of a
state, but not a special-purpose
governmental unit such as a school
district or water district.
Check-Processing Region. Section
229.2(m) The geographical area
served by an office of a Federal
Reserve Bank for purposes of its
check-processing activities. Effective
February 27, 2010, all check
processing regions were consolidated
into one check processing region
administered from the Federal
Reserve Bank in Cleveland, Ohio.
Wire Transfer. Section 229.2(ll) An
unconditional order to a financial
institution to pay a fixed amount of
money to a beneficiary that is
transmitted electronically or otherwise
through the Federal Reserve, CHIPS
or another similar network between
financial institutions. It does not
include an electronic fund transfer.
Consumer
Account.
Section
229.2(n) A transaction account used
primarily for personal, family, or
household purposes.
Conclusion
The provisions of Regulation CC are
extremely complex, particularly when
exceptions are invoked. Every employee of
a financial institution that accepts or
processes deposits should have explicit
procedures on how to handle each type
item that they will be required to process in
the normal course of business. Supervisors
of those people should additionally know the
institution‘s policy on when to invoke
exceptions and procedures to follow when
exceptions are invoked.
Electronic
Payment.
Section
229.2(p) A wire transfer or an ACH
credit transfer.
Local Check. Section 229.2(r)
A check payable by, at, or through a
bank located
in
the
same
geographic region served
by
an
office of a Federal Reserve Bank for
purposes of its check-processing
activities as the branch or ATM of the
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Check 21
Regulation CC
a demand or NOW account only. Savings
accounts (which include money market
deposit accounts) and time accounts are not
covered by the federal funds availability
requirements. Banks allow customers to
write checks against MMDAs and other
types of accounts all the time, so for Check
21 to achieve its purpose, those other
accounts needed to be included. They are,
but for Subpart D only, the Check 21
regulation. The funds availability part of
Regulation CC continues to cover only
demand and NOW accounts. Accounts that
are not deposit accounts are not accounts
for the purposes of Check 21, even if
consumers can write checks against them.
Credit card checks and home equity line of
credit checks, for example are not covered
by Check 21.
CHECK 21
The purpose of the Check 21 law is to
reduce the costs of clearing, handling, and
storing paper checks. It will allow a financial
institution to ―truncate‖ a paper check. Stop
the paper check from going any further in
the collection chain, and send instead
electronic information gleaned from the
paper item. It does not require any financial
institution to accept electronic items.
Instead, an institution may insist on paper
items. Check 21 contains rules for some of
those items that have been converted back
into paper after having been passed around
electronically. Section 229.51
Here is what a financial institution does not
have to do under the new law:
Consumer Section 229.2(ss) is a natural
person who, in the case of a check handled
for forward collection, draws the check on a
consumer account. In the case of a returned
item, it is a natural person who deposits the
check into, or cashes it against, a consumer
account.
1. Use electronic processing;
2. Receive electronic items; or
3. Create what are called ―substitute
checks,‖ the paper reproductions of
the electronic items that other financial
institutions may have created from
checks written by your customers.
Original check Section 229.2(ww) is the
first paper check issued with respect to a
particular payment transaction. There can
be only one original check for a particular
payment transaction. There can be multiple
substitute checks created from that original,
but only one original.
The main things the law does require a
financial institution to do are:
1. Accept a legally-equivalent substitute
check in place of the original check;
2. Place a ―5‖ in Position 44 of the MICR
band of a ―qualified returned substitute
check‖ instead of the ―2‖ you would put
there on a qualified returned original
check;
Reconverting bank Section 229.2(zz) is
the bank that creates a ―substitute check,‖
defined below. It is also possible to be a
reconverting bank even if you did not create
the substitute check. A merchant might want
to do its own truncation to avoid bank fees
for that service. If your bank agrees to
accept electronic data and substitute checks
rather than paper original checks it
becomes the reconverting bank as to the
substitute checks the merchant created
because it is the first bank to handle those
items. A bank is not required to accept a
substitute check from its customer.
3. Give disclosures to consumers in
certain circumstances.
The Federal Reserve amended Regulation
CC by adding Subpart D with commentary
and model forms. A good introduction to
what all this means is to read the Fed‘s
Model Notice C-5A.
Account. Section 229.2(a) The term
―account‖ as defined for the rest of
Regulation CC (on funds availability) means
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Check 21
Regulation CC
Substitute check Section 229.2(zz) is a
paper reproduction of an original check,
containing an image of the front and back of
the original check. It has to have a MICR
line containing all the information in the
MICR line of the original check (with a few
exceptions). It must conform in paper stock,
dimensions, and other ways to the new
American National Standards X9.100-140.
A substitute check must be suitable for
automated processing in the same manner
as an original check. That means its MICR
line has to be printed in magnetic ink.
customer has agreed to it, a financial
institution may supply the ―copy‖ in
electronic
form.)
―Sufficient‖
means
sufficient to resolve the claim. If the claim is
that the original check was for $100 but the
financial institution debited it for $1,000, all
that is needed is a clear image of the face of
the original check. The financial institution
would not have to supply a copy of the
back.
Truncate Section 229.2(ddd) is to remove
an original check from the forward or return
collection process and to send instead
either a substitute check or, by agreement
with the receiver, information in electronic
form about the original check. Sending
anything other than a substitute check
requires the agreement of the financial
institution that is going to receive the item.
A substitute check must contain all
endorsements applied by previous parties
who handled the check in paper or
electronic form. So the reconverting bank
must convert into physical, visual form any
endorsements
that
were
applied
electronically to that check after it was
truncated but before the substitute check
was created. Appendix D to the regulation
contains the standards for doing it. The
reconverting bank is liable for any losses
because endorsements that are supposed
to be legible have been rendered illegible by
other required endorsements.
A financial institution must accept substitute
checks, but it need not accept electronic
items. (In the preamble to the regulation, the
Fed stated that Check 21‘s ―overriding goal‖
is ―that paying banks and other persons that
demand paper checks will not bear costs
associated with receiving a substitute check
instead of an original check.‖ Right!)
―Truncate‖ does not include removing a
substitute check from the collection or return
process. Only removing an original check is
covered.
At some merchants, the consumer hands
over a paper check, and the merchant‘s
equipment reads the MICR band and
creates an ACH debit for the payment. The
Fed decided that is not an original check for
Check 21 purposes, so nobody can create
anything that qualifies as a substitute check
from it.
Subpart D
Legal equivalence. Regulation CC is
Section 229. We use only the numbers to
the right of the decimal after ―229‖ in the
material that follows. Under section 51, if a
substitute check meets certain conditions, it
is the legal equivalent of the original check
for all parties and purposes. Section 229.51
That is a departure from prior Anglo-Saxon
legal practice. There are rules of evidence
that require people to produce the hardcopy original of something if it still exists,
and if it does not, to prove that fact and
prove the copy they want to show is a true
copy of the original. But since Subpart D to
the regulation was added, everyone will
Sufficient copy Section 229.2(bbb) means
a copy of an original check that accurately
represents all of the information on the front
and back of the check at the time it was
truncated or is otherwise sufficient to
determine the validity of a claim. Because
of fears that the substitute check might be
illegible or might be debited against a
customer‘s account more than once, or that
the original paper item would also come in
and post, there is a claim procedure.
To be a copy, it must normally be an image
printed on a piece of paper. (But if the
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have to accept a substitute check as legal
proof that John Jones paid his debt.
Check 21
Regulation CC
inconsistent with Check 21 is preempted,
however. Section 229.51(c)
Warranties. Section 229.52(a) Section 52
contains the two warranties a financial
institution makes when it transfers,
presents, or returns a substitute check for
which it receives consideration:
Conditions. For an item to be a substitute
check, a financial institution must be on the
hook for certain warranties about it under
section 52. They are that the check meets
the requirements in section 51 (which we
will come to shortly) and that no one will be
asked to pay twice for the same transaction.
As we mentioned earlier, to be a legally
equivalent substitute check, the substitute
must accurately represent ―all the
information‖ on the front and back of the
original at time of truncation. The
commentary says that does not include
watermarks, micro printing, and other
security features on the original.
1. The substitute check meets the
requirements for legal equivalence.
(The check accurately represents all
the information on the front and back
of the original at truncation and bears
the legal equivalence legend.)
2. Nobody in the collection or return
process will be asked to pay twice for
the same item.
Those warranties are given to any collecting
or returning financial institution, the drawer,
the drawee, the payee, the depositor, and
any endorser of the substitute check.
Section 229.52(b) They are given whether
those parties received the substitute check
or a paper or electronic representation of
the substitute check. They continue through
any of those conversions and reconversions
back and forth to paper and electronic that
we mentioned earlier. The ―nobody will have
to pay twice‖ warranty applies regardless of
the order in which duplicate payment
demands occur. It is not dependent on a
financial institution‘s knowledge or fault in
creating or passing along a duplicate.
Legend.
Section 51 requires that the
substitute check accurately represent all of
the information on the face and reverse of
the original check as of the time it was
truncated, and bear the legal equivalence
legend. That legend must be exactly the
words, ―This is a legal copy of your check.
You can use it the same way you would use
the original check.‖ Section 229.51(a) No
changes are permitted. There are detailed
standards for where the legend must be
placed on the substitute check in ANS
X9.100-140.
Reconverting bank duties. Section
229.51(b) For each substitute check for
which it is the reconverting bank, a financial
institution must ensure that the check bears
all the indorsements put on by parties that
previously handled the item in any form,
paper or electronic. The reconverting bank
also must identify itself in a way that
preserves the identifications of any prior
reconverting banks on the same item. (A
check can go from paper to electronic to
paper substitute, back to electronic, and
back to paper multiple times in the collection
or return process.)
Laws. Substitute checks are subject to all
the laws an original check would be subject
to, including the Uniform Commercial Code
and other federal and state laws. Any law
But the warranties attach only to a
substitute check or a paper or electronic
representation of a substitute check. They
do not arise when a financial institution
truncates a paper original check and, by
agreement,
transfers
the
check
electronically to the next financial institution
in the collection chain. That electronic check
is not a substitute check, so it does not
carry the warranties.
