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FEDERAL RESERVE BANK OF MEW YORK [ Circular No. 1 0 2 6 2 "I October 12, 1988 AMENDMENTS TO REGULATION Y Limitations on Grandfathered Nonbank Banks To A ll Depository Institutions and Bank Holding Companies in the Second Federal Reserve District, and Others Concerned: Following is the text of a statement issued by the Board of Governors of the Federal Reserve System: The Federal Reserve Board has issued amendments to Regulation Y (Bank Holding Companies and Change in Bank Control) to implement the limitations placed on grandfathered nonbank banks by the Competitive Equality Banking Act of 1987 (CEBA). CEBA redefined the term “bank” in the Bank Holding Company Act to include any bank whose deposits are insured by the Federal Deposit Insurance Corporation (FDIC) and to prohibit the formation of new FDIC-insured nonbank banks. CEBA also contains a grandfather provision that permits a nonbanking company that controlled a nonbank bank on March 5, 1987 to retain the nonbank bank and not be treated as a bank holding company if the company and its subsidiary nonbank bank observe certain limitations. These limitations generally restrict the ability of nonbank banks to commence new activities or to engage in new cross-marketing activities with affiliates after March 5, 1987; to permit overdrafts by, or incur overdrafts on behalf of, affiliates at a Reserve Bank; and to expand their assets by more than 7 percent annually during any 12-month period after August 10, 1988. Specific details concerning limitations on growth, treatment of overdrafts, definition of activities, and curbs on cross-marketing are contained in the Board’s notice. Enclosed — for all depository institutions, bank holding companies, and those who maintain sets of the Board’s regulations — is the complete text of the amendments to Regulation Y, which has been reprinted from the Federal Register of September 28; copies will be furnished to others upon request directed to the Circulars Division of this Bank (Tel. No. 212-720-5215 or 5216). Questions regarding Regulation Y may be directed to our Domestic Banking Applications Division (Tel. No. 212-720-5861). E. G e r a l d C o r r ig a n , President. Board off Governors of the Federal Reserve System B A N K H O L D IN G COM PANIES AND C H A N G E IN B A N K C O N T R O L AMENDMENTS TO REGULATION Y (Effective September 28, 1988) FEDERAL RESERVE SYSTEM 12CFR Part 225 10,1988, or permitting overdrafts by affiliates or incurring overdrafts on behalf of affiliates at a Federal Reserve Bank. 12 U.S.C. 1843(f) (2) and (3). [Regulation Y; Doeket M®. R-0637] To implement these limitations, the rules and interpretation: (1) discuss how LomsSati@6is Monbanlk @aok® the term “activity” will be applied; (2) clarify the scope of the cross-marketing A©EW<gv: Board of Governors of the limitation; (3) describe how compliance Federal Reserve System. with the 7 percent annual asset growth ACTION: F inal rule. rate will be determined; and (4) define the restrictions on overdrafts. SUMMARY: The Board has adopted rules This rule also amends the definition of and an interpretative ruling to “bank” in Regulation Y to reflect the implement provisions of the Competitive changes in that definition made by Equality Banking Act of 1987 (“CEBA”) CEBA. (Pub. L. No. 100-86), relating to so-called EFFECTIVE PATS: This regulation is nonbank banks. CEBA amended the definition of "bank” in the Bank Holding effective September 28,1988, except for § 225.52 which will be effective January Company Act (the "BHC Act” or the 1,1989, and § 225.145, which will be “Act”) to include certain banking effective October 28,1988. institutions that had previously been outside that definition (so called FOIH! FURTHER INFORMATION CONTACT: “nonbank banks”). CEBA also contained For information regarding §§ 225.2, a grandfather provision that permitted 225.51 and 225.145, contact J. Virgil nonbanking companies that controlled Mattingly, Deputy General Counsel nonbank banks as of March 5,1987, to (202/452-3430), Robert D. Frierson, retain control of the institution and not Senior Attorney (202/452-3711), or be treated as a bank holding company Thomas M. Corsi, Attorney (202/452— for purposes of the BHC Act if the 3275); for information regarding section company and its subsidiary nonbank 225.52, contact Oliver I. Ireland, bank observe certain restrictions. These Associate General Counsel (202/452limitations generally restrict nonbank 3625); or Elaine M. Boutilier, Senior banks from commencing new activities Attorney (202/452-2418), Legal Division, or certain cross-marketing programs Board of Governors of the Federal with affiliates after March 5,1987, Reserve System; or for the hearing increasing their assets at an annual rate impaired only: Telecommunications of more than 7 percent during any 12Device for the Deaf, Earnestine Hill or month period commencing after August Dorothea Thompson (202/452-3544). SUPPLEMENTARY INFORMATION: CEBA amended the Bank Holding CompanyAct of 1956 (“BHC Act”) by expanding the definition of “bank” to include any bank the deposits of which are insured by the Federal Deposit Insurance Corporation (“FBIC") as well as any other institution that accepts demand deposits or accounts with third party payment capabilities and that is engaged in the business of making commercial loans. This new definition covers certain institutions that had not previously been covered by the BHC Act (“nonbank banks”) and prevents banking and nonbanking companies from forming new nonbank banks. CEBA also contains a grandfather provision that permits a nonbanking company that controlled a nonbank bank on March 5,1987, to retain the nonbank bank and not be treated as a bank holding company if the company and its subsidiary nonbank bank observe certain limitations designed to prevent unfair competition with banks owned by bank holding companies and to reduce risks posed to the payments system by nonbank banks. With certainlimited exceptions, the grandfathered parent company may not after March 5, 1987, acquire control of an additional bank or thrift institution or more than 5 percent of its assets or shares. The grandfathered nonbank bank may not-— (1) Engage in any activity after March 5,1987, unless it was lawfully engaged in that activity as of March 5,1987; (2) Offer or market products or For this Regulation to be complete, retain: 1) Regulation Y pamphlet, effective February 3, 1984. 2) Amendments effective November 3, 1986, November7, 1986, December 15, 1986, and June 16, 1987 (inclu d ed in slip sh e e t d a te d J u ly 1987). 3) This slip sheet. [Enc. Cir. No. 10262] PRINTED IN NEW YORK, FROM FED ERAL R E G IS T E R , VOL. 53, NO. 188, pp. 37733-37751 services of an affiliate that are not permissible for bank holding companies under the BHC Act or permit its products or services to be offered or marketed by an affiliate engaged in activities not permissible for bank holding companies under the BHC Act, unless the specific cross-marketing activity was conducted as of March 5, 1987, and then only in the same manner as conducted as of that date; (3) Permit an overdraft (including an interday overdraft) by an affiliate, or incur an overdraft in its account at a Federal Reserve Bank on behalf of an affiliate; and (4) Increase its assets at an annual rate of more than 7 percent during any 12-month period beginning after August 10, 1988.1 On June 3,1988 (53 FR 21,462, June 8, 1988), the Board issued for comment proposed rules to implement these provisions of CEBA. In response to this request for comment, the Board received 92 public comments from interested individuals and organizations. Approximately 52 percent of these commenters (48) favored adoption of the regulations as proposed or with slight modifications. Forty-two of the commenters opposed the proposed regulations and suggested that they be substantially changed before being adopted as final rules. During the regulatory comment period, the Board received several requests for a hearing. In response to these requests, the Board conducted a full-day informal hearing on July 29,1988, to permit interested parties an additional opportunity to express their views on the proposal. The comments on the proposal received during the comment period and the informal hearing are summarized below. The comments generally centered on the proper interpretation of the Congressional purposes in enacting CEBA and the appropriate degree of restrictiveness in the implementation of CEBA’s limitations. Commenters in favor of the proposed rule, principally from banking organizations and their trade groups, argue that the CEBA limitations should be adopted as written and that the impact of the rules on nonbank banks should not be ameliorated by administrative action. In their view, it was the overwhelming, if not uniform, view of Congress that nonbank banks present a serious potential for damage to the nation’s banking system and that 5 12 U.S.C. 1843'f] (2) and (3). the CEBA limitations were intended to restrict the operations of nonbank banks in order to prevent to the extent possible these adverse effects, even at the risk of making nonbank banks less competitive or viable. For example, the chairman of the Senate Banking Committee stated that in establishing the CEBA restrictions, Congress rejected the testimony of nonbank banks that these limitations would impair competition, impede desirable innovation, jeopardize bank safety and soundness and increase risk to the FDIC. These commenters contend, based upon the statutory findings in CEBA, that the proposed rule properly implements the legislative intent to hold nonbank banks in place until Congress can formulate a permanent policy. Comments unfavorable to the proposed rule, predominantly from the affected nonbank banks, interpret CEBA and its legislative history as reflecting © balancing approach intended to permit nonbank banks to be competitive. They contend that, although Congress chose to constrain grandfathered nonbank banks in significant and unprecedented ways, the limitations were not intended to be implemented in such a maimer a© to prevent nonbank banks from continuing to compete in the marketplace. These commenters maintain that the actual balance achieved by CEBA cannot be fully appreciated unless the language of the statute is considered in light of its legislative history, including particularly, statements by the chairman of the Senate Banking Committee during the Senate’s consideration of CEBA. As explained in the interpretive ruling, the Board resolved this issue with respect to particular provisions of the CEBA limitations with reference to the terms of the statute and the stated intent of the statute to minimize the potential for conflicts of interest, unsound banking practices, unfair competition, partiality in the credit-granting process and other adverse effects that would be associated with the grandfathered affiliations of federally insured nonbank banks and companies engaged in activities forbidden to regulated bank holding companies. Based on the statutory findings, the Board has not accepted the view of the unfavorable commenters that the nonbank bank restrictions must be applied to permit nonbank banks to maintain their unique competitive position. The principal issuesTaised by the comments and at the public hearing regarding the proposed rules and the 2 Board’s resolution of these issues are discussed in the following sections as well as in the interpretative ruling: 1. A ctivity Limitation: CEBA provides that a nonbank bank may not— engage in any activity in which such bank w as not lawfully engaged as of March 5,1987 * 4 * 12 U.S.C. 1843lf)(3)(B)(i). The proposed rule defined the term "activity’*as applying to discrete lines of banking or nonbanking business and, consistent with legislative history of the provision, pointed out that this definition did not envision a product-by product approach. To implement this definition, the proposed rule focused on five major categories of activities: deposit taking, lending, trust services, payment and clearing services, and nonbanking activities. Within these categories, examples of separate activities were set forth for purposes of applying the grandfather limitation. For example, deposit-taking activities were separated into demand deposits, non demand checkable deposits, and time or savings deposits; and lending was divided into commercial lending and types of consumer lending (credit card, mortgage banking and other consumer loans). Favorable comments considered these differentiations to be consistent with the express language in the statute and representative of recognized lines of banking or non banking