The legal equivalence warranty, by its
nature, is tied to one specific substitute
check. The first financial institution that
reconverts an electronic item into a
substitute
check
makes
the
legal
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equivalence warranty only as to that first
substitute check, not as to any subsequent
one that later institutions may create. A
financial institution farther down the chain
may truncate the substitute, turn it into an
electronic item, and pass it on electronically
to another institution that then reconverts it
into a second substitute check. That second
reconverting bank and all financial
institutions that handle that second
substitute check, or a representation of it,
are on the hook for the legal equivalence
warranty as to both of the substitute checks.
The warranty, like water, flows downhill
only. An earlier financial institution in the
chain normally cannot claim the warranty
from a later institution.
Check 21
Regulation CC
items that would have been paid were
returned. Naturally the payees of those
other items charged the consumer returned
check fees. She has a warranty claim
against any of the warranting banks,
including her own financial institution, and
she can assert an indemnity claim, as well.
She can recover the amounts of any
returned check fees she was charged by the
payees of the wrongfully returned checks
she wrote. She could recover interest she
lost on the amount of the second substitute
check wrongfully debited against her
account and on any NSF or similar fees her
own financial institution charged. And she
could recover any costs and fees of her
attorney and any other losses proximately
caused by the doubling up on the one
original check. Her financial institution
would, in turn, have rights back against the
institution that presented the ―extra‖
substitute check to it.
Indemnity is a legal term meaning, ―I‘ll pay
you money.‖ Under Check 21 it is given by
any bank that transfers, presents, or returns
a substitute check or a paper or electronic
representation of a substitute check for
which it receives consideration. Section
229.53(a) That financial institution gives the
indemnity to any recipient of the check,
including a collecting or returning institution,
the depositary financial institution, the
drawer, the drawee, the payee, the
depositor, and any endorser.
Comparative
negligence.
Section
229.53(b) The indemnity is subject to a
―comparative negligence‖ standard. That is,
if a judge or jury determines that Bank A‘s
negligence was 53% of the cause of the
loss and Bank B‘s negligence was 47% of
the cause, then that is how they share the
loss. All other rights to sue over a substitute
check are expressly preserved. There is a
one-year statute of limitations on indemnity
claims.
The amount to be indemnified is determined
by what the claim is for. Section 229.53(b) If
it is for a breach of one of the substitute
check warranties under section 52, it is the
amount of the loss plus interest, costs,
attorney‘s fees and expenses proximately
caused by the breach. If the claim is for
some other problem, the amount of the
indemnity is the amount of the loss, up to
the amount of the substitute check, plus
interest and expenses, including attorney‘s
fees and expenses related to the substitute
check.
Liability limit. Section 229.53(b) The
indemnifying financial institution on a
particular substitute check can limit its
liability somewhat by quickly producing a
―sufficient copy‖ of the original check. That
stops any increases in liability beyond what
they were on the day the institution gave the
sufficient copy to the claimant.
Subrogation means, ―I paid you, so I get
your rights.‖ The indemnifying financial
institution step into the shoes of the person
it paid under its indemnity, and that person
is required by this law to ―comply with all
reasonable requests for assistance‖ from it
in its attempts to get reimbursement from
other parties up the chain against whom it
has rights. Section 229.53(c)
What may become the classic example is
when a customer discovers that her account
has been charged for two different
substitute checks that were based on the
same original check she wrote. Because her
financial institution charged both of the
substitute checks against her account, other
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Parties indemnified. Section 229.53(a) As
with the warranties, the indemnity flows
downstream only. It is available to any party
who transferred for consideration the
substitute check of a paper or electronic
representation of the substitute check. It is
not available to someone who handled only
the original check or any paper or electronic
version of the original that was not based on
a substitute check.
Check 21
Regulation CC
substitute check, the consumer could have
the right to an expedited recredit there.
One requirement imposed on the consumer
may turn out to be very important: a
consumer must make his claim ―in good
faith.‖ Section 229.54(a) Normally in
consumer protection law, when you see that
requirement, it will be impossible to prove
the consumer was not acting in good faith.
But under Check 21 the elements for a valid
claim are very clear, and the technology
financial institutions use is such that it
obviously has produced them or not. A
consumer who tries to dispute a clear image
will not be acting in good faith, for example,
and the financial institution he claims
against may dispute it on that ground.
Security features. Suppose your financial
institution issues a cashier‘s check to a
customer who raises the amount. The check
stock your institution uses has security
features in it that would have allowed you to
detect the raising had the original check
been presented. The customer deposited
the check into his account with a financial
institution that truncated the check and so
you received a substitute check. Your
people did not immediately detect the
raising of the amount on that smaller size
item, and your return deadline passed. Your
financial institution has an indemnity claim
against the institution that created the
substitute check. But if, even after being
raised, the amount was still under your floor
amount for visual examination, you lose.
The reconverting bank can say, ―You
wouldn‘t have discovered the raising of the
amount even if you‘d had the original.‖
Prerequisites. If the consumer acts in good
faith, he or she may make a claim if four
things are true:
1. The consumer‘s financial institution
charged his or her account for a
substitute check;
2. That charge was not proper OR the
consumer has a warranty claim with
respect to the substitute check (that is,
the
substitute
check
doesn‘t
accurately
represent
all
the
information on the front and back of
the original at time of truncation or
doesn‘t bear the legal equivalence
legend, or someone has been asked
to pay the same item twice);
3. As a result, the consumer suffered a
loss; AND
4. Production of the original check or a
sufficient copy is necessary to
determine whether the substitute was
a proper charge to the consumer‘s
account. Section 229.54(a)
Consumer claims. Section 229.54(a)
Section 54 gives a consumer special rights
to an expedited recredit. They are intended
to put a consumer who receives a substitute
check in the same position she would have
been in if she had received the original
check. Section 54 does not apply to
consumers who have already agreed not to
receive paper checks back with their
periodic statements.
Similarly, a consumer normally does not
have expedited recredit rights on a check
that is not drawn on the consumer‘s
account. There is an exception, however,
for checks deposited into that account. If a
deposited check is bounced and comes
back for chargeback in the form of a
Timing. Section 229.54(b) Section 54(b)
gives the consumer the biblical 40 days to
make his claim. The days start on the later
of the day on which the financial institution
sent the consumer the statement that
showed the charge or the day on which the
financial institution sent the consumer the
substitute
check.
Extenuating
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circumstances, such as a trip or a hospital
stay get the consumer more time. But
understand, unless the consumer gets a
substitute check, he or she has no
expedited claim rights. For example, Joe‘s
financial institution sends only images of
checks in its statements, and after 41 days,
Joe spots a problem with a check on his.
The institution gives him a substitute check
in response to his complaint. Joe‘s 40-day
period begins when the institution gives him
the substitute check. On the other hand, if
the financial institution does not give Joe a
substitute check, but rather a better image
or a copy of a substitute check, Joe has no
expedited recredit claim under Check 21.
(He may have rights under other law, such
as Article 4 of the Uniform Commercial
Code, however.)
Check 21
Regulation CC
it has to tell that fact to a consumer who
tries to make a claim orally. The institution
has to tell him the address to send the claim
to and that he has 10 business days to get it
there. So a consumer could get a total of 54
calendar days to get his claim to the
financial institution. If a consumer submits
an incomplete claim, the institution must tell
him it is incomplete and what it lacks.
Substitutes only (again). A claim may be
made only for a loss that occurred on a
substitute check the consumer received. If
the consumer received only an image
statement, containing an image of a
substitute check, he has no right to an
expedited recredit. Assume John Jones
receives a substitute check with his
statement and claims his signature on it was
forged. It does not resemble the signature
he gave the financial institution on the
signature card or his signature on the other
checks in with that statement. It is an
obvious forgery. If there is no other defect in
that item, Joe has no Check 21 expedited
recredit claim, because he does not need a
better copy or the original to prove his case.
(His only claim in most states is under the
Uniform Commercial Code for the financial
institution paying an item that was not
properly payable.)
Content. The claim must contain four
elements:
1. A description of the claim, including
why the charge was improper or the
nature of the warranty claim (missing
equivalency legend, illegible copy,
whatever);
2. A statement that the consumer
suffered a loss and an estimate of the
amount;
3. The reason why the consumer needs
the original or a sufficient copy;
Valid claim. Section 229.54(c)
If you
determine that a consumer‘s Check 21
claim is valid, you have to recredit his
account for that charge. If his account bore
interest, you have to give him the interest
that the amount would have earned had it
been in there. You must do so no later than
the end of the business day after the
banking day you make that determination.
You also have to notify him that you are
recrediting his account and when those
funds will be available.
4. Enough information to permit the
financial institution to identify the
substitute check and investigate the
claim.
Writing. The financial institution may
require the claim to be in writing. We
recommend it because the calculation of the
time periods begins from the date the
consumer submits the claim in writing. The
regulation also says that if you require the
claim in writing, you may permit it
electronically. Whether you do that will
depend on what systems you have and how
secure you believe they are.
Invalid claim. If you determine that the
consumer‘s Check 21 claim is not valid, you
have another notice to send. It must be sent
by the business day after the banking day
you made the determination and include
three things:
Notice about writing. If a financial
institution requires that claims be in writing,
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1. The original check or a sufficient copy
(unless the consumer has agreed to
electronic receipt of a copy);
2. An explanation of why the substitute
check was properly charged or that
the consumer‘s warranty claim was
invalid; and
3. Any information or documents besides
the original or sufficient copy of the
check that you relied on in making that
determination. (Alternatively, you may
tell the consumer he has a right to
request those documents.)
Check 21
Regulation CC
more on two or more days in the past
six months.)
3. Reasonable cause to believe the claim
is fraudulent. (You have facts that
would cause ―a well-grounded belief in
the mind of a reasonable person‖ that
the claim is fraudulent. It must not be
based on a class of persons or
checks.)
Model forms. Model C-22 is the Expedited
Refund Claim, Valid Claim Refund Notice. It
tells the customer when the funds will be
available for withdrawal. There‘s an optional
sentence if the notice relates to a refund of
the amount in excess of $2,500 on a
previous credit of that amount.
Undecided. If, within 10 business days you
are not able to decide whether the
consumer‘s Check 21 claim is valid, you
have to provisionally recredit his account for
the amount of the claim, up to the lesser of:
Model C-23 is for a provisional refund
pending investigation. It has similar fields to
be filled in. Be sure to add in the optional
sentence in brackets at the end of the first
paragraph if you are recrediting only the first
$2,500 of a claim for a larger amount.
1. The amount of the substitute check; or
2. $2,500.
You must also include interest if the account
is interest bearing. You have to recredit the
balance of the claim, plus interest, if
applicable, by the end of the 45th calendar
day after you received the claim.
Model C-24 is the denial notice. The
financial institution has to state why the
charge was proper and enclose the item or
a copy. There are optional sentences in this
notice to let a financial institution state either
that it is enclosing other information beyond
the check as proof of the correctness of the
charge, or to tell the customer that she has
a right to request such documentation.
Reversals. The regulation allows reversal
of a recredit if you determine that the charge
actually was proper and you notify the
consumer. You may take the money first
and notify the consumer immediately
afterwards. The right to reverse a recredit
expires in a year.
Model C-25 tells the consumer that the
financial institution has reversed a recredit it
gave him. Again the original or a copy of the
check is expected to be enclosed, and
additional documents either enclosed or the
customer‘s right to obtain them noted.
Availability. Section 229.54(c) The funds
you‘ve recredited must be available at the
start of the business day after the banking
day on which you recredited the account.
There are safeguard exceptions similar to
those for normal funds availability:
Bank claims. Section 55 lays out the
expedited return provisions for financial
institutions. They are similar to the
consumer recredit provisions because they
are driven by consumer claims. Jane
Consumer makes a claim against her
institution, which makes a claim against the
institution that sent it the substitute check.
1. New accounts. (30 days after the
account was established).
2. Repeat overdraft customers. (The
consumer has had ODs (or would
have if you‘d paid his checks) on six or
more days in the past six months, or
has been OD (or would have been if
you‘d paid his checks) by $5,000 or
Liabilities. Section 56 makes any financial
institution that breaches a warranty or
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otherwise fails to comply with Subpart D
liable to the aggrieved party for:
Check 21
Regulation CC
consumers, who were existing customers,
with the financial institution‘s first regularly
scheduled communication to them after
October 28, 2004. Then for consumers who
open deposit accounts after October 28,
2004, the notice must be given at account
opening if they will receive paid checks with
their statements.
1. The lesser of the amount of the
substitute check or the amount of the
party‘s loss resulting from the breach
of warranty or other failure to comply;
plus
2. Interest and expenses related to the
substitute check, including attorney‘s
fees and expenses.
But if your financial institution has some, or
even all, of its consumer depositors
converted to image statements, they don‘t
get paid checks back with their statements.
In that case, you do not have to do the
mass mailings or give C-5A at account
opening. But those folks occasionally
request an original check or a copy of a
check because of a dispute over when or
whether they paid somebody. If the check
they ask you for was truncated and then
reconverted into a substitute check, you
may be giving that customer something that
is subject to Check 21.Then you have to
give the C-5A notice at the time of the
consumer‘s request ―if feasible.‖ It will not
be feasible if the consumer phones or mails
her request, and you may not know then
whether what you‘ll be supplying will be a
substitute check. In those circumstances,
the regulation allows you to provide the
notice with the substitute check. Remember,
the Check 21 rules apply only to substitute
checks. So if you give your customer
something that is not a substitute check,
such as a photocopy of an original check, a
photocopy of a substitute check, or a
statement page containing images of
several checks, you are not subject to these
rules.
There is a comparative negligence standard
here,
and
there
are
extenuating
circumstances that will excuse delays in a
financial institution‘s actions. They parallel
the emergency exception holds in the funds
availability part of Regulation CC:
1. Interruption of communications or
computer facilities (I‘ve always
wondered how you ―interrupt‖ a
―facility‖)
2. Suspension of payments by another
financial institution
3. War
4. Emergency conditions
5. Failure of equipment
6. Other circumstances beyond the
financial institution‘s control if it uses
such diligence as the circumstances
require.
Limitations. Section 229.56(c) Any lawsuit
must be brought within one year of the date
on which it ―accrued.‖ That is defined to
mean when the claimant first learn of the
facts that gave rise to the claim, including
the identity of the financial institution that
made the warranty or indemnity, or when he
reasonably ought to have learned those
things.
Model C-5A. There are several times when
you have to give the Model C-5A disclosure
to consumers, and some of them are not
intuitive. First, you have to give it to all
consumers who receive paid checks with
their periodic deposit account statements.
There was a mass mailing to those
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Truth in Savings
Regulation DD
the exception of IRAs and SEPs to the
extent the funds are invested in a deposit
account. Though IRAs and SEPs are
custodial accounts and title is technically
held by a nonindividual (i.e., the institution)
the Federal Reserve Board found that the
consumer
beneficiary
controlled
the
investment decisions for the account, and
that was the relationship that Congress
intended to protect. Totten trust accounts
(―John Jones in trust for Little Billy Jones‖)
and pay-on-death (POD) accounts also are
covered.
Truth in Savings
Common name: Regulation DD
Introduction
The Federal Reserve Board issued
Regulation DD to implement the provisions
of the Truth in Savings Act. The bulk of the
regulation prescribes notices and disclosure
information that a regulated financial
institution must provide to its consumer
deposit customers. It also prohibits certain
deposit account related practices and
mandates others. This section describes the
requirements of the regulation with the
exception of its rules on advertising, which
are covered in the Advertising Deposits
chapter, and the rules on overdraft
protection that are covered in the ―Overdraft
Protection Products‖ chapter of this Manual.
As a general rule, the following types of
deposit accounts are covered by the
regulation:
An account held by an individual for a
personal,
family
or
household
purpose.
An IRA, an ITF or POD account, or
SEP.
Coverage
Definitions
The regulation applies to all depository
institutions other than credit unions. Section
230.1(c) (Credit unions have a regulation
similar to Regulation DD governing Truth In
Savings.)
Specifically, it applies to all
commercial banks, savings banks, and
savings and loan associations. Within a
covered institution, it applies to all deposit
accounts held by or offered to a consumer.
The title ―Truth in Savings‖ is somewhat of a
misnomer as the act applies to noninterestbearing accounts as well as those that do
bear interest. It also applies to both
uninsured and insured accounts.
Advertisement. Section 230.2(b) A commercial
A commercial message promoting directly
or indirectly the availability of, or a
deposit in, an account. The definition of
advertisement is as encompassing as
possible. Virtually any communication to
present or potential deposit customers will
be deemed to be an advertisement. About
the only exception is an in-person
discussion with a potential customer or
information provided to a customer about an
existing account. For example, for a time
deposit that does not automatically renew, a
maturity notice relates to the existing
account and is not an advertisement. A
notice of the terms available if the customer
renews the account, however, is an
advertisement because it relates to a new
account and not an existing account.
Marketing
messages
on
periodic
statements, messages on ATMs, and
messages on voice response machines are
all advertisements. See the Advertising
Deposits chapter in the Deposits section of
this Manual for more information.
A ―consumer‖ is ―a natural person who holds
an account primarily for personal, family, or
household purposes or to whom such an
account is offered.‖ Section 230.2(h) In
other words, a consumer is an individual
who holds a deposit account for a
nonbusiness purpose. A sole proprietorship
is an individual that holds an account for a
business purpose and is not covered.
Custodial accounts are not covered, with
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Annual Percentage Yield. Section 230.2(c)
The total amount of interest paid on an
account, expressed as a percentage of the
account balance, based on the interest rate
and the frequency of compounding for a
365-day period. For example, if a $100
deposit would earn $5 in interest if held in
an account for one year, the annual
percentage yield (APY) would be 5 percent.
Truth in Savings
Regulation DD
account level. Thus, a consumer could be
given $8 in a year for each of two accounts
and the payments would not constitute a
bonus. The commentary also provides an
exception when an item valued at, say, $7 is
offered to people who open accounts in one
time period, then the institution introduces a
different promotion later in the year that
includes an offer to those same people for
another item, valued at $8, for maintaining
an average balance above a particular
amount. In these circumstances, the
commentary says the bonus rules would not
be triggered. The logic of this position is not
immediately apparent, and institutions
should proceed carefully, with good
regulatory advice.
Average Daily Balance Method. Section
230.2(d) The application of a periodic rate to
the average daily balance in an account for
a period. The average daily balance is
calculated by adding the full amount of
principal in the account for each day of the
period and dividing by the number of days in
the period. For any day that the balance in
the account is negative (overdrawn), treat
the balance as zero for the purpose of
calculating average daily balance.
Business Day. Section 230.2(g) A day
other than a Saturday, Sunday, or legal
holiday. This is the same definition used in
Regulation CC.
Bonus. Section 230.2(f) A premium, gift, or
other consideration worth more than $10
(whether in the form of cash, credit,
merchandise, or any equivalent) given or
offered to a consumer during a calendar
year in exchange for opening, maintaining,
renewing, or increasing an account. The
giving or offering of a bonus triggers certain
disclosure and advertising requirements. An
institution may give up to $10 during each
calendar year to a consumer for an account
and stay under the disclosure requirements.
―Other considerations‖ granted a consumer
by an institution, such as the waiver or
reduction of a fee, or the absorption of
expenses, are not considered to be a
bonus. Thus, an institution may provide a
free checking account or reduced-fee
traveler‘s checks for consumer deposit
customers without the value of those
services being classified as a bonus. Also,
money, merchandise, etc., given to
someone (even a consumer deposit
account holder) for bringing in a third party
to open an account is not a bonus. The
consideration must be given to the
individual opening or owning the account for
it to be classified as a bonus. The $10
bonus limit generally is calculated at the
Fixed-Rate Account. Section 230.2(l) An
account for which the institution contracts to
give at least 30 calendar days advance
written notice of decreases in the interest
rate. (Note that advance notice is never
required for a rate increase.) For example, if
an institution retains the right to change
interest rates at its discretion, but agrees to
provide customers 30 days prior written
notice before a decrease becomes effective,
the account is a fixed-rate account. If the
institution does not agree to provide
customers 30 days prior written notice of an
interest-rate decrease, the account is a
variable-rate account. See the definition of
variable-rate account for more information.