activity, although some commenters urged the Board to narrow certain of the activities. Commenters unfavorable to the proposal characterized the approach as being overly narrow and contradictory of legislative intent not to define activity on a product-by-product or customer-bycustomer basis. In their view, Congress only intended to prevent grandfathered entities from becoming full-service banks or altering their basic character. As an alternative, these comments generally proposed to delete the subcategories within each major category of banking activity except where further differentiation was necessary to prevent a nonbank bank from becoming a full-service commercial bank. Thus, the commenters would favor the following categories based on socalled “core” banking activities: (1) deposits (differentiating between demand deposits and other deposits], (2) lending (differentiating between commercial loans and other types of lending), (3) trust services (including products and services incidental thereto], and (4) nonbanking (or noncore banking) activities permissible for the bank under state law, such as travel agency, real estate development or general insurance brokerage. Some of these commenters would also include clearing and payment services, as a separate activity, while others regarded this activity as incidental to offering transaction accounts. For the reasons stated in the interpretive ruli.ng, the Board believes the term activity should be interpreted and applied with reference to prior Board and judicial precedent regarding this term as it appears in section 4 of the BHC Act, except in instances where CEBA requires modification of this analysis, as in the case of deposit-taking and lending activities. This approach is implemented through the following revised major categories of activities: deposit taking, lending, trust services and other activities consistent with recognized activities under section 4 of the BHC Act.2 Deposit-taking would include three activities: demand-deposit taking, non demand deposits that the depositor may withdraw by check or similar means for payment to third parties, and other time and savings deposit-taking activity. Thus, an institution that did not offer demand or other transaction accounts on March 5,1987, could not begin to offer these services after March 5. As explained in the interpretation, consistent with the Board’s decisions under the activity provisions of section 4, lending would include the following activities: commercial lending, consumer mortgage lending, consumer credit card lending and other consumer lending.3 Some commenters stated that deposit taking activity should be broken down only to reflect the distinction in the "bank” definition before CEBA between demand deposits and other deposits and that the Board should not treat non demand transaction accounts as a separate activity. They rely on the fact that in Board of Governors v. Dimension Financial Corp.,4 the Supreme Court held that NOW accounts may not be treated as a “deposit that the depositor has a legal right to withdraw on 2 Paym ent and clearing services, w hich w ere considered as a sep a ra te category of activity under the original proposal, have been deleted as a sep a ra te activity and will be considered under the general principles set out in the interpretation regarding other activities. 3 The B oard's decisions under section 4 have not generally differentiated betw een types of com m ercial lending. A ccordingly, the Board believes that com m ercial lending should be view ed as a single activity under the CEBA lim itation. 4 474 U.S. 361 (1986). demand” under the pre-CEBA bank definition. As explained in the interpretive ruling, the treatment of transaction accounts as a separate activity from non-transaction account deposit-taking is consistent with the structure of the BHC Act, Board decisions regarding the term activity m section 4, and banking practice. In this regard, the Board notes that .the Dimension decision did not overturn the Board’s decision that the taking of NOW accounts was a separate activity under section 4 of the Act. The decision ruled only that a NOW account was not "a deposit that the depositor has a legal right to withdraw on demand" in the pre-CEBA bank definition in the BHC Act. Indeed, in CEBA, Congress amended the bank definition in the BHC Act to treat the taking of transaction accounts as separate and distinct from the taking of non-transaction deposits, thus recognizing that transaction deposits have characteristics such that they should be viewed in the same manner as demand depsoits for purposes of the bank definition and not as traditional non-checkable savings or time deposits. This distinction between these types of deposits was carried over into the credit-card, trust company and certain other exceptions from the Act's definition of bank. The Board believes these amendments support the view that transaction accounts are a separate activity in the case of a nonbank bank that did not offer such a service as of March 5,1987. The Board has also considered the views of certain commenters that the reference in the proposed rules to section 225.25(b) of the Board’s Regulation Y as a guide for defining activities other than lending or deposit services is inappropriate in that these provisions identify activities that the Board considers to be closely related to banking. These commenters contend that CEBA’s activity restrictions, on the other hand, are applicable to core banking services and not activities closely related thereto. They also state that many of the activities identified in Regulation Y are incidental elements to core banking functions and should not be considered separate activities under CEBA. Moreover, the nonbanking activities list contains, for these commenters, duplication and overlap. Other commenters, including nonbank banks, stated that use of this regulation as a reference point for activities under CEBA was appropriate. As noted in the interpretive rule, if 3 Congress had intended the activity limitation in CEBA to distinguish only between demand deposit and commercial lending activity, Congress would have used the restriction it used in another section of CEBA dealing with nonbank banks owned by bank holding companies, which has this result. See 12 U.S.C. 1843(g). In accordance with the ordinary meaning of the term, the placement of the CEBA activity limitation in a section of the Act dealing with the activities of banking organizations, and the legislative history of the provisions, the Board believes the view of the term set out in the interpretive ruling is appropriate. The Board believes that the commenters are mistaken in their view that reference to the activity limitation of section 4 is not appropriate in the case of activities conducted by banking companies. The Board’s decisions and regulations under section 4 authorize deposit-taking, lending and associated banking fuactioag for companies that do not qualify as banks, but, like the nonbank banks, are federally insured, operate under bank thrift or other depository institution charters, and exercise many of the powers of banks. See e.g. US. Trust Corporation, 70 Federal Reserve Bulletin 371 (1984); Citizens Fidelity Corporation. 70 Federal Reserve Bulletin 231 (1984); Citicorp/Fidelity Federal Savings fr Loan Association, 68 Federal Reserve Bulletin 856 (1982). Finally, the Board also notes that the courts have set out standards by which one activity would be viewed as incidental t® another under section 4. National Courier Ass'n v. Board of Governors, 516 F.2d 1229 (1975). (a) Meaning of "EngagedIn". Under the proposed rule, a nonbank bank must demonstrate that it had a program in place to provide a particular product or service associated with the grandfathered activity to a customer and that it was in fact offering the product or service to the customer as of March 5, 1987. Comments in favor of this proposal stated that it carried out the Congressional intent of placing limitations on the activities of grandfathered entities by requiring an established program rather than a program in its planning stages. Unfavorable comments to the proposal stated that the rule should permit more flexibility in its concept of program and offered various approaches that were less formal than the standard proposed. Several commenters expressed concern over the proposed rule’s provision that an isolated transaction may not be sufficient to demonstrate that a grandfathered entity was engaged in a particular activity as of the grandfather date. In their view, this statement suggests that the Board is imposing a quantitative test. products or services unless they would be permissible for bank holding companies, or permitting the bank’s products or services to be offered or marketed by an affiliate engaged in impermissible nonbanking activities. This prohibition is subject to a grandfather provision for crossmarketing activities engaged in as of the The Board believes that the rule as March 5 grandfather date, but only in proposed requires the appropriate degree of formalization in the marketing the same manner as conducted as of that date. Unlike the activity limitation, activities of a grandfathered entity to which applies to separate lines of carry out the legislative intent that an activity must be ‘‘engaged in” in order to business, the language of the statute qualify for grandfathered treatment. The specifies that the cross-marketing Board also notes that this interpretation limitations apply to products or services. At the outset, it is important to note is consistent with the meaning given the term ‘‘engaged in” in other provisions of that the cross-marketing restriction does not limit in any manner the direct section 4 of the BHC Act. The isolated transaction example stated in the rule is marketing activities of nonbank banks. Moreover, the restriction does not not a quantitative test because the rule prevent a nonbank bank from marketing expressly states that it would be any product or service of an affiliate insufficient unless evidence was that bank holding companies may offer presented indicating the existence of a or from permitting the bank’s products program associated with the and services to be offered or marketed transaction. by affiliates engaged in activities (b) Meaning of “As Of”. The rule as permissible for bank holding proposed stated that the grandfather companies.5 date “as of March 5,1987” as used (a) Products or Services. The throughout section 4(f)(3) should refer to interpretation published for comment activities engaged in on March 5,1987, did not attempt to define “product or or a reasonably short period of time service,” but rather illustrated the preceding this date not exceeding 13 application of the grandfather provision months. This period of time is expressly with an example that a securities confirmed by the legislative history company that marketed automobile during colloquy in the Senate debates. loans from an affiliated nonbank bank Proponents commented that this on the grandfather date could not begin approach was consistent with the to offer checking accounts without loss legislative history. Certain opponents, of the privilege. The draft interpretation on the other hand, commented that this also made clear that an institution could period was too short and should be change the terms and conditions of the generally more comprehensive in scope product, referring to the statement of the to include, for example, promotional chairman of the Senate Banking activities or activities that had received Committee during the debates on CEBA regulatory approval. that a nonbank bank offering a threeIn this instance, the Board finds that year certificate of deposit through an the legislative history provides the affiliate could thereafter market a onenecessary clarification on the year certificate of a different amount appropriate scope of the grandfather and interest rate. 133 Cong. Rec. S3959 date and that the proposed rule (daily ed. March 26,1987). accurately reflects the Congressional intent of the provision. The interpretation has been clarified, however, to provide that a nonbank bank may not commence an activity that it had terminated within this period. For example, a nonbank bank that had terminated commercial lending to avoid bank status within 13 months of March 5,1987, could not recommence that activity after March 5,1987. 