Grace Period. Section 230.2(m) A period
following the maturity of an automatically
renewing time account during which the
consumer may withdraw funds from the
renewed account without being assessed a
penalty. A grace period may not exceed 10
days.
Interest. Section 230.2(n) A payment to a
consumer or to an account for the use of
funds in an account, calculated by the
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application of a periodic rate to the account
balance.
Truth in Savings
Regulation DD
earns interest at 4 percent, but requires an
average daily balance of $1,000 or no
interest is earned, is not a tiered-rate
account with a bottom tier of zero.
Interest Rate. Section 230.2(o) The annual
rate of interest paid on an account that does
not reflect compounding.
Time Account.
Section 230.2(u)
An
account with a maturity of at least seven
days in which the consumer generally does
not have the right to make withdrawals from
the account during the first six days unless
an early withdrawal penalty of at least seven
days interest on the amount withdrawn is
charged. This is the same time account
definition used in Regulation D.
Periodic Statement. Section 230.2(q) A
statement setting forth information about an
account (other than a time account or
passbook savings account) that is provided
to a customer at a regular frequency of four
or more times a year. Information provided
periodically on time and passbook accounts,
such as on a combined statement, is not a
periodic statement as to the time or
passbook accounts and the periodic
statement disclosure requirements do not
apply to those accounts even though the
requirements do apply to the lead account.
Even if an institution provides periodic
statements on time accounts, those
statements are not periodic statements for
Regulation DD purposes.
Variable-Rate Account. Section 230.2(v)
An account in which the interest rate may
change after the account is opened and the
institution does not agree to give the
customer 30 days prior written notice of
interest-rate decreases. An interest-rate
decrease may be the result of a decrease in
an index to which a rate is tied or it may be
at the institution‘s discretion. An account
where an interest-rate change may be
initiated only by the customer and the
change is solely at the customer‘s discretion
is also a variable-rate account.
Stepped-Rate Account. Section 230.2(s)
An account that has two or more interest
rates that take effect in succeeding periods
and for which the rates and periods are
known when the account is opened.
General Disclosure
Requirements
Tiered-Rate Account. Section 230.2(t) An
account that has two or more interest rates
that are applicable to specific balance
levels. The regulation describes two
different types of tiered-rate accounts. One
type is where the interest rate paid on the
entire account balance is dependent on the
balance. An example is an account that
pays 4 percent on the entire balance if the
average daily balance is less than $5,000,
and 5 percent on the entire balance if it is
$5,000 or greater. A second type is where a
different interest rate is applied to different
portions (tiers) of an account balance. An
example is an account where 4 percent
interest is paid on the portion of the account
balance less than $5,000, and 5 percent is
paid on the portion that is $5,000 or greater.
An account that requires a minimum
balance to earn interest is not a tiered-rate
account. For example, an account that
The bulk of Regulation DD describes
disclosures that an institution must provide
to a present or prospective consumer
customer at various times. Whenever an
institution provides a Regulation DD
disclosure, the disclosure must be in writing
and in a form the consumer may keep.
Each item that must be disclosed must be
written in plain language and must be
conspicuous. Section 230.3(a)
Items that are required to be disclosed by
Regulation DD and also by other regulations
only need to be disclosed once.
A
disclosure that meets the requirement of the
other regulation will satisfy Regulation DD.
The regulation does not prescribe any
required format for any of the disclosures.
So long as they are not misleading, the
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disclosures may be in any order and may be
contained in multiple documents.
The
disclosures may be intermingled with other
information; however, the consumer must
be given all of the disclosures at one time.
A financial institution, for example, may not
give a consumer a brochure disclosing
everything but interest rates and mail a rate
table the next day.
Truth in Savings
Regulation DD
primary account holder for disclosure
purposes.
Delivery of the account
disclosures to any one of multiple account
holders is adequate. Section 230.3(d)
Account Disclosures
An institution must provide a consumer an
account disclosure before a new account is
opened or a service is provided. If the
consumer is present at the institution, the
disclosure must be given in person. If the
consumer is not present, the disclosure
must be mailed or delivered within 10
business days. Section 230.4(a) Be aware
that a renewal of a time deposit that does
not automatically renew is considered a new
account that requires all new account
disclosures. A rollover of an automatically
renewable time account with a term of
over one year also requires new account
disclosures. Some other events may not be
considered as the opening of a new
account, but they are. Examples include
accepting a deposit to an account
previously classified as closed, and closing
a money market account because of
excessive preauthorized transactions and
opening a new account with the proceeds.
There is no requirement that any disclosure
be more conspicuous than any other. The
regulation does require the use of the terms
―annual percentage yield‖ and ―interest
rate,‖ but there are no other language
requirements. One constraint is that an
institution must be consistent in the use of
terms throughout its disclosures.
If a
monthly service fee, for example, is
described as a ―monthly fee‖ on the account
disclosure, it must also be described as a
―monthly fee‖ on the periodic statement and
on any change notice.
The regulation requires that, where the
annual percentage yield and interest rate
are disclosed, they must be expressed to
two decimal places and rounded to the
nearest one-hundredth of one percentage
point (.01%). For example, 5.344% would
be disclosed as 5.34% and 5.345% would
be disclosed as 5.35%. 5% would be
disclosed as 5.00%. On account opening
disclosures only, the interest rate only may
be disclosed to more than two decimal
places.
An institution must also provide an account
disclosure at the consumer‘s request.
Section 230.4(b) If the consumer is not
present at the institution, the institution must
mail or deliver the disclosure to the
consumer within a ―reasonable time‖ (that
is, up to ten business days). The content of
the account disclosure that is provided on
request is slightly different than that which is
given to a consumer opening a new
account. On the requested disclosure, the
term of a time deposit (e.g., 90 days) must
be disclosed; on a new account disclosure,
the actual date of maturity must be
disclosed (e.g., October 17, 1996). On the
requested disclosure, you may disclose an
annual percentage yield and an interest rate
that was offered within the most recent
seven calendar days, a stated date on
which they were effective, and a telephone
number consumers may call to obtain
current information. On a new account
disclosure, an institution must disclose the
When the annual percentage yield is
disclosed, it must be accurate to 1/20 of one
percentage point (.05%). If the actual yield
falls within that tolerance, there is no
violation of the regulation. However, an
institution may not purposely misdisclose an
account‘s APY by the tolerance amount.
When the interest rate is disclosed, it must
be precisely accurate.
There is no
tolerance. Section 230.3(f)
If there are multiple parties on an account,
the disclosures only need to be given to one
of them, and it does not matter which. An
institution does not need to designate a
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Truth in Savings
actual annual percentage yield and interest
rate applicable to the account.
Regulation DD
If the account is a variable-rate
account, an institution must also
disclose:
An inquiry about rates or fees is not a
request for written information and does not
trigger the duty to provide account
disclosures.
When a consumer asks
numerous questions about the terms of an
account, even though he or she has not
specifically requested a written account
disclosure, it becomes apparent that the
complete account disclosure is the
information being sought. The best policy is
to offer a written disclosure to a consumer
who asks two or more questions about the
terms of an account other than about rates
and fees, although technically the regulation
does not require this.
The fact that the interest rate and
the annual percentage yield may
change.
How
the
determined.
interest
rate
is
The frequency with which the
interest rate may change.
Any limitation on the amount the
interest rate may change.
The frequency with which interest is
compounded and credited.
An account disclosure must contain the
following items, to the extent applicable:
A statement if the customer will forfeit
accrued but uncredited interest when
an account is closed.
The annual percentage yield and
interest rate, using those terms.
Any minimum balance required to
open an account.
If an account has only one interest
rate applicable to it, the disclosure is
reasonably straightforward.
For
stepped-rate accounts, disclose one
composite annual percentage yield
and each interest rate and the time the
interest rate would be in effect.
avoid imposition of a fee and how the
balance is calculated for this purpose.
earn the annual percentage yield
disclosed and how the balance is
calculated for this purpose.
For tiered-rate accounts where the
same rate of interest is paid on the
entire balance of the account based
on the tier in which the balance falls
(Tier Method A), an institution must
disclose the annual percentage yield
and interest rate for each tier. For
tiered-rate accounts where a different
rate is applied to the balance that falls
within each tier (Tier Method B), the
interest rate for each tier and the
annual percentage yield range for
each tier must be disclosed. Accounts
that require a minimum balance to
earn interest are not tiered-rate
accounts and no disclosure need be
made of the interest rate or annual
percentage yield if the account
balance falls below the minimum.
An explanation of how the balance on
which interest is calculated is
computed.
A statement of when interest begins to
accrue on noncash deposits.
The dollar amount of any fee that may
be imposed in connection with the
account if it is a fixed fee, or how it will
be calculated or determined if it is not
a fixed fee, and the conditions under
which the fee may be imposed. In this
regard, every fee that may be imposed
on the account must be disclosed.
These include maintenance fees (such
as service fees and dormant account
fees); transaction fees (such as percheck fees, ATM fees, stop payment
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fees and NSF fees); special account
service fees (such as balance inquiry
fees and the fee to certify a check);
fees to open or close an account
(other than early-withdrawal penalties
for time accounts, which are treated
separately); and miscellaneous fees
(such as fees for check printing). Fees
unrelated to an account do not need to
be disclosed even if different fee
amounts are charged to customers
versus noncustomers. Examples are
wire transfer fees and cashier‘s check
fees. Section 230.4(b)
Truth in Savings
Regulation DD
Note: For check printing fees, the
regulation permits a variety of ways to
make the disclosure. An institution may
disclose the lowest price at which checks
could be purchased and indicate that
higher prices may apply, it may give a
range of prices, or it may simply state that
prices vary.
Any limitation on the number or dollar
amount of withdrawals or deposits,
such as a limit on restricted
transactions from money market
accounts or ATM cash withdrawal
limits. For time accounts, if either
additional deposits or withdrawals are
not permitted, that fact must be
disclosed.
An institution must disclose both the amount
of a fee and the condition or event that will
cause the fee to be imposed. In most cases,
the name of the fee is adequate disclosure
of the condition or event. One exception
may be a fee for closing an account if the
institution closes accounts on other than a
customer‘s request. If an institution closes
accounts on a zero balance or under some
other condition and imposes a fee for the
closure, the condition that will cause the
closure and trigger the fee must be
disclosed.
The amount or type of any bonus,
when the bonus will be provided, and
any minimum balance or time
requirement to obtain the bonus. If a
bonus may be reclaimed from a
consumer because of an early
withdrawal, that fact must be
disclosed.
The institution must disclose the following
additional items for time accounts.
The regulation contains explicit rules on the
balance in an account on which interest
must be paid and how the balance must be
calculated. An institution may not require
both a minimum daily balance and a
minimum average daily balance to earn
interest, and a negative balance must be
treated as a zero balance for interestcalculation purposes. The same rules do not
apply to the requirements to avoid a fee. For
example, an institution could charge a
monthly service fee for any month that a
customer did not maintain an average daily
balance of $1,000 and a daily balance of at
least $500 every day. Additionally, an
institution may use negative balances in
determining whether an average-balance
requirement to avoid a fee has been met.
There are no rules regarding when a fee
may be charged. The only requirement is
that the circumstances that will cause the
fee to be charged be clearly disclosed.
The maturity date of the account. For
disclosures given to a consumer on
request, a term (e.g., 90 days) may be
stated.
If early withdrawal from an account is
permitted, a statement that a penalty
will/may be imposed for each
withdrawal and how the penalty will be
calculated. If an early withdrawal
triggers an interest rate change on the
balance of the deposit or a change in
any other disclosed item, the change
must be stated as an early withdrawal
penalty.
If compounding occurs during the term
and if interest may be withdrawn prior
to maturity, a statement that the
annual percentage yield assumes that
interest will remain on deposit until
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maturity and that an early withdrawal
will reduce earnings.
Notice before maturity for time
accounts longer than one month
that renew automatically. Section
230.5(b) If a time account renews
automatically without the consumer‘s
request (a rollover account) and has a
term greater than 31 days, the
consumer must be provided a
disclosure. The content of the
disclosure depends on the term of the
deposit. The disclosure must be
mailed or delivered by the later of 30
calendar days prior to maturity or 20
calendar days before the end of the
grace period on the existing account,
provided a grace period of at least five
days is allowed. In other words, if a
60-day
time
account
renews
automatically and has a seven-day
grace period, the disclosure must be
mailed or delivered not later than 13
days prior to the account‘s maturity.
Subsequent Disclosures
There are various disclosures and notices
an institution must provide a consumer
account holder subsequent to the opening
of the account. These notices are:
Change-in-terms notice. Section
230.5 Any time an institution changes
a term of an account that must be
disclosed on a new account
disclosure, the institution must give
the consumer notice of the change if
the change will reduce the annual
percentage yield or may potentially
adversely affect the consumer in any
way. The notice must describe the
change and state the effective date of
the change. The notice must be
mailed or delivered 30 days before the
effective date of the change. A
change-in-terms notice is not required
for:
If the term of the account is greater
than one month but not more than one
year (365 days), the disclosure that
must be provided must state:
The date the existing account
matures.
A change in interest rate and
annual percentage yield for
variable rate accounts.
in
fees
for
Regulation DD
changes, no notice to the customer is
required. If any other disclosed term
changes, notice is required. The
notice must be sent to the customer
within a reasonable time (10 days)
after renewal.
A statement of whether the account
will renew automatically at maturity. If
it will, a statement of whether there is
a grace period and, if so, the length of
the period. If the account does not
renew automatically, a statement of
whether interest will be paid after
maturity, and for how long, if the
customer does not renew.
A change
printing.
Truth in Savings
The date the new account will
mature if the account is renewed.
The interest rate and annual
percentage yield for the new
account if they are known. If they
are not known, a statement that
they have not been determined, a
date by which they will be
determined, and a telephone
number to call to obtain the rates
when determined.
check
A change in any term for time
accounts with maturities of one
month or less.
accounts of one month or less that
renew
automatically.
Section
230.5(a) At renewal, if only the interest
rate or annual percentage yield
Any difference in the terms of the
new account as compared to the
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terms required to be disclosed for
the existing account.
Regulation DD
new account
given.
If the term of the account is greater than
one year, an institution must provide a
complete new account disclosure and
the date the existing account matures. If
the interest rate and annual percentage
yield are not known, the institution must
include a statement to that effect, a date
when they will be determined, and a
telephone number to call to obtain the
new rates.
disclosure must
be
Periodic Statements
Regulation DD does not impose any
requirements for providing consumers
periodic statements. What it does require is
the disclosure of certain information on
periodic statements. Section 230.6 A
periodic statement must include the
The annual percentage yield earned
during the statement period. The
formula
for
calculating
annual
percentage
yield
for
periodic
statement purposes is:
There is no requirement for a grace period,
but the timing of disclosures is easier to
accommodate if there is a grace period.
There is also no requirement relative to
when an institution must set its interest rate
for automatically renewing accounts, or that
the time be the same for all accounts. For
example, for relatively small deposits, an
institution could set its rate three days prior
to maturity, and for larger accounts wait until
the day of maturity. There is also no
requirement that the telephone number
provided to obtain rates that are not set at
the time of disclosure be toll-free.
APY Earned = 100 [(1 + Interest
Earned/Average Daily
Balance)(365/days in period) -1].
―Interest earned‖ is the actual
amount of interest stated in dollars
that was earned on the account
during the period.
―Average Daily Balance‖ is the
average daily balance in the
account during the period.
Lastly, there is no limitation on how far in
advance of maturity the disclosures may be
given. Institutions will find that operationally
it will be easier to send the disclosures as
late in time as allowable in order that the
disclosures include as many term changes
as possible.
―Days in period‖ is the actual
number of days in the period.
For the purpose of calculating APY
earned
for
periodic
statement
purposes, the numerator of the
exponent fraction is always 365, even
in a leap year and even in the period
that includes February 29. The exact
words ―Annual Percentage Yield
Earned‖ must be used. The regulation
requires that interest earned be
rounded to whole cents before the
APY is calculated. This can cause the
reported APY on an account that has
earned only a few cents of interest to
be significantly higher or lower than
the actual APY.
accounts that do not automatically
renew. If a time account does not
automatically renew and has a
maturity of one year or less, no notice
of any type is required. If a time
deposit that does not automatically
renew has a maturity greater than one
year, a notice must be sent not less
than ten calendar days prior to
maturity stating the maturity date and
whether interest will be paid after
maturity. If the holder of a non-rollover
account elects to renew, then the full
The dollar amount of interest earned
during the period.
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A statement of fees debited to the
account during the statement period.
(Fees not debited to the account, for
example, fees paid in cash, need not
be on the statement.) The fees must
be itemized by type and dollar
amount. For example, if a per-check
fee is imposed and during the period
10 charges of 25 cents each were
made, an institution may disclose
each fee charged individually or it may
disclose a total $2.50 charge for percheck fees. Regardless of the method
used, the type of the fee charged must
be disclosed in sufficient detail to
enable the consumer to identify the
nature of the fee. An institution may
use a code to identify a particular fee
or aggregation of fees. If it does so,
the codes must be explained on the
statement or on a document
accompanying
the
statement.
Additionally, a fee must be described
on a periodic statement in the same
manner as it was described on the
new-account disclosure.
Truth in Savings
Regulation DD
Overdraft Fee Disclosures.
Since
January 1, 2010, all regulated financial
institutions are required to display
information about a consumer‘s
overdraft and insufficient funds
charges on the consumer‘s periodic
statement for each type of deposit
account
where
a
discretionary
decision to pay or return an item is
possible. Prior to January 1, 2010,
only those institutions that promoted
their discretionary overdraft programs
were required to display this
information on periodic statements.
While fees incurred during the
statement cycle are required to be
listed on the periodic statement (as
described previously), overdraft and
insufficient funds charges have special
treatment.
The information to be
displayed is the breakdown of
overdraft charges resulting from
discretionary overdraft programs, and
separately, charges resulting from
insufficient funds items. Both types of
fees are to be broken down by
monthly incurred charges and year-todate incurred charges. A complete
discussion of the periodic statement
disclosure requirements can be found
in the chapter on Overdraft Protection
Products in the Deposits section of
this Manual.
Note: If a fee is charged to an
account because of the account’s
relationship with another account,
the fee must be shown on the
periodic statement of the account to
which it is charged.
The length of the period. An institution
may meet this requirement by
disclosing either the actual number of
days in the period or the beginning
and ending dates of the period. If the
beginning and ending dates are used,
the statement must clearly indicate
what days are included. For example,
a statement that the period is April 1
through April 30 clearly indicates that
April 1 and April 30 are included in the
statement period. Alternatively, an
institution could disclose that the
preceding period ended March 31 and
the current period ended April 30.
The disclosures required on a periodic
statement need only be made to the extent
that they are applicable. Thus, neither the
annual percentage yield earned nor the
interest earned need be disclosed on a
noninterest-bearing account. Likewise, other
than the special disclosures for overdraft
insufficient funds fees, there is no specific
format that the disclosures must take. No
disclosure must be ―more prominent‖ as in
Regulation Z and the disclosures do not
need to be grouped together or isolated
from other information on the statement. If
the required information is conspicuous and
its meaning is clear, the requirement of the
regulation is fulfilled.
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Periodic Statements – Regulation E
Accounts. When an institution provides
regular, quarterly statements on an account,
and, in compliance with Regulation E,
provides a monthly statement when an
electronic transfer occurs, the institution
need not, but may, treat the intermittent
monthly Regulation E statements as
periodic statements. More important, if an
institution provides rate or interest
information on those monthly Regulation E
statements, those statements will be
deemed to be periodic statements and
subject to all of the periodic statement
disclosure rules. In other words, if on its
―interim Regulation E‖ statement an
institution provides information about either
the interest earned or the annual
percentage yield on the account, then the
statement becomes a periodic statement
and all of the periodic statement rules apply.
Truth in Savings
Regulation DD
ledger balance for periodic statement APY
calculations. An institution that accrues on
the ledger balance must use the ledger
balance for APY disclosures.
Payment of Interest
The regulation requires that an institution
calculate interest ―on the full amount of
principal in an account for each day...‖ This
means that interest must be calculated on at
least the collected balance in the account. If
an institution wants to be more liberal in its
practices, for example, by paying interest on
checks from the day of deposit, that is
permissible. However, an institution may not
calculate interest on less than the collected
balance. For example, the practice of
paying interest on the investable balance
(the collected balance less reserve
requirements) is in violation of the
regulation. Commentary to Section 230.7(a)
Periodic Statements – Account Balance
Information. If you put some basic
information to keep the account holder
informed as to status for one account on the
periodic statement for another account, do
you have to make all of the required
periodic statement disclosures for the
―status‖ account? You do not have to
provide additional disclosures if the status
account is a time deposit or passbook
savings account as they are excluded from
the periodic statement requirements in the
regulation.
For other types of deposit
accounts, you may include the account
number, account type, and account balance
of the status account on the periodic
statement for another account without
triggering the full periodic statement
disclosures for the status account.
The interest calculation can be done on
either the daily balance method or the
average daily balance method. Section
230.7(a) The regulation does not prohibit
requiring a minimum balance to earn
interest. If the daily balance method is used,
no interest would be earned on any day on
which the balance was below the minimum.
If the average daily balance method is used,
no interest would be earned for the period if
the average daily balance was less than the
minimum.
What the regulation does prohibit is an
account that does not accrue interest for a
period if at any time during the period the
balance falls below a prescribed minimum
(sometimes called the ―low balance‖
method). For example, if an account has a
minimum balance requirement of $1,000, it
would be in violation of the regulation to fail
to pay interest during the period just
because the balance fell below the
minimum on one day. Commentary to
Section 230.7(a)
Periodic Statements – Ledger Balance.
Institutions may accrue interest on a
consumer account on either the account‘s
credited balance or the ledger balance. An
institution may use the same balance for
both accruing interest and disclosing the
periodic statement APY. An institution that
accrues interest on the credited balance
may use either the credited balance or
If an institution has ―minimum balance‖
accounts, it must use the same method to
calculate the minimum balance as it does
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the balance on which interest is calculated.
Section 230.7(a)
Truth in Savings
Regulation DD
guidance with respect to automated
overdraft payment programs. Please refer
to our Overdraft Protection Products chapter
which is included in the Deposits section of
this Manual for details.
An institution must pay interest on a
dormant account. Fees for dormancy may
be assessed (if properly contracted for and
disclosed) but the institution may not cease
paying interest just because the account
has gone ―dormant‖ under state law or
institution rules. Commentary to Section
230.7(a)(1)
Suggestions for Compliance
Compounding
and
Crediting.
Compounding occurs when the interest
earned on an account begins to earn
interest itself.
The frequency of
compounding is the frequency in which
interest that has been earned is added to
the balance of the account on which interest
is earned. Whether the earned interest is or
is not available for withdrawal is of no
consequence
to
the
compounding
frequency.
Record Retention
An institution must retain records that are
adequate to demonstrate compliance with
the regulation. Section 230.9(c) Number
one on the list of things examiners will look
for is a procedure which, if followed, will
cause the proper payment of interest and
the provision of timely disclosures. An
institution should also maintain a sample of
an account disclosure for each type of
account it offers, sample time deposit
renewal
notices,
sample
periodic
statements, and copies of any change-interms notices.
Institutions should also
maintain a copy of all deposit advertising,
including pictures of lobby boards.
Crediting is the process of making interest
that has been earned available for
withdrawal. The frequency of crediting is
the frequency with which that process
occurs. Whether or not interest begins to
be earned on the interest that becomes
available for withdrawal is not a factor.
Crediting of interest and compounding of
interest are separate and distinct functions.
The greatest confusion about crediting and
compounding occurs on time deposit
disclosures where, at the customer‘s
request, interest is paid periodically to the
customer either by check or by credit to
another account.
Overdraft Protection
The July 1, 2006 amendments to Regulation
DD, which were updated in January 2009
with an effective date of January 1, 2010,
establish a number of requirements with
respect to overdrafts of deposit accounts.
The rules set standards for disclosures that
are required, for information which must
appear on account statements, and for the
manner in which discretionary overdraft
programs can be advertised to consumers.
In addition, on November 24, 2011 in its
FIL-81-2010, the FDIC issued its Final
Guidance on overdraft protection programs.
This guidance built upon the best practices
outlined in the 2005 Joint Guidance on
Overdraft Protection Programs, and is
meant to reaffirm existing regulator
expectations concerning overdraft payment
programs generally, and to provide specific
Assume a time deposit on which interest is
normally
compounded
and
credited
quarterly; however, at the customer‘s
election, the institution will transfer the
earned interest to the customer‘s savings
account monthly. For the customer who
elects that option, his or her disclosure must
state monthly crediting and not quarterly
crediting. A disclosure must describe the
customer‘s specific account, not the way an
account of that type is normally processed.
The real confusion in this instance is the
disclosure
of
compounding.
The
compounding frequency must be disclosed
as quarterly. But, you are thinking, because
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interest is paid from the account monthly, it
never compounds and the disclosure must
be specific to the account. You are right
and wrong.
Compounding and annual
percentage yield are disclosed on the
assumption that the customer will leave the
interest in the account until maturity. This is
true even though you know the assumption
is wrong. These are the two exceptions to
the specific-to-the-account rule.
Even
though the customer has signed a request
that the interest earned be sent to him by
check monthly, the compounding frequency
and APY disclosed must assume that
interest is not withdrawn from the account
until maturity.
Truth in Savings
Regulation DD
best policy is to give the customer a
complete account disclosure before the
customer signs the account agreement or
the signature card and before accepting the
opening deposit.
Club Accounts – Are They Time Deposits
or Savings Deposits?
Some club
accounts bear interest while others pay a
bonus if a certain account balance is
attained. Many customers participate in the
same club plan year after year. Are these
time deposits or savings deposits? The fact
is they can be either. It depends on how
they are structured. If they require an early
withdrawal penalty of at least seven days‘
interest on withdrawals during the first six
days, they are time accounts. If not, they
are not time accounts, even though they
have a maturity date. And if a consumer
has agreed to the transfer of payments from
another account into a ―time‖ club account
for the next club period, the institution must
give the disclosures for automatically
renewing time accounts, even though the
consumer may withdraw funds from the club
account at the end of the current club
period.
The other exception is when an institution
requires a customer to withdraw credited
interest. For time deposits with maturities
greater than one year that do not compound
interest at least annually, the APY is less
than the interest rate. In this situation,
Regulation DD allows an institution to
disclose and advertise an APY equal to the
interest rate if the institution also discloses
and states in its advertisements that interest
accrued on the account may not remain on
deposit and that an annual payout of
interest is mandatory.
Communication to the Customer – What
Does Regulation DD Cover? Regulation
DD mandates the content and the timing of
new account disclosures and time deposit
renewal notices.
It also specifies the
content of advertising and periodic
statements, but does not require either.
Regulation DD does not govern the content
of any other communications between an
institution and its customers.
Periodic
statements are account statements sent to
account holders on a quarterly or more
frequent basis. The regulation excludes
from the definition of periodic statement any
statement about either time accounts or
passbook savings accounts. Thus, a notice
to a holder of an automatically renewable
time deposit that the account has renewed
and what the renewal interest rate is, is not
governed by Regulation DD. Time deposit
information included with the periodic
statement for another account of a customer
Disclosure of Maturity Date. One of the
required disclosures for time deposits is the
maturity date of the account.
For
disclosures given to potential customers on
request, the term of the account (e.g., six
months) is sufficient. However, when a
customer actually opens a time deposit, the
actual maturity date (e.g., June 25, 2015)
must be disclosed. Some institutions fail to
make this specific disclosure and some only
disclose the maturity date by putting it on
the certificate of deposit. The first practice
is clearly a violation of the regulation. The
second is technically a violation.
The
required disclosures must be given before
the account is opened or a transaction
occurs. The certificate is given to the
customer after the account is opened and
after a deposit has been made. When a
customer is opening a new account, the
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Truth in Savings
Regulation DD
does not require all of the Regulation DD
periodic statement disclosures, such as
APY and interest earned during the period.
must process the account in accordance
with the erroneous disclosure for the
required time period.
How are Regulation DD Disclosure
Errors Corrected? The correction process
for Truth in Savings errors is similar to the
process for correcting Truth in Lending
errors. Also, as with Truth in Lending, the
corrective process is in the Act and not the
regulation. If an institution has made a
Truth in Savings disclosure error, as with
Truth in Lending, the institution is stuck with
it.
An institution must live up to its
disclosures to the extent it will benefit the
customer, even though the actual contract
may say something different.
If the
disclosure was for a time deposit, an
institution must comply with the disclosed
terms until maturity (but not through any
renewals). If the erroneous disclosure was
for a deposit account other than a time
deposit, an institution may send a change in
terms notice correcting the error, but must
wait the required 30 days before
implementing the correction.
In either
event, the institution must pay the APY
disclosed, may not charge any fee or other
charge not appropriately disclosed, and
Disclose Early Withdrawal Penalties in
Days, Not Months. Because interest is
earned each day, we recommend that early
withdrawal penalties be expressed in days.
Because the number of days in a month
varies, expressing the penalty in days will
avoid any disagreement with a customer
about how much penalty should be charged.
Have Pending Renewal Notices for Time
Deposits Prepared Two or Three Days in
Advance of Their Due Date. Holders of
most automatically renewable time deposits
and time deposits with a term greater than a
year that do not automatically renew must
be given a notice of pending maturity. Most
institutions rely on their automation systems
to create all or part of these notices. Set
your automation systems to produce the
notices two or three days prior to the time
they must be mailed.
This provides
sufficient time to verify the accuracy of the
notices and put additional information with
them where necessary.
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Prohibition of Funding of
Unlawful Internet Gambling
Regulation GG
Federal Reserve, the FDIC, the OCC the
OTS and the NCUA.
Unlawful Internet
Gambling
Entities
Subject
Regulation
to
the
Regulation GG‘s policy and procedure
requirements apply to persons that are
considered ―non-exempt participants in a
designated payment system.‖ Participants
include operators, third-party processors,
and financial transaction providers that are
members of a designated payment system,
have contracted with one, or otherwise
participate in one.
Common name: Regulation GG
In 2006, Congress passed the Unlawful
Internet Gambling Enforcement Act, which
prohibited anyone in the business of betting
or wagering from knowingly accepting
payments that result from unlawful Internet
gambling. The statute also required the
regulatory agencies to identify which
payment systems could be used to facilitate
prohibited
transactions,
and
require
participants in those systems to have
policies and procedures to identify and
block prohibited transactions, or prevent or
prohibit them. As a result, the Federal
Reserve put Regulation GG in place, which
had a mandatory compliance date of
June 1, 2010.
1. Designated Payment Systems
The payment systems that are considered
―designated payment systems‖ under
Regulation GG are:
ACH systems – These are payment
systems that are governed by the ACH
rules.
Card systems – These are any
systems for authorizing, clearing and
settling credit card, debit card or
stored-value card transactions, such
as the MasterCard and Visa networks.
Under Regulation GG, financial institutions
and other businesses that play a role in
certain payment systems are required to
have policies and procedures in place to
identify and block proceeds from unlawful
Internet gambling transactions, or prevent or
prohibit the unlawful transactions. Internet
gambling is any gambling that involves the
use of the Internet in some way. However,
the regulation doesn‘t say what is
considered ―unlawful,‖ and in finalizing the
rule, the Federal Reserve declined to
provide a list of businesses that engage in
unlawful Internet gambling that financial
institutions could use to compare against
their customers. Rather, institutions have to
determine what is considered unlawful
themselves under federal, state or tribal law.
Section 233.2. However, there is some
guidance, included in this chapter, from a
jointly issued Examination Manual by the
Check collection systems – These are
interbank systems for presenting and
settling checks, as well as systems
within a financial institution for settling
on-us checks.
Wire transfer systems.
Money transmitting businesses –
These are businesses that engage in
funds transfers where the transfers
can be initiated a remote location.
This definition is not intended to apply
to funds transfer services where a
business‘ customers can only initiate
transactions from an office of the
business. This definition is also not
intended to apply to other types of
businesses that would be considered
money services businesses under the
Bank Secrecy Act, such as businesses
that engage in check cashing,
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currency exchange, or the issuance or
redemption of money orders or
travelers checks. Section 233.3
Regulation GG
transaction
are
Regulation GG.
exempt
from
Money transmitting businesses –
Other
than
the
operator,
all
participants in a money transmission
business are exempt from Regulation
GG.
An operator of a money
transmission business is an entity that
provides centralized clearing and
delivery services between participants
in the system and maintains the
operational framework for it.
2. Exemptions
The regulation does not require all
participants in a designated payment
system to have policies and procedures in
place to identify and block, or prevent or
prohibit, restricted transactions. Rather, it
exempts certain participants in each of the
designated payment systems other than
card systems.
For card systems, all
participants in the system are subject to the
policy and procedure requirements of
Regulation GG. This is because, unlike the
other payment systems, card systems have
coding capabilities that can provide card
issuers and other participants with the
information necessary to identify or prevent
restricted transactions.
Most financial institutions are exempt from
the policy and procedure requirements
relating to a money transmission business.
However, as potential recipients of funds
from restricted transactions, most financial
institutions do not fall within the exemptions
for ACH systems, check collection systems,
and wire transfer systems. A participant
that does not meet an exemption is called a
―non-exempt participant.‖
Consequently,
most financial institutions are considered
―non-exempt participants‖ and need policies
and procedures for their ACH, check
collection and wire transfer processes, as
well as their debit, credit and stored value
card processes. Section 233.4
For financial institutions, most of the
exemptions do not apply and an institution
will be required to put policies and
procedures in place.
However, the
exemptions are helpful for financial
institutions because they highlight the
activities that are the focus of institutions‘
policies and procedures.
Required Policies and
Procedures
ACH systems – Participants in a
transaction that is going through an
ACH system are exempt from
Regulation GG unless they are the
receiving
depository
financial
institution that receives an ACH credit
transaction on behalf of a receiver, or
the originating depository financial
institution that initiates an ACH debit
transaction on behalf of an originator.
Non-exempt participants are required to
have policies and procedures to identify and
block, or prevent or prohibit, restricted
transactions. The focus of the regulation is
on the receipt of proceeds from unlawful
Internet gambling transactions, not the
initiation of the transactions. Further, the
regulation limits the burden of the policies
and procedures to those non-exempt
participants with commercial customers that
are receiving the proceeds. In other words,
non-exempt participants do not have to
identify consumers who are engaging in
unlawful Internet gambling. They are only
required to:
Check collection systems – Other than
the depositary financial institution, all
participants in a transaction that is
being processed through a check
collection system are exempt from
Regulation GG.
Wire transfer systems – Other than the
beneficiary‘s financial institution, all
participants in a wire transfer
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Regulation GG
participant blocks, or prevents or prohibits, a
transaction where:
The transaction was a restricted
transaction,
The institution or other participant
reasonably
believes
that
the
transaction
was
a
restricted
transaction, or
The institution or other participant
blocked the transaction in reliance on
the policies and procedures of the
payment system.
Identify their commercial customers
that may be providing Internet
gambling, and
Have policies and procedures that are
reasonably designed to identify and
block, or prevent or prohibit, Internet
gambling
transactions
that
are
unlawful.
Where a non-exempt participant identifies a
restricted transaction, it is required to
―block‖ it. Blocking a transaction under
Regulation GG simply means rejecting the
transaction before or during the processing
of the transaction.
The non-exempt
participant is not required to freeze funds in
the business customer‘s account or prevent
subsequent transfers from the customer‘s
account. Further, once the funds are
returned to the original account, they are not
frozen or restricted for the original account
holder.
Non-exempt participants‘ policies and
procedures must be written, and must be
―reasonably designed‖ to identify and block,
or
prevent
or
prohibit,
restricted
transactions. The regulation contains ―nonexclusive examples‖ of policies and
procedures that a participant can use that
are deemed to be compliant. Alternatively,
an institution can follow the procedures of
its designated payment system, such as the
NACHA guidelines or the rules governing
debit or credit card payment networks, if the
operator of the designated payment system
puts its own Regulation GG policies and
procedures in place and notifies users in a
written statement or notice that the
procedures comply with the requirements of
Regulation GG.
For example, Sue Smith gave her debit card
number to Online Gambling, Inc. for online
poker that turned out to be unlawful.
Financial Institution A holds the account for
Sue Smith. Because Sue is a consumer, A
is not responsible for monitoring her
account or identifying transfers in or out of
her account for unlawful Internet gambling.
However, Financial Institution B holds the
account for Online Gambling, Inc.
Consequently, B is a non-exempt participant
and will need to have policies and
procedures in place to identify transfers into
the account that resulted from unlawful
Internet gambling.
Thus, when Online
Gambling, Inc. submits Sue‘s payment,
Financial Institution B must reject the
transaction and return the funds to Financial
Institution A. A will then credit the funds
back to Sue‘s account and does not have to
freeze the funds or prohibit any transactions
in her account.
Because the examples of policies and
procedures in the regulation are ―nonexclusive,‖ an institution may have different
policies and procedures in place, and can
customize the examples as necessary to
meet the institution‘s needs. Further, an
institution can use different policies and
procedures in different business lines and
areas of its business. While the regulation
allows flexibility in each institution‘s
procedures, the non-exclusive examples are
considered compliant. As a result, most
institutions should consider developing
policies and procedures that conform to the
non-exclusive examples in the regulation.
The regulation also provides institutions with
protection from liability for rejecting
transactions. The protection applies where
an institution or any other non-exempt
The non-exclusive examples effectively
contain three different requirements: due
diligence, a notice to an institution‘s
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commercial customers, and procedures for
blocking,
preventing
or
prohibiting
transactions for each designated payment
system. Section 233.6
Regulation GG
engaging in Internet gambling, the institution
must apply the requirements of Step 3.
Step 3 – Documentation. Where an
institution cannot determine that a
commercial customer is at minimal risk of
engaging in Internet gambling, it must meet
one of two requirements:
1. Due Diligence Procedures
The examples effectively contain two due
diligence
requirements.
The
first
requirement applies at account opening for
a commercial customer.
The second
requirement applies where the institution
receives actual knowledge that an existing
commercial customer is engaging in an
Internet gambling business.
If the customer does not engage in
Internet gambling, the customer has to
provide the institution with a
certification to that effect, or
If the customer engages in Internet
gambling, the institution has to obtain
evidence of the customer‘s legal
authority to engage in the business,
and a third-party certification about the
customer‘s systems.
a) Account Opening Due Diligence
The
account-opening
due-diligence
example is designed to allow an institution
to identify its commercial customers that
pose a risk of engaging in unlawful Internet
gambling. The account-opening duediligence procedures should include the
following steps:
Evidence about the customer‘s legal
authority must consist of either a copy of the
customer‘s state- or tribe-issued license that
expressly authorizes them to engage in the
Internet gambling business, or a reasoned
legal opinion from the customer‘s legal
counsel concluding that the customer‘s
activities don‘t involve unlawful Internet
gambling activities. The customer also has
to provide the institution with a written
commitment that it will notify the institution if
its legal authority changes. If the institution
has any questions about the customer‘s
license or legal authority, it can confer with
the state or tribal licensing authority, or
request that the customer get confirmation
from the licensing authority or the
customer‘s legal authority to engage in the
Step 1 – Due Diligence Information. The
first requirement set forth in the example is
gathering due-diligence information. Here,
an institution would determine how much
due-diligence information it needs, based on
the commercial customer‘s business, in
order to determine the customer‘s risk of
engaging in an Internet gambling business.
Step 2 – Risk Rating. The next step is to
determine the risk that the customer is
engaging in an Internet gambling business.
If the institution determines that the
commercial customer is at minimal risk of
engaging in Internet gambling, it will not
have to take any additional steps under the
Regulation GG account-opening duediligence requirements. In applying these
procedures, institutions can assume that
federal and state governmental entities,
regulated financial institutions and certain
organizations that are regulated by the SEC
and the FTC are at minimal risk of engaging
in Internet gambling.
However, if the
institution cannot determine that the
customer presents a minimal risk of
In addition to the evidence of the customer‘s
legal authority, the institution must get a
third-party certification that the commercial
customer‘s systems for the Internet
gambling business are reasonably designed
to ensure that the business stays within the
licensed and legal limits, including
verification of the age and location of
gamblers.
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b) Due Diligence where Institution
has Actual Knowledge of Internet
Gambling Business
Regulation GG
In addition to the due-diligence procedures,
an institution must notify its commercial
customers that restricted transactions are
prohibited from being processed through the
customer‘s account or relationship. The
regulation gives institutions flexibility in how
they provide the notice. For example, they
could provide the notice as a mailing, or as
part of the commercial account agreements.
However, the notice is required for all new
and
existing
commercial
customers,
regardless if they engage in Internet
gambling. As a result, institutions may want
to provide notice to existing customers
when they initially implement their
Regulation GG policies and procedures to
ensure that their existing customers are
notified. The institution can include the
notice in the agreement or other account
opening documentation to ensure that new
commercial customers receive the notice as
well.
In addition to the due diligence that the
institution must apply at account opening, it
must also apply the documentation
requirements when it receives actual
knowledge that one of its commercial
customers is engaging in an Internet
gambling business.
Actual knowledge
occurs when information is brought to the
attention of an officer of the institution or
someone with compliance responsibility with
respect to that customer or its transactions.
The regulation does not explain who would
be
viewed
as
having
compliance
responsibility with respect to a customer or
transaction, so each institution must
determine where that responsibility lies and
set it out in its procedures. For example,
unlawful Internet gambling is a SAR
reportable event. As a result, it may be
easiest for some institutions to make
Internet gambling, or gambling generally, an
activity that all staff of the financial
institution should watch for, and create a
procedure for all such activities to be
reported to the institution‘s BSA officer or
department.
3. Procedures for Blocking
Transactions
In addition to the due diligence and notice
requirements, the non-exclusive examples
of policies and procedures in the regulation
include specific procedures for each
designated payment system.
Once the institution has actual knowledge
that one of its commercial customers is
engaging in an Internet gambling business,
it must gather the same due-diligence
documentation that it had to gather in Step
3 of the account-opening due-diligence
procedures, including:
Procedures for ACH Systems. Under the
non-exclusive examples, the additional
procedures that should be put in place for
ACH systems are only required where:
The institution is an originating
depository financial institution (or
ODFI) for a debit transaction on behalf
of the commercial customer, or is a
receiving
depository
financial
institution (or RDFI) for an ACH credit
transaction
on
behalf
of
the
commercial customer, and
A copy of the customer‘s state- or
tribe-issued license that expressly
authorizes them to engage in the
Internet gambling business, or a
reasoned legal opinion from the
customer‘s legal counsel concluding
that the customer‘s activities don‘t
involved prohibited unlawful Internet
gambling activities, and
The institution has actual knowledge
that a restricted transaction has
occurred.
A third-party certification about the
customer‘s systems.
The actual knowledge standard is the same
standard that applies under the due
2. Notice to Commercial Customers
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diligence requirements above. As a result,
where an institution effectively receives
funds through an ACH and has actual
knowledge that the transaction is a
restricted transaction, it must reject or block
the transaction if possible. In addition, it
should have procedures with respect to the
customer, such as procedures that address
the circumstances where the customer will
no longer be allowed to originate or receive
ACH transactions and when the account
should be closed. Gateway operators and
third-party processors also have additional
responsibilities under the regulation where
they receive instructions from a foreign
sender to originate ACH debit transactions.
Regulation GG
of payments patterns to detect
suspicious payment volumes from
merchant customers.
4. Card system operators, merchant
acquirers and third-party processors
have to have procedures for taking
action when they receive actual
knowledge that a merchant has
received a restricted transaction
through the card system.
Procedures
for
Check
Collection
Systems. Similar to the requirements for
ACH transactions, the additional procedures
that should be put in place for check
collection systems are only required where:
Procedures for Card Systems. For card
systems, card issuers and other participants
have the option of putting in place the due
diligence procedures that apply at account
opening and when they have actual
knowledge that a commercial customer is
engaging
in
Internet
gambling,
or
implementing a code system to identify and
block restricted transactions. There are
several requirements to utilize a code
system:
A commercial customer deposits
checks with the institution, and
The institution has actual knowledge
that the checks are restricted
transactions.
Where these events occur, the institution
must reject or block the transaction if
possible. It should also have procedures
with respect to the customer, such as
procedures that address the circumstances
where the customer will no longer have
access to the institution‘s check collection
services, and when the account should be
closed. In addition, where an institution
receives checks for collection from a foreign
office of a U.S. or foreign institution, it
should have procedures that apply if it is
notified by the government that the
transaction is restricted.
For this
requirement, the institution can send the
foreign office a notice explaining the
requirements of Regulation GG.
1. Under the code system, the code
could
include
transaction
or
merchant/business category codes
and
would
accompany
the
authorization request for a transaction.
2. The code system would have to have
the operational functionality to give the
card system operator or card issuer,
such as a financial institution, the
ability
to
identify
and
deny
authorization for any transactions that
are identified in the code system as
potential restricted transactions.
Procedures for Wire Transfer Systems.
3. The code system has to include
procedures for the card system
operator to monitor and test the
system
for
potential
restricted
transactions, including testing of the
coding for transaction authorization
requests and monitoring and analysis
The additional procedures that should be
put in place for wire transfer systems are
required where the institution receives
actual knowledge that a commercial
customer has received a restricted
transaction through a wire transfer. Where
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this happens, the institution should have
procedures with respect to the customer,
such as procedures that address the
circumstances where the customer will no
longer have access to the institution‘s wire
transfer services, and when an account that
the commercial customer has with the
institution should be closed.
Regulation GG
government or a designated payment
system about the commercial customer‘s
transactions should be factors in your
BSA/AML program that can be used to
periodically review your customer‘s risk
rating, monitor its activities and determine if
a SAR should be filed for any suspicious
activities identified. Section 233.6
Procedures for Money Transmitting
Businesses. While the regulation indicates
that all participants in money transmitting
businesses other than the operator of the
business are exempt from the policy and
procedure
requirements,
financial
institutions that have money transmitting
businesses as customers are still expected
to have due-diligence requirements in place
for account opening and circumstances
where they receive actual knowledge that
the customer is engaging in Internet
gambling activities.
Conclusion
Regulation GG is intended to enable
financial institutions and other participants in
designated payment systems to identify and
block, or prevent or prohibit, unlawful
Internet gambling transactions. However,
the requirements of the regulation are
intended to be practical. For example, not
all restricted transactions can be identified
in advance, or blocked in time. As a result,
the regulation heavily emphasizes the
importance of initial due diligence as a way
to mitigate the risk that customers could
receive restricted transactions in the first
place. Where coding systems are in place
or payment systems have policies and
procedures in place for their participants to
follow, institutions should be able to rely on
them.
Where institutions and other
participants have questions about the
legality of Internet gambling transactions,
they can confer with the state and tribal
licensing organizations, or require their
commercial customers to get confirmation
from licensing agencies, in order to
minimize the burden on the institution in
determining what Internet gambling is
considered ―illegal.‖ Despite this effort to
minimize the burden, however, it‘s important
that all financial institutions have the
mandatory due diligence and procedures for
―blocking‖ transactions.
In addition to the due diligence for both
account opening and instances when the
institution has actual knowledge that a
commercial customer engages in an
Impact on BSA/AML Program. In addition
to the procedures required by Regulation
GG, an institution will need to incorporate
unlawful Internet gambling as a factor in its
BSA/AML program.
Unlawful Internet
gambling is, by definition, illegal. As a
result, any restricted transactions identified
by a financial institution will be SAR
reportable.
Further, actual or potential
restricted transactions, and gambling
activities generally, are higher risk activities
and may be unusual for that particular
commercial customer. Consequently, any
of those activities and transactions, any
SARs filed, and any notices from the
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Regulation GG
Prohibition of Funding
of Unlawful Internet Gambling
Regulation GG
A sample policy can be found in our Policy Manual.
Sample Language for Notice to Commercial
Customers
In accordance with the requirements of the Unlawful Internet Gambling Enforcement Act of 2006
and Regulation GG, this notice is to inform you that restricted transactions are prohibited from
being processed through your account or relationship with our institution.
Restricted
transactions are transactions in which a person accepts credit, funds, instruments or other
proceeds from another person in connection with unlawful Internet gambling.
Sample Language for Notice
to Foreign Banking Offices
From Appendix to Regulation GG
[Date]
[Name of foreign sender or foreign banking office]
[Address]
Re: U.S. Unlawful Internet Gambling Enforcement Act Notice
Dear [Name of foreign counterparty]:
On [date], U.S. government officials informed us that your institution processed payments
through our facilities for Internet gambling transactions restricted by U.S. law on [dates,
recipients, and other relevant information if available].
We provide this notice to comply with U.S. Government regulations implementing the Unlawful
Internet Gambling Enforcement Act of 2006 (Act), a U.S. federal law. Our policies and
procedures established in accordance with those regulations provide that we will notify a foreign
counterparty if we learn that the counterparty has processed payments through our facilities for
Internet gambling transactions restricted by the Act. This notice ensures that you are aware that
we have received information that your institution has processed payments for Internet gambling
restricted by the Act.
The Act is codified in subchapter IV, chapter 53, title 31 of the U.S. Code (31 U.S.C. 5361 et
seq.). Implementing regulations that duplicate one another can be found at part 233 of title 12 of
the U.S. Code of Federal Regulations (12 CFR part 233) and part 132 of title 31 of the U.S.
Code of Federal Regulations (31 CFR part 132).
Sincerely,
[Officer of FURST Bank]
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9/15/10
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2 Lettered Regulations of the Board of System

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