2. Cross-Marketing Limitation: CEBA’s second limitation prohibits grandfathered nonbank banks from offering or marketing an affiliate’s Proponents of the proposed rule have stated that the express statutory focus of the cross-marketing limitations on specific products and services supports a narrow view of the limitation’s scope. These commenters also argue that this approach is entirely consistent with the stated Congressional intent of the 5 Thus, for example, a nonbank bank may offer permissible credit-related insurance products of an affiliated insurance company. Similarly, the bank may offer any of its products and services through an affiliate engaged only in permissible activities, for example, through an affiliated consumer finance or mortgage banking company. 4 provision to prevent unfair competition with banks controlled by bank holding companies that may not offer such services and with the legislative history in which the broader approach for activities discussed above is contrasted with the more restrictive product-by product approach.6 Opponents have countered that a narrow approach to the definition of product and service would be inconsistent with legisjative intent and would limit innovation and competition. In their view, Congress intended product or service to be defined in functional terms and to be permitted to be changed in its character and design in response to market and technological innovations.7 Under this approach, incidental aspects of products may be changed and enhancements may be developed. Finally, some comments suggested that the limitation should not apply to joint-maiketing activities such as utilizing customer lists or back-office facilities that do not involve any public identification of the affiliate relationship in conducting the activities. The Board was also requested to provide for grandfathered treatment under the cross-marketing provisions if a grandfathered affiliate is reincorporated or otherwise subject to a corporate restructuring.8 B During the Senate debate on CEBA, Chairman Proxmire stated: The w ord 'activity' is not defined in the bill, how ever. I w ant to confirm that the m eaning stated in the report is w hat is intended and that no effort to m easure activity unduly narrow ly on a productby-product. custom er-by-custom er basis is intended, so that if a nonbank bank w ere engaged in offering any type of loans on M arch 5, it may offer that sam e type of loan thereafter. 133 Cong. Rec. S4054-5 (daily ed. M arch 27.1987). 7 These commenters rely on Chairman Proxmire's confirmation during the Senate debate on CEBA of Senator Dodd's understanding that under the cross marketing restriction: A grandfathered nonbank bank that was cross-marketing a specific product or service could at any time in the future cross-market a product or service which had been developed to reflect general changes in the grandfathered service’s or product’s character and design generated by competition, market innovation or technology. 133 Cong. Rec. S3957 (daily ed. March 26, 1987). 8 In this regard, the Board notes that the legislative history indicates that the grandfather exception to the cross-m arketing restriction applies "only to a specific com pany that w as engaged in the activity as of M arch 5,1987. An affiliate that w as not engaged in a given joint-m arketing activity as of M arch 5. 1987, may not com m ence that activity even if it w as being conducted by another affiliate as of M arch 5, 1987." S. Rep. No. 100-19, 100th Cong.. 1st Suss. 34-35 (1987). into a new product. In the Board’s view, however, this approach would not permit the evolution of credit card lending discussed in the commenter’s example above because unsecured lending by credit card or otherwise is clearly a different product or service from that of secured lending. Indeed, several nonbank banks commenting on the proposal, whose activities would be directly affected by the proposal, stated in their comments that secured and unsecured consumer lending constitute distinct products for purposes of the cross-marketing restriction. means of offering or marketing the product or service must remain the same. Because a determination with respect to a particular cross-marketing effort under this standard would necessarily depend on the particular facts and circumstances in a given case, the revised interpretation indicates that the scope of the restriction would be applied based on a case-by-case basis consistent with the guiding principles set out in the interpretation. 3. Eligibility for Grandfathered Nonbank Bank Status: The proposed rule stated that institutions that had not commenced operations on August 10, (b) Cross-Marketing “Only in the 1987, could not qualify for grandfather Same Manner". With respect to GEBA’s privileges under CEBA. One affected limitation that grandfathered products company urged the Board to recognize or services may be offered or marketed grandfathered status if the company had ‘‘only in the same manner,” the received preliminary approval from its proposed interpretation stated that the chartering authority and had established method of offering or marketing the a plan for operation. For the reasons product or service must remain the same. The interpretation illustrated this stated in the rule, the Board has decided limitation by indicating that an affiliate to adopt the interpretation as proposed. 4. Enforcement: The proposed rule not using direct mailings as a marketing technique for the particular product may noted that under section 4(f) of CEBA, a company that controls a nonbank bank not commence this activity after the would lose its grandfathered status if it grandfather date. or a subsidiary nonbank bank acquires Proponents of the rule state that the control of an additional bank or thrift, limitation on cross-marketing to the same manner in which it was conducted acquires more than 5 percent of voting on the grandfather date must be applied shares of a bank or thrift (subject to certain exceptions), or violates the other as written in order to minimize the CEBA limitations. Section 4(f)(4) of potential for unfair competitive CEBA provides for the penalty of advantage. They contend that defining divestiture within 180 days of the loss of the term to include broad categories of grandfather exemptions through failure marketing techniques would read the to comply with the CEBA limitations. limitation out of the statute. Commenters argued that imposition of Opponents of the rule, however, divestiture as the only sanction under disagreed with the Board's approach. these circumstances was unwarranted Some commenters stated that it was under the Act and its legislative history. inappropriate to consider the media or According to these comments, both of medium used to cross-market in these sources indicate that the Board applying the limitations. Other has a range of administrative commenters suggested that, in light of enforcement options to deal with CEBA the constitutional protections accorded violations. Some commenters urged the commercial free speech, marketing Board to clarify that divestiture would methods should be broken down into broad categories, and if companies were be reserved only for willful, material, recurring or wanton violations. Others using any market method within a particular category as of the grandfather requested the Board to apply this penalty only prospectively and provide date, then all of the methods in that prompt CEBA interpretations to category would be available under the limitation. Although different categories requesters. By its terms, the statute provides for were suggested, the most commonly loss of grandfather rights for violations suggested categories were: (a) mass media, (b| direct mail or direct response of the CEBA limitations, and, in this regard, the Conference Report states marketing, and (c) personal or face-tothat nonbank banks that violate the face solicitation. Some commenters favored even broader categories: (a) overdrafts provisions of CEBA "lose The interpretation permits general their grandfathered status”. H.R. Rep. changes in the character of a product or mass marketing and (b) direct marketing. No. 100-261 at 127-128. The Conference service as the result of market or technological innovation to the extent As noted, the proposed interpretation Report, however, also indicates that the Conferees expected the Board to use its that these modifications do not did not define the term “in the same transform the grandfathered product cease and desist or other supervisory manner" other than to indicate that the The Board believes that the cross marketing limitation in CEBA by referencing particular products and services is by its terms more restrictive in scope than the activity limitation. In this regard, the Board notes that all or nearly all of the commenters agree that an affiliate marketing one type of loan from a nonbank bank before the grandfather date would not be entitled to offer or market any other type of loan. The commenters, however, disagree over the precise degree of specificity required by CEBA’s use of the term , product or service. Some commenters have maintained that this formulation requires a narrow definition which, for example, distinguishes between automobile loans and boat loans. Other commenters have argued in favor of a general functional approach that would permit a product to evolve from one type of consumer lending to another type of consumer loan in response to market changes. One commenter cited as an example of a change that would justify expansion of grandfathered cross-marketing the fact that after the changes in tax laws in 1986, many lines of credit offered by banks that were accessible by credit card or other means began to be secured by a home mortgage, so that the interest paid by the borrower is deductible for income tax purposes. This commenter stated that if a nonbank bank was cross marketing credit cards on the grandfather date, it should consequently now be allowed to cross-market consumer home equity lines of credit. As set forth more fully in the interpretive rule, the Board believes that the term product or service must be interpreted in light of its accepted ordinary commercial usage and the Congressional purpose underlying the limitation to minimize the potential for unfair competition and other adverse effects. To provide guidance as to the manner in which the limitation will be applied, the interpretation provides examples of the types of products and services covered by the cross-marketing restrictions in the areas of deposit taking and lending. In other areas, the rule provides that the determination as to what constitutes a product or service will have to be made on a case-by-case basis consistent with the general principles set out in the interpretation. 5 authority as appropriate. Id. at 125. The Board has deleted reference to the divestiture provision of CEBA as Board rules do not normally contain provisions relating to enforcement. The Board’s responsibility under CEBA would be to enforce the statute and implementing rules in each case, taking into account the terms of the statute, its legislative history, and the particular facts and circumstances of the case. Taking these factors into account, the Board would use its prosecutorial discretion to determine the appropriate enforcement action. The Board is prepared to provide prompt guidance in individual cases regarding the scope or application of the CEBA limitations. 5. Seven Percent Growth Rate Limitation: Under CEBA, a nonbank bank’s asset growth is limited to an annual rate of 7 percent during any 12month period beginning after August 10, 1988. Two principal issues are raised by this provision: the method for determining the base against which the 7 percent growth limit is to be applied during the initial 12-month period and the period over which the calculation will be made. In its proposed rule, the Board noted that under CEBA, the 7 percent growth limitation would not be applicable for one year following the date of enactment of CEBA. Accordingly, the proposed rule indicated that nonbank banks could, at their option, choose to use the actual amount of assets reported on their books on August 10,1988, as the initial base or the average total assets reported on the call report for the quarter ending September 30,1988. The latter option was provided in order to eliminate the need for additional reporting by permitting use of the quarterly report of condition for the bank. The proposed rule stated that the growth limit would be applied on a rolling twelve-month basis, commencing initially on August 10,1988, and thereafter at the start of each quarterly call report period [i.e. September 1,1988, January 1,1989, April 1,1989, July 1, 1989, and so on). The rule proposed further noted compliance would be determined using the institution’s average assets over the 12-month period in accordance with the directive in the CEBA Conference Report.9 9 The Conference Report states that the Board should "in determining compliance with the 7 percent growth rate, (to) utilize a procedure that computes the grandfathered institution’s growth rate on an average basis.” H.R. Rep. No. 100-281 at 125. Under this approach, compliance with the 7 percent growth limit would be measured for the first 12-month period by comparing the average assets for the third quarter of 1989 as reported on Schedule RC-K of the Report of Condition 10 with either the assets.on August 10,1988, or the average assets for the third quarter of 1988, at the nonbank bank’s option. Thereafter, growth would be measured by comparing the average assets for each quarter with the average assets for the previous quarter. The alternate method of calculating the initial base figure by using the average assets for the third quarter of 1988 was not opposed, provided the final rule would continue to permit a nonbank bank to use its actual assets on the bank’s books on August 10,1988. Commenters opposed to the proposedrule stated that the proposed rolling 12month method of measuring compliance was in conflict with the statutory language and the legislative intent that growth be measured on an annual average basis. They also argued that this method of measuring compliance could lock then into quarterly business patterns of growth and reduction that might be inconsistent with their nonrihl growth patterns or cause them to make unsound business decisions solely to comply with this needlessly restrictive method of measuring growth. This approach would also inhibit successful marketing, compaigns and restrict opportunities in the market place. Finally, the comments from certain of the commenting nonbank banks urged the Board to avoid the “use it or lose it” result under the proposed rule’s method of using each year’s actual average annual assets as the base for measuring the following year’s growth. To avoid this result, they proposed an annual asset cap that would be projected forward for each grandfathered nonbank bank from the bank’s base figure, at 7 percent, compounded annually. Thus, an institution that failed to achieve a 7 percent growth rate in one year could make up for this in the following year by increasing its growth rate by a corresponding amount above 7 percent. advocated by the nonbank banks, which would allow growth in excess of 7 percent, would by its terms violate CEBA’s limitation on asset growth during any 12-month period to no more than 7 percent. (a) Initial Base for Growth Limit. The revised rule retains both of the methods specified in the proposed rule for calculation of the initial base. The Board has also provided a third option. A nonbank bank may, in its discretion, elect to use at its initial base its total assets over the four quarters ending September 30,1988, as reported on Schedule RC-K of its report of condition. This option would avoid the problem of having to annualize growth during the first year and may be a desirable alternative for nonbank banks that experienced even or no growth during the year after August 10,1987. A nonbank must advise the Board by October 15,1988 of the method it has chosen to calculate its base figure for the initial 12-month compliance period. If the nonbank bank elects to use its actual assets on August 10,1988, as its initial base, in must report that figure to the Board by October 15,1988, along with its average assets for the third quarter of 1988 prepared in accordance with the rales in Schedule RC-K of the Report of Condition. While not required, a nonbank bank electing to use the August 10,1988 figure, may provide the Board with its assets at the end of the third quarter or any additional information it believes may be of assistance to the Board in reviewing the August 10 figure in light of the concerns over “window dressing” transactions discussed below. The revised rale addresses concerns raised that an institution could effect "window-dressing” transactions on August 10,1988, by engaging in extraordinary short-term transactions to inflate artificially its assets. The revised rale notes that if the Board determines that a reporting nonbank bank’s assets The comments in favor of the rule have been inflated on August 10,1988, supported the Board’s approach, without reference to the customary indicating that the alternate approach business activity of the institution, the Board would disallow the window 10 Banking institutions with $100 million in assets dressing-transactions or require that the cr more must file with their reports of condition initial date for the first 12-month period their average assets over the quarter calculated’ be adjusted to a date following August either on a daily basis or u w eekly basis [/.e., an 10,1988. The Board believes these rules average of the W ednesday of each w eek of the quarter). Institutions with less than $100 million are consistent with the terms of the may report using an average of the four month-end figures. 6 statute 11 and the Board’s authority to act to prevent evasions of the BHC Act. Comments from certain nonbank banks stated that such window-dressing transactions could be disallowed in determining the initial base. (b) Frequency of Measurement of Growth Limit. After considering the public comments, the Board has decided to revise the rule to permit nonbank banks to measure compliance with the growth limitation once a year at the end of the third quarter of each year. Thus, compliance with the growth rate would be deternained for 12 month periods beginning on October 1 of each year and ending on September 30 of the following year. The initial 12-month period would begin on October 1,1988 and end of September 30,1989. After the first 12-month period, compliance for all nonbank banks will be determined by measuring the average assets over the four quarters during the year (e.g., the fourth quarter of 1989 and the first three quarters of 1990] with the average assets for the proceeding four quarters [e.g., the fourth quarter 1988 and the first three quarters of 1989). This approach would pose the least administrative burden while maintaining consistency with the intent of the statute to limit the overall asset growth of nonbank banks. Moreover, this approach avoids locking the nonbank banks into the same patterns of growth during the year. Compliance with the growth limit for the initial 12-month period commencing October 1,1988, will be determined by comparing the average total assets (as reported on Schedule RC-K) for the four quarters ending with the third quarter of 1989 with the initial based figure chosen by the nonbank bank. —Annualization Required for Initial 12-Month Period. Because the nonbank bank’s average assets over the initial year will be compared to its average assets over the immediately preceding quarter, or its assets on a single day in that quarter (August 10,1988), the simple rate of asset growth between these periods will differ from the annual rate of asset growth as limited by the 11 The statute provides that the growth rate be applied during any 12-month period beginning after August 10,1988. Thus, the Board need not start the first annual period on August 10,1988, particularly where the record show s that the nonbank bank has manipulated its assets on the dated unrelated to its ligitimate business activities. annualizing ratio. In the previous example, the simple growth rate permissible during the initial period would be about 4^5 percent and assets could average no more than $104.47 million over the first compliance period under this option. Nonbank banks selecting the average assets over the third quarter of 1988 as the base figure for the initial 12-month period would apply an annualizing ratio of 1.601 (365 days divided by 228 days from August 15,1988 to March 31,1989). The nonbank bank’s average assets over the first 12-month period could not exceed the average total assets for the third quarter of 1988 by more than 7 percent divided by this annualizing ratio. In the previous example, the simple growth rate permissible during the initial period would be about 4.4 percent and assets could average no more than $104.37 million over the first compliance period. Nonbank banks electing to use the average total assets for the four calendar quarters ending with the third quarter of 1988 as the initial base period would not be required to annualize because like-periods, one year apart, are being compared. As noted, annualization for all 12-month periods after the initial period (ending September 30,1989) is also not necessary because like periods, one year apart, are being compared. —Compliance on a Quarterly Basis. The Board has also decided, to permit a nonbank bank, at its option, to measure 12 Because compliance during all subsequent 12compliance with the>7 percent annual month periods will be determined by comparing growth rate limitation under the rolling comparable periods {i.e. average assets over a year to average assets over the preceding year), no quarterly approach originally proposed. an n u alizatio n is required for those periods. A nonbank bank deciding to elect this “ Calculating annual growth rates requires three method must advise the Board of this decision by October 15,1988. pieces of information: the value of the item w hose growth is being measured for the initial or base Finally, escrow deposit accounts are period; the same information for the final period: treated as deposits for purposes of the and the length of time betw een these periods. The annual rate of growth then may be calculated as call report [see Schedule RC-E) and the follows: Board does not believe it appropriate to G = lF~h* im * 365 exclude such deposits from the asset I L base. The Board is also constrained by Where: G is the annual rate of growth, not the terms of the statute from permitting compounded. F is the value of the quantity w hose growth is being measured as of the final period. 1 is a nonbank bank to grow at an annual the value of the quantity whose growth is being rate greater than 7 percent during a 12measured as of the initial period. L is the length of month period, because during some time between the initial and final periods, preceding period, the nonbank bank expressed in days. The first part of this formula, failed to achieve a 7 percent growth I rate. Accordingly, the Board has decided 109, expresses the percent change in the series as a not to adopt the view of certain simple growth rate. The second term, 365/L, converts the simple growth rate to an annual rate of commenters that the Board should growth, not compounded. permit a nonbank bank to establish an “ The midpoint of the third quarter of 1988 is asset cap based on 7 percent of the August 15,1988 and the midpoint of the four nonbank bank’s assets on August 10, calendar quarters ending with the third quarter of 1988, projected forward. 1989 is March 31, 1989. statute.12 A 7 percent simple growth rate over this period would convert to an annual rate of growth of over 10 percent. For example, a nonbank bank with assets in the amount of $100 million on August 10,1988, and which had average assets of $107 million over the four quarters ending with the third quarter of 1989, would grow at a simple rate of 7 percent. At an annual rate, however, this growth would be 10.97 percent. Adjusting the simple growth rate for this initial period is accomplished by using a factor that converts a simple growth rate into an annual growth rate.13 This factor is calculated as the ratio of 365 days, the number of days in a year, to the number of days between the midpoint of the base period and the midpoint of the first compliance period, i.e., the four quarters ending with the third quarter of 1989.14 The ratio is therefore based on comparable measurements [i.e., the midpoint of the third quarter of 1988 with the midpoint of the first 12-month period following the end of this quarter). •For a nonbank bank electing to use its assets on August 10,1988 as its base figure for the initial 12-month compliance period, the annualizing ratio is 1.597 (365 days divided by 233 days from August 10,1988 to March 31,1989). The nonbank‘bank’s average assets over the first 12-month period could not exceed its assets on August 10,1988 by more than 7 percent divided by this 7 0. Overdrafts: The fourth limitation onFederal Reserve Banks, and that such an overdraft could result in the loss of the nonbank banks prohibits a nonbank bank from permitting an overdraft by an bank’s grandfathered status. affiliate and from incurring an overdraft CEBA and its legislative history in its account with a Federal Reserve indicate that Congress was concerned Bank on behalf of an affiliate. about overdrafts by nonbank banks' affiliates because of the risks they CEBA states that a eonbank bank: present to uninsured depositors and shall not * * * after the date of the creditors of the bank, as well as the enactment of [CEBAJ, permit any overdraft Federal Reserve and the FD1C, because (including an intraday overdraft), or incur any such overdraft in such bank’s account at a nonbank bank would be unable to a Federal Reserve bank, on behalf of an make an independent evaluation of the affiliate, other than an overdraft [due to an creditworthiness of an affiliate making inadvertent accounting or computer error or a payments through the nonbank bank.1 516 secured overdraft on behalf of an affiliate Congress also restricted overdrafts by that is a primary dealer). 12 U.S.C. the nonbank bank in its account with 1843(f](3)(B)(in). the Reserve Bank even though the The language of this statute dearly affiliate’s account at the nonbank bank prohibits overdrafts by affiliates on the had not been overdrawn. This latter books of eonbank banks.15. The statute restriction was included, in part, for also prohibits overdrafts by the nonbank ease of monitoring. bank in its account at its Federal To implement the statutory language Reserve Bank on behalf of an affiliate. prohibiting overdrafts on behalf of The language “on behalf of an affiliate” affiliates by nonbank banks at Federal is unclear. To read this language to Reserve Banks, the proposed rule preclude only those overdrafts at a provided that an overdraft by a nonbank Federal Reserve Bank where the affiliate bank in the nonbank bank’s account at a has also overdrawn its account at the Federal Reserve Bank would be deemed nonbank bank would render the to be on bahalf of an affiliate whenever: language unnecessary, because the (1) a nonbank bank holds an account for overdraft by the affiliate is already an affiliate from which third party specifically prohibited. As the rules of payments can be made; and (2) the statutory construction generally disfavor aggregate balance of all of am affiliate’s interpretations that render statutory accounts with the nonbank bank is less, language meaningless, it is appropriate at the time the nonbank bank incurred to resort to extrinsic aids, such as the an overdraft in its account at a Federal legislative history, in order to interpret Reserve Bank, than the aggregate this language. The Conference Report to balance of all of the affiliate’s accounts CEBA states: maintained by the nonbank bank at the opening of business on the day on which Overdrafts in an affiliate's accounts at a the nonbank bank incurred the nonbank bank are difficult to police, particularly in times of financial difficulty of overdraft 'Thirty-five comments discussed this the affiliate, when the potential for overdrafts resulting in losses is highest. Accordingly, the definition of when a nonbank bank overdraft restrictions provide that nonbank overdraft at its Reserve Bank was “on banks lose their grandfathered status if they behalf of an affiliate”. Eight of the incur overdrafts at Federal Reserve banks. comments stated that all overdrafts by a, Federal Reserve banks are in a position to nonbank bank should be prohibited. Of ' monitor such overdrafts on a real time basis. the remaining twenty-seven comments, H.R. Rep. 100-261, pp. 127-128. twenty-one were opposed to the definition, and six supported the This report indicates that Congress definition. contemplated that the Federal Reserve Those comments opposed to this would monitor overdrafts by the section objected to the presumption that nonbank banks in their accounts at a drawdown by an affiliate at any time on the day a nonbank bank had an 15 This overdraft prohibition does not prevent nonbank b an k s from making loans to affiliates overdraft caused the overdraft. They con sisten t w ith o th er law s, e.g., sections 23A a n d requested that a clearer causal 23B of the Federal R eserve Act, ap p licab le bank connection be made. Although soma© lending limits, an d CEBA's restricts®® a® new activities. A n onbank bank that w a s not making comments suggested that the statute com m ercial loans prior to M arch 5,1987, w ould merely intended to prohibit overdrafts violate the new activity restrictions of CEBA by making loans to affiliates after that d ate. W here a debit is p osted lo a n a c c o u n t overdraw s the account, and is not covered by a loan at that time, it is an overdraft. 10 S s s . MLR. Rep. N o . 1(10- 261, lOJKtj Corag.. 1st Sess. 127-12©; com m ents of C hairm an ProHmire (floor m anager). 133 Coag. Rec. S3fl£tt {daily edL March 25,1987). by affiliates in their accounts with nonbank banks, this is clearly not the case because such interpretation would make the reference to overdrafts “on behalf of an affiliate” superfluous. To implement this language, yet clarify the causal connection, the revised rule defines an overdraft “on behalf of an affiliate” to occur when the posting of an affiliate’s transaction to the nonbank bank’s account at a Reserve Bank creates or increases the nonbank bank’s overdraft at its Reserve Bank. The affiliate would not necessarily have t® overdraw an account with the nonbank bank for an overdraft at the Reserve Bank to be deemed to be on its behalf; rather, the transaction would have to put the nonbank bank into an overdraft position at its Federal Reserve Bank or increase the amount of an already existing overdraft by a nonbank bank in its account with the Federal Reserve Bank. The Board recognises that a decrease in an affiliate's account at its nonbank bank may cause a subsequent overdraft in the nonbank bank’s account at its Federal Reserve Bank. Therefor®, if a nonbank bank shows a consistent pattern of incurring overdrafts at its Federal Reserve Bank, after allowing an affiliate to draw down its account, the Board may view the pattern as evidence that the nonbank bank is evading the provisions of the Bank Holding Company Act. To facilitate administration of this rule, under the proposal, nonbank banks were to be required to report to their Reserve Bank accounts held for affiliates from which third party payments could be made. All six comments received on this section opposed it as too burdensome and unnecessary. By dropping the reporting requirement, the Board will have to monitor overdrafts of all nonbank banks, instead of just those-..with transaction accounts for affiliate. Nevertheless, the Board believes that the overdraft restrictions can be implemented without this requirement, and has deleted the reporting requirement from the final regulation. In addition to the CEBA overdraft restrictions, the Board considered imposing a zero “cap” for purposes of the Board’s general risk reduction program on all nonbank banks that offer to their affiliates accounts with third party payment capabilities. Eighteen comments were- received on this issue, and fourteen of those comments were opposed to i t Cosnmenters objected to this proposal as discriminatory and unjustified. The Board has therefore determined that the zero cap should not be imposed at this time, but the question may be studied further under the ongoing large dollar risk reduction program. Nevertheless, each Reserve Bank will pay particular attention to noebank banks when monitoring the depository institutions in its District, but no specific procedures have been adopted for monitoring noab&nk banks. Any nonbank bank that becomes a “problem” institution (as defined by a Federal Reserve Bank) will be monitored most closely. —Posting. Posting is the procedure whereby the debit or credit adjustments resulting from payments transactions are made to the appropriate account. In order for nonbank banks to avoid overdrafts at Reserve Banks, they must know when entries will be posted to their accounts. Similarly, posting rules are necessary to determine whether an overdraft has occurred at a nonbank bank. Without posting rules, nonbank banks could evade the purpose of the statute by posting entries at such times of the day as to mask overdrafts. Accordingly, the Board proposed posting rules for the accounts of nonbank banks at Federal Reserve Banks and affiliates’ accounts at nonbank banks. Sixteen comments discussed these proposed posting rules, with three in favor and 13 opposed. Those opposed considered them to be burdensome and unnecessary. The Board, however, believes that uniform posting rules are necessary to ensure equal treatment of all nonbank banks and their affiliates, because the posting procedures currently in place are not uniform throughout the industry. These rules only apply for the purposes of measuring overdrafts under CEBA and nonbank banks may continue to use other posting procedures for other purposes. These rules do not apply to depository institutions that are not nonbank banks covered by CEBA and are in addition to rules applicable to depository institutions’ accounts at Federal Reserve Banks under the Board’s general risk reduction policy. overdraft restrictions. The ex post monitor posting rules were developed for a voluntary program which does not involve the serious divestiture (or loss of exemption, in the case of industrial banks) consequences that can result from an overdraft under CEBA. The Board is continuing to review the ex post monitor in light of this and other issues, and the Board wishes to note that changes may be made to the CEBA posting rules in conjunction with any future modification of the ex post monitor posting rules. — Posting b y Federal R eserve Banks. Reserve Banks will post funds and bookentry securities transfers as they are made. For check, ACH, and noncash transactions, net settlement entries, and nonelectronic transactions, all credits will be posted as of the opening of business and all debits at the close of business. With regard to discount window loans, the Board proposed to post credits for discount window loans as of the close of business on the day the loan is made, and to post debits for repayment of loans as of the close of business at the maturity of the loan. Commenters suggested that credit for discount window loans should be posted at the time of day the loan was actually made. In general, a discount window loan will be posted as of the close of business. However, it is within a Federal Reserve Bank’s discretion to grant a discount window loan that is requested during the day to cover intraday transactions. Therefore, under the final rule where it is expressly agreed to by the Federal Reserve Bank at the time of the loan is made, a discount window loan may be posted prior to the close of business. In addition to the posting rules, Reserve Banks will pay particular attention to depository transfer checks and ACH cash concentration debits used by affiliates of nonbank banks. These transactions are likely to present risks that are not addressed by the proposed posting rules. For example, where an affiliate of a nonbank bank deposits depository transfer checks with a nonbank bank in order to transfer funds to its account at the nonbank bank from its account at another This procedure differs from the depository institution, it is likely that the posting rules used by the Board’s ex check will be returned in the event of post monitoring system under the risk reduction program. Although the ex post failure of the affiliate. Failure of the affiliate, in turn, may precipitate failure monitor method used in the risk reduction program is familiar to of the nonbank bank. The returned depository institutions, the Board check will come to the Federal Reserve believes that it is inappropriate to apply after the day when the credits for these its posting rules to nonbank banks for transactions are posted to a nonbank the purposes of applying the CEBA bank’s account, and therefore the risks 9 presented by these returns are not addressed by posting rules. Consequently, where appropriate to protect against risk of return of these transactions, nonbank banks may be required to establish a special clearing balance at their Reserve Bank to be maintained at all times at a sufficient level to protect against these risks. — Posting b y G randfathered Banks. Because depository institutions’ rights with respect to their customers differ from the rights that a Reserve Bank has with respect to transactions that it processes, particularly in the area of check and ACH transactions, the posting rules do not require nonbank banks to post all transactions for CEBA monitoring purposes at the same time that the transactions are posted by Reserve Banks. The regulation permits nonbank banks to post checks and ACH transfers at any time during the day of the transaction—i.e., settlement day for ACH transactions or the day of presentment or credit to the nonbank banks for check transactions—so long as debits are posted no later than the time that the nonbank bank’s account at the Reserve Bank is debited for the transaction for purposes of CEBA overdraft monitoring, and credits are posted no earlier than the time when the credit for the transaction is posted to the nonbank bank’s account for purposes of CEBA overdraft monitoring. Some commenters opposed the posting provisions, stating that they would be burdensome and unnecessary. One commenter suggested that any bona fid e posting system should be acceptable unless it discriminated against nonaffiliates. The Board, however, continues to believe that posting rules are necessary to ensure equal treatment of all nonbank banks and their affiliates, because the posting procedures currently in place are not uniform throughout the industry. A modification to the regulation has been made to accomodate the provisions of another title of CEBA—the Expedited Funds Availability Act—and state funds availability laws. These laws require that, in certain cases, funds from check deposits must be made available for withdrawal by the depositor prior to collection (posting). Therefore, in those situations where state or federal law requires a nonbank bank to make funds available to its affiliate prior to the “normal” posting time for such check deposits set by the proposed regulation, the nonbank bank may post the transaction to its affiliate’s account as of the time availability must be provided under the Expedited Funds Availability Act or state law. Another question raised by the comments was whether affiliates’ accounts at a nonbank bank may be aggregated for determination of whether an affiliate had incurred an overdraft at the nonbank bank. Aggregation of the accounts of separate affiliates is not permitted by the regulation, but a nonbank bank that has a legal right to offset one affiliate’s account against another could post transactions that would overdraft an individual affiliate’s account to another affiliate’s account. A nonbank bank may aggregate the separate accounts of an individual affiliate for the purpose of determining whether that affiliate has incurred an overdraft. Nonbank banks may keep two sets of books for posting: one for affiliates for CEBA purposes and another for other purposes. No posting to an affiliate’s account is necessary for CEBA purpose if a nonbank bank returns a check or an ACH debit transfer in accordance with applicable law. One concern of the commenters on the posting issue was the receipt of timely account information from the Federal Reserve Bank. As set out more fully below, nonbank banks currently have access to sufficient information to monitor their account balances, in addition, in mid-1989, the Federal Reserve Banks expect to offer a service allowing institutions to check their actual balance in their reserve account on a real-time basis. —Exemptions. CEBA provides two exemptions from the restriction on overdrafts. One exemption is for overdrafts on behalf of an affiliate that is a primary dealer, where the overdraft is fully secured;17 and the other exemption is for inadvertent computer or inadvertent accounting errors that are beyond the control of both the grandfathered nonbank bank and the affiliate. —Primary Dealers. CEBA defines a primary dealer as one that is recognized as a primary dealer by the Federal Reserve Bank of New York. Currently, there are 42 such primary dealers, but only eight are affiliated with nonbank banks. Some of these eight primary dealers do not currently clear bookentry securities transfers through their nonbank banks. The overdraft prohibition in CEBA does not prohibit primary dealers from incurring overdrafts at affiliated nonbank banks and the affiliated 17 This exemption does not apply to industrial banks. nonbank banks from incurring overdrafts at their Federal Reserve Bank on behalf of the primary dealer affiliate, provided that these overdrafts are fully secured, "as required by the Board, by bonds, notes, or other obligations which are direct obligations of the United States or on which the principal and interest are fully guaranteed by the United States or by securities and obligations eligible for settlement on the Federal Reserve Book, entry system.”18 The proposed regulation defined “fully secured" as secured by a perfected security interest in specific, identified obligations listed in the statute with a market value that, in the Reserve Bank’s judgment, is sufficiently in excess of the amount of the overdraft to provide a margin of protection against a volatile market or the chance that the securities would need to be liquidated quickly. Eleven comments were received on the Board's proposed implementation of the primary dealer exception. Only one comment supported the proposal. The remaining comments expressed concern about the discretion given to the Reserve Bank to determine what constitutes "fully secured”. In general, the commenters expressed the belief that any “haircuts’’ on collateral should be set the same as for collateral posted by other depository institutions. The Board believes that generally haircuts should be based on the quality of the collateral offered rather than the institution offering the collateral. Haircuts for discount window lending have historically been the province off the Federal Reserve Banks, and the Board believes that it is inappropriate to specify haircuts by regulation absent a compelling reason. Nevertheless, the Board believes that Federal Reserve Banks should be encouraged to adopt comparable collateral valuation procedures for book entry securities for nonbank banks and other depository institutions. One primary dealer was particularly concerned about the interaction of the definition of overdrafts "on behalf of an affiliate” and the collateralization Requirement for primary dealer overdrafts. This commenter believed that due to the drafting of the proposal, a primary dealer faced the possibility that nonaffiltete securities overdrafts . would be deemed to be on its behalf arid consequently requiring collateralization. An overdraft i8 oh benatf o8 e primary dealer affiliate only to the extent that the primary dealer has drawn down its accounts; the overdraft does not include any drawdown or overdraft on the b'x Vs of the nonbank bank by a nonaffiliate of the nonbank bank. 10 The regulation has been revised to clarify that it does not require collateralization of overdrafts by customers other than affiliates. The Board proposed establishing a cap or ceiling on the level of securitiesrelated overdrafts to be permitted by any one nonbank bank. Such a cap was to be set through self-evaluation procedures similar to those used in the risk reduction program, and nonbank banks exceeding the cap would be counseled or subject to other action by their Federal Reserve Bank, in accordance with the Board’s risk reduction policy. Only two comments were received on this question—one in favor and one opposed. After further consideration, the Board has determined that a cap should not be imposed in conjunction with the CEBA overdraft regulation. —Inadvertent Errors. CEBA also exempts from the overdraft restrictions those overdrafts resulting from inadvertent computer or inadvertent accounting errors that are beyond the control of both the nonbank bank and the affiliate. An inadvertent accounting error is an error involving the recordation of entries to an account of a nonbank bank or affiliate resulting in an overdraft that was not reasonably foreseeable or preventable by the nonbank bank or the affiliate. A misposting of an entry by a Reserve Bank would not result in an overdraft in a nonbank bank’s account because no extension of credit had been made. Similarly, a misposting of an entry by a nonbank bank to an affiliate’s account would not result in an overdraft. An inadvertent computer error is an error resulting from a computer malfunction or from computer processing of adjustments in an account that results in an overdraft that was not reasonably foreseeable or preventable. Such errors would include problems where a nonbank bank or affiliate could not avoid book-entry securities overdrafts from inbound securities transfers, because it could not originate off-setting outbound transfers of securities or where a nonbank bank received a book-entry securities transaction sent to it in error. On the other hand, if a Federal Reserve Bank's computer should go down so as to prevent a Fedwire funds transfer from being sent to the nonbank bank, any overdraft due to outband Fedwire funds transfers would be*within the control of the nonbank bank, because the nonbank bank could have waited until it had sufficient funds in its account to cover the outbound transfer. Sixteen commenters argued that this definition of inadvertent error should be broadened to include overdrafts where the nonbank bank executes a transaction on behalf of an affiliate that results in a debit to its account, and incurs an overdraft because an anticipated transaction that would have created an offsetting credit to its account is delayed because of Federal Reserve Bank computer problems. The Board believes that it would be inappropriate to broaden the definitions of inadvertent error to this extent. Nonbank banks should be responsible for controlling their own accounts. Although some nonbank bank commenters argued that they had a responsibility to make some transfers to prevent the customer’s default on an obligation, customer account agreements between banks and their customers generally permit banks to delay customer transactions where necessary. The posting rules and the Federal Reserve’s advice services enable a nonbank bank to monitor its account balance. Under the posting rules, generally the only debits that are posted intraday result from funds and securities transfers. Credits for other transactions are posted in the morning and debits at the end of the day. A nonbank bank can get its opening balance each day from its Federal Reserve Bank at the time Fedwire opens for business in its district. The nonbank bank will know the amount of any ACH credits for which it has previously received advices, all its cash letters sent for collection, and the amount of any ACH debits that it originated and can add these credits to its opening balance. A Federal Reserve bank gives an automatic advice to on-line institutions of each funds or securities transfer when it is posted to the reserve account. Those institutions that are not on-line can have a standing request for a telephone advice for each such transfer. Therefore, the nonbank bank can adjust its balance throughout the day to reflect funds and securities transfers. And when the cash letter and ACH tape are presented to the nonbank bank, it can make the debit adjustments to its account as of the close of business. Thus, the nonbank bank should be able to closely monitor its balance with the Federal Reserve Bank according to the regulation’s posting rules. Finally, if the inadvertent error provision is expanded to cover Federal Reserve Bank computer outages, it would be difficult to justify not expanding it to cover outages at other banks. Staff believes that such a definition would lead to extremely complex inquiries into individual overdrafts and should be rejected. Nevertheless, staff recommends that the definition of an inadvertent error be expanded to include overdrafts due to the receipt of book entry securities transfers that are promptly returned as erroneous transfers. 7. Definition of Bank: The proposed rules amended the definition of bank in Regulation Y to reflect the changes to the bank definition in the BHC Act made by CEBA. They also added the definition of “affiliate” from CEBA and a definition of nonbank bank. The Board received no comment on the bank and affiliate definitions and is adopting them as proposed. The Board is adopting the nonbank bank definition to describe those institutions that were covered by the CEBA amendments. Conclusion: Except for the limitation on overdrafts (§ 225.52) which is effective in 90 days, these amendments to Regulation Y are effective immediately. The amendments to section 225.2 merely set forth the definition of “bank”, “nonbank bank”, and “affiliate” that are provided in CEBA. The new section 225.51 defines the limitation on the asset growth of nonbank banks established by CEBA. The Board finds good cause to make these amendments effective immediately. The amendments to the section on definitions conform the regulation to the change in the statute. As a result of the enactment of CEBA, these definitions are already effective. The addition of section 225.51 is effective immediately because CEBA requires that grandfathered nonbank banks limit their annual asset growth for 12 -month periods after August 10,1988. This new section sets forth the means by which the Board will measure this growth. Because the statutory annual growth rate requirement is already in effect, the Board finds that there is good cause to make the regulation implementing that requirement effective immediately to allow nonbank banks to plan their business activities so as to conform to the method the Board will use to measure compliance with the limitation. Paperwork Reduction Act Notice The Board finds good cause for instituting a new collection of information without providing an opportunity for public comment. The 11 new collection of information is a one time occurrence. To comply with the statutory requirements of CEBA, nonbank banks must report the base asset figure against which the 7 percent limitation on growth will be measured.*The rules provide that the nonbank banks with three options for determining their initial base figure. The nonbank bank must advise the Board by October 15.1988 of the method elected. Should a nonbank bank elect to use the August 10.1988 base date, it must file a report of that asset figure by October 15,1988, along with its average assets for the third quarter of 1988. (Should a nonbank bank elect to use the third calendar quarter 1988 data or the average assets for the four quarters ending September 30,1988, the information is already collected in Schedule RC-K of its Report of Condition.) A nonbank bank electing to measure compliance with the growth rate on a rolling quarterly basis as permitted by the Board’s rules, must report that election to the Board also by October 15, 1988. The new collection of information must be instituted quickly and public participation in the approval process would substantially interfere with the Board’s ability to perform its statutory obligation of enforcing the 7 percent growth limitation set forth in CEBA. The information to be collected from nonbank banks is contained in a new information collection, the “Report by Nonbank Banks of Total Assets on August 10,1988” (form FR 3050; OMB No. 7100-0236). This information collection consists of a free-form voluntary report of the method chosen by the nonbank banks to calculate their initial base figure and the total assets of these institutions on August 10,1988, if this method for calculating the annual base is elected along with the institution’s average assets for the third quarter of 1988. This report was approved by the Board under delegated authority from the Office of Management and Budget (“OMB”) at the same time the Board approved this final rule. The Board estimates that the disclosure requirement will result in a one-time reporting burden of 28 hours. Final Regulatory Flexibility Act Analysis Of the items required to be obtained in a final regulatory flexibility analysis by 5 U.S.C. § 604(a), the first (a statement of the need for and objectives of the rule) and the second (a summary of the issues raised by the commenters, the Board's assessment of the issues, and the changes made to the proposed rule in response to the comments) are contained elsewhere in this preamble. The third item required for a final regulatory flexibility analysis is a description of the significant alternatives to the rule consistent with the objectives of applicable statutes and designed to minimize any significant economic effect of the rule on small entities considered by the Board, and why these were rejected. The Board proposed that all requirements of the amended rules be applicable to all nonbank banks and industrial banks subject to the rules regardless of size. The small entities most likely to be affected by this rulemaking are the industrial banks that are subject to the limitations on overdrafts. No comments were received requesting exemption of industrial banks due to their small size. According to Board records on overdrafts under the current risk reduction policy, very few industrial banks reporting to the Board have incurred overdraft since the enactment of CEBA. Thus, it does not. appear that a substantial number of industrial banks will be affected by the rule. No comments were received stating that the new rules impose burdens specifically on small banks. Some comments stated that certain requirements, such as the posting rules, were burdensome and should not be required, but rather, that the Board should accept any bona fide posting system that did not discriminate against nonaffiliated depositors. As stated elsewhere in this preamble, the Board considered this comment but determined that uniform posting rules are necessary to ensure equal treatment of all industrial banks, nonbank banks and their affiliates, because the posting procedures currently in place are not standardized throughout the industry. Other than the overdraft rules for which the posting rules were set, the limitations established by these rules apply only to nonbank banks. There are approximately 55 of these institutions, and less than half are small entities. The Board considered exempting small banks from the rule’s requirements, but CEBA does not provide an exempiton according to the size of the nonbank bank. List of Subjects in 12 CFR Part 225 Banks, banking, Federal Reserve System, Holding companies, Reporting and recordkeeping requirements, Securities. For the reasons set out in this notice, and pursuant to the Board’s authority under section 5(b) of the Bank Holding Company Act of 1956 (12 U.S.C. 1844), the Board amends 12 CFR Part 225 as follows: PART 225—BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL added immediately following Subpart E to read as follows: Subpart F—Limitations on Wonlbank Bank© 225.51 Seven percent growth limit for nonbank banks. 225.52 Limitation on overdrafts. Subpart ^ L im ita tio n s ©ns Nonbank Banks § 225.511 Seven percent grow th 5imit for nonbank banks. (a) Period for determining compliance. A nonbank bank’s annual rate of asset growth for purposes of Authority: 12 U.S.C. 1817(j)(13), 1818, paragraph (b) of this section shall be 1843(c)(8), 1844(b), 3106, 3108, 3907 and 3909. determined for twelve-month periods 2 . In § 225.2 paragraphs (a) through (f) that begin on October 1 of each year and end on September 30 of the following and (g) through (1) are redesignated as year, unless the bank elects to use the paragraphs (b) through (g) and (i) alternative method described in through (n) respectively; new paragraph (c) of this section. The initial paragraphs (a) and (h) are added; and 12 -month period shall commence on newly redesignated paragraph (b) is October 1,1988, and expire on revised to read as follows: September 30,1989, unless the Board § 225.2 Definitions. establishes a different period pursuant * * * * * to paragraph (d) of this section. (b) Computing annual rate of asset (a) "Affiliate” means any company growth.— (1 ) Initial 12-month period. For that controls, is controlled by, or is the initial 12 -month period beginning on under common control with, a bank or October 1,1988, the average of the nonbank bank. nonbank bank’s Total Assets as (b) (1 ) "Bank” means: reported on Schedule RC-K of its Report (1) An insured bank as defined in of Condition for the four quarters during section 3(h) of the Federal Deposit this period may not increase by more Insurance Act (12 U.S.C. 1813(h)); or (ii) An institution organized under thethan 7 percent of the nonbank bank’s initial base. The nonbank bank may law of the United States which both: determine its initial base under any of (A) Accepts demand deposits or the following methods: deposits that the depositor may (1) Its Total Assets as reported on withdraw by check or similar means for Schedule RC-K of its Report of payment to third parties or others; and Condition for the quarter ending (B) Is engaged in the business of September 30,1988, divided by 1.601; or making commercial loans. (ii) Its total assets on August 10,1988, (2 ) “Bank” does not include those divided by 1.567, unless the Board institutions qualifying under the determines pursuant to paragraph (d) exceptions listed in section 2 (c)(2 ) of the that such amount may not be used; or BHC Act (12 U.S.C. 1841(c)(2)). (iii) The average of its Total Assets as * * * * * reported on Schedule RC-K of its Report (h) “Nonbank bank” means any of Condition for the fourth quarter of institution that: 1987 and the first three quarters of 1988. (1 ) Became a bank as a result of (2 ) Succeeding 12-month periods. For enactment of the Competitive Equality each 12 -month period after the initial Amendments of 1987 (Pub. L. No. 100 period, the average of the nonbank 86 ), on the date of such enactment bank’s Total Assets as reported on (August 10,1987); and Schedule RC-K of its Report of (2 ) Was not controlled by a bank Condition for the four quarters during holding company on the day before the that period may not increase by more enactment of the Competitive Equality than 7 percent of the average of its Total Amendments of 1987 (August 9,1987). Assets as reported on Schedule RC-K of * * * * * its Report of Condition for the four quarters in the preceding 12 -month 3. The heading "Appendices to Subparts A through E” is revised to read period. (c) Alternative method to compute “Appendices to Subparts.” Subpart F, annual rate of asset growth.—(1) consisting of §§ 225.51 and 225.52, is 1. The authority citation for Part 225 continues to read as follows: 12 K of its Report of Condition for that Quarterly measurement permitted. In quarter. lieu of the methods for measuring compliance with the asset growth rate § 225.52 Limitation on overdrafts. described in paragraph (b) of this (a) Definitions. For purposes of this section, a nonbank bank may elect to section— have its compliance with the growth (1) “Account" means a reserve rate determined in the following manner: its Total Assets as reported on account, clearing account, or deposit account as defined in the Board’s Schedule RC-K of its Report of Condition for each quarter ending after Regulation D (12 CFR 204.2(a)(l)(i)), that is maintained at a Federal Reserve Bank August 10,1989, may not increase by or nonbank bank. more than 7 percent of its Total Assets (2 ) "Cash item” means (i) a check as reported on Schedule RC-K of its Report of Condition for the same quarter other than a check classified as a noncash item; or (ii) any other item of the previous year. payable on demand and collectible at (2 ) Initial quarter. In measuring par that the Federal Reserve Bank of the compliance with the growth rate under district in which the item is payable is paragraph (c)(1 ) of this section for the third quarter of 1989, the nonbank bank willing to accept as a cash item. (3) "Discount window loan” means may elect to use its assets on August 10 , any credit extended by a Federal 1988, as the base rather than the Total Reserve Bank to a nonbank bank or Assets for the third quarter of 1988 as reported on Schedule RC-K of its Report industrial bank pursuant to the provisions of the Board’s Regulation A of Condition. (12 CFR Part 201 ). (3) Notice required. A nonbank bank (4) “Industrial bank” means an electing to compute its asset growth institution as defined in section pursuant to this paragraph shall notify 2 (c)(2 )(H) of the BHC Act (12 U.S.C. the Board by Ocober 15,1988, of this 1841(c)(2)(H)). election. The nonbank bank may not (5) “Noncash item” means an item thereafter alter its election. handled by a Reserve Bank as a (d) Determination of total assets on noncash item under the Reserve Bank’s August 10, 1988. If the Board determines “Collection of Noncash Items Operating that a nonbank bank has engaged in Circular” (e.g., a maturing bankers’ transactions that have artificially acceptance or a maturing security, or a inflated its total assets on August 10, demand item, such as a check, with 1988, and that are unrelated to its special instructions or an item that has normal business activities, the Board not been preprinted or post-encoded). may require that— (6 ) “Other nonelectronic transactions” (1 ) The nonbank exclude such include all other transactions not amounts in calculating its total assets on included as funds transfers, book-entry August 10,1988, for purposes of securities transfers, cash items, noncash paragraph (b)(l)(ii); or items, automated clearing house (2 ) The initial 12 -month period for transactions, net settlement entries, and determining compliance with the 7 discount window loans [e.g., original percent growth rate shall commence on issue of securities or redemption of a date later than August 10,1988, and securities). the institution’s total assets on that later (7) An “overdraft” in an account date shall be used instead of the bank’s occurs whenever the Federal Reserve total assets on August 10,1988, for Bank, nonbank bank, or industrial bank purposes of measuring compliance with holding an account posts a transaction the 7 percent growth rate under to the account of the nonbank bank, paragraph (b)(1 ). industrial bank, or affiliate that exceeds (e) Required reports. (1 ) A nonbank the aggregate balance of the accounts of bank shall file with the Board by the nonbank bank, industrial bank, or October 15,1988, a statement indicating affiliate, as determined by the posting the method it has elected to compute its rules set forth in paragraphs (d) and (e) initial base for purposes of paragraph of this section and continues until the (b)(1 ). of this section. aggregate balance of the account is zero (2) A nonbank bank electing to use itsor greater. actual total assets on August 10,1988, as (8 ) “Transfer item" means an item as its initial base for purposes of paragraph defined in Subpart B of Regulation J (12 (b)(1 ) of this section, shall report that CFR 210.25 et seq). figure to the Board by October 15,1988, (b) Restriction on overdrafts.—(1 ) and the nonbank bank’s Total Assets for Affiliates. Neither a nonbank bank nor the third calendar quarter of 1988 as an industrial bank shall permit any required to be reported on Schedule RC- affiliate to incur any overdraft in its 13 account with the nonbank bank or industrial bank. (2 ) Nonbank banks or industrial banks, (i) No nonbank bank or industrial bank shall incur any overdraft in its account at a Federal Reserve Bank on behalf of an affiliate. (ii) An overdraft by a nonbank bank or industrial bank in its account at a Federal Reserve Bank shall be deemed to be on behalf of an affiliate whenever: (A) A nonbank bank or industrial bank holds an account for an affiliate from which third-party payments can be made; and (B) When the posting of an affiliate’s transaction to the nonbank bank’s or industrial bank’s account at a Reserve Bank creates an overdraft in its account at a Federal Reserve Bank or increases the amount of an existing overdraft in its account at a Federal Reserve Bank. (c) Permissible overdrafts. The following are permissible overdrafts not subject to paragraph (b) of this section: (1 ) Inadvertent error. An overdraft in its account by a nonbank bank or its affiliate, or an industrial bank or its affiliate, that results from an inadvertent computer error or inadvertent accounting error, that was not reasonably forseeable or could not have been prevented through the maintenance of procedures reasonably adopted by the nonbank bank or affiliate to avoid such overdraft: and (2) Fully secured primary dealer affiliate overdrafts, (i) An overdraft incurred by an affiliate of a nonbank bank, which affiliate is recognized as a primary dealer by the Federal Reserve Bank of New York, in the affiliate’s account at the nonbank bank, or an overdraft incurred by a nonbank bank on behalf of its primary dealer affiliate in the nonbank bank’s account at a Federal Reserve Bank; provided: the overdraft is fully secured by bonds, notes, or other obligations which are direct obligations of the United States or on which the principal and interest are fully guaranteed by the United States or by securities and obligations eligible for settlement on the Federal Reserve bookentry system. (ii) An overdraft by a nonbank bank in its account at a Federal Reserve Bank that is on behalf of a primary dealer affiliate is fully secured when that portion of its overdraft at the Federal Reserve Bank that corresponds to the transaction posted for an affiliate that caused or increased the nonbank bank’s overdraft is fully secured in accordance with paragraph (c)(2 )(iii) of this section. (iii) An overdraft is fully secured under paragraph (c)(2 )(i) when the settlement entries, and all other nonbank bank can demonstrate that the or industrial bank as of the opening of business on settlement day. Total nonelectronic transactions shall be overdraft is secured, at all times, by a aggregate debits for these transactions posted to an affiliate's account on the perfected security interest in specific, and entries shall be posted to the day of the transaction [i.e., settlement identified obligations described in account of a nonbank bank or industrial day for ACH transactions or the day of paragraph (c)(2 )(i) with a market value credit for check transactions), but no bank as of the close of business on that, in the judgment of the Reserve settlement day. earlier than the Federal Reserve Bank’s Bank holding the nonbank bank’s (e) Posting by nonbank banks and opening of business on that day. Credit account, is sufficiently in excess of the industrial banks. For purposes of for cash items that are required by amount of the overdraft to provide a margin of protection in a volatile market determining the balance of an affiliate's federal or state statute or regulation to be made available to the depositor for or in the event the securities need to be account under this section, payments and transfers through an affiliate’s withdrawal prior to the posting time set liquidated quickly. (d) Posting by Federal Reserve Banks.account at a nonbank bank or industrial forth in the preceding paragraph shall be posted as of the required availability For purposes of determining the balance bank shall be posted as follows: (1 ) Funds transfers, (i) Fedwire time. of an account under this section, transfer items shall be posted: (ii) Debits. Debits for cash items, payments and transfers by nonbank (A) To the transferor affiliate’s noncash items, ACH transfers, net banks and industrial banks processed account no later than the time the settlement entries, and all other by the Federal Reserve Banks shall be transfer is actually made by the nonelectronic transactions shall be considered posted to their accounts at transferor’s Federal Reserve Bank; and posted to an affiliate’s account on the Federal Reserve Banks as follows: (B) To the transferee affiliate's day of the transaction (e.g., settlement (1 ) Funds transfers. Transfer items account no earlier than the time the day for ACH transactions or the day of shall be posted: transferee’s Reserve Bank sends the presentment for check transactions), but (1) To the transferor’s account at the transfer item, or sends or telephones the no later than the Federal Reserve Bank’s time the transfer is actually made by the advice of credit for the item to the close of business on that day. If a check transferor’s Federal Reserve Bank; and transferee, whichever occurs first. drawn on an affiliate’s account or an (ii) To the transferee’s account at the (ii) For funds transfers not sent or ACH debit transfer received by an time the transferee’s Reserve Bank received through Federal Reserve Banks, affiliate is returned timely by the sends the transfer item or sends or debits shall be posted to the transferor nonbank bank or industrial bank in telephones the advice of credit for the affiliate’s account not later than the time accordance with applicable law and item to the transferee, whichever occurs the nonbank bank or industrial bank agreements, no entry need to be posted first. becomes obligated on the transfer. to the affiliate’s account for such item. (2) Book-entry securities transfers Credits shall not be posted to the 4. Section 225.145 is added to read as against payment. A book-entry transferee affiliate’s account before the follows: securities transfer against payment shall nonbank bank or industrial bank has be posted: (i) to the transferor’s account received actually and finally collected § 225.145 Limitations established by the at the time the entry is made by the Competitive Equality Banking Act off 1987 funds for the transfer. transferor’s Reserve Bank; and (ii) to the on the activities and growth off nonbank (2 ) Book-entry securities transfers banks. transferee’s account at the time the against payment, (i) A book-entry entry is made by the transferee’s (a) Introduction. Effective August 10 , sec u ritie s tra n sfe r ag a in st p a y m e n t sh all Reserve Bank. 1987, the Competitive Equality Banking be posted: (3) Discount window loans. Credit for Act of 1987 (“CEBA”) redefined the term (A) To the transferor affiliate’s a discount window loan shall be posted account not earlier than the time the "bank” in the Bank Holding Company to the account of a nonbank bank or Act ("BHC Act” or "Act”) to include any entry is made by the transferor’s industrial bank at the close of business Reserve Bank; and bank the deposits of which are insured on the day that it is made or such earlier by the Federal Deposit Insurance (B) To the transferee affiliate's time as may be specifically agreed to by account not later than the time the entry Corporation as well as any other the Federal Reserve Bank and the institution that accepts demand or is made by the transferee’s Reserve nonbank bank under the terms of the checkable deposit accounts and is Bank. loan. Debit for repayment of a discount (ii) For book-entry securities transfersengaged in the business of making window loan shall be posted to the against payment that are not sent or commercial loans. 12 U.S.C. 1841(c). account of the nonbank bank or received through Federal Reserve Banks, CEBA also contained a grandfather industrial bank as of the close of entries shall be posted: provision for certain companies affected business on the day of maturity of the (A) To the buyer-affiliate’s account by this redefinition. CEBA amended loan or such earlier time as may be not later than the time the nonbank section 4 of the BHC Act to permit a bank or industrial bank becomes agreed to by the Federal Reserve Bank company that on March 5,1987, obligated on the transfer; and and the nonbank bank or required by controlled a nonbank bank (an (B) To the seller-affiliate’s account not institution that became a bank as a the Federal Reserve Bank under the before the nonbank bank or industrial result of enactment of CEBA) and that terips of the loan. bank has received actually and finally was not a bank holding company on (4) Other transactions. Total August 9,1987, to retain its nonbank aggregate credits for automated clearing collected funds for the transfer. (3) Other transactions.—(i) Credits. bank and not be treated as a bank house transfers, cash items, noncash holding company for purposes of the items, net settlement entries, and other Except as otherwise provided in this paragraph, credits for cash items, BHC Act if the company and its nonelectronic transactions shall be subsidiary nonbank bank observe posted to the account of a nonbank bank noncash items, ACH transfers, net 14 certain limitations imposed by CEBA. 1 accompanying CEBA states that the Certain of these limitations are codified restrictions CEBA places on nonbank banks “will help prevent existing in section 4(f)(3) of the BHC Act and nonbank banks from changing their generally restrict nonbank banks from basic character * * * while Congress commencing new activities or certain cross-marketing activities with affiliates considers proposals for comprehensive legislation; from drastically eroding the after March 5,1987, increasing their separation of banking and commerce; assets at an annual rate exceeding 7 percent during any 12 month period after and from increasing the potential for August 10,1988, or permitting overdrafts unfair competition, conflicts of interest, undue concentration of resources, and for affiliates or incurring overdrafts on behalf of affiliates at a Federal Reserve other adverse effects." S. Rep. No. 100 Bank. 12 U.S.C. 1843(f)(3).2 The Board’s 19,100th Cong., 1 st Sess. 12 (1987). See views regarding the meaning and scope also H. Rep. No. 100-261,100th Cong., 1 st Sess. 124 (1987) (the “Conference of these limitations are set forth below Report"). and in provisions of the Board’s (2 ) Thus, Congress explicitly Regulation Y (12 CFR 225.51 and 52). recognized in the statute itself that (b) Congressional findings. (1 ) At the nonbanking companies controlling outset, the Board notes that the scope grandfathered nonbank banks, which and application of the Act’s limitations include the many of the nation’s largest on nonbank banks must be guided by commercial and financial organizations, the Congressional findings set out in were being accorded a significant section 4(f)(3) of the BHC Act. Congress competitive advantage that could not be was aware that these nonbank banks matched by bank holding companies had been acquired by companies that because of the general prohibition engage in a wide range of nonbanking against nonbanking activities in section activities, such as retailing and general 4 of the BHC Act. Congress recognized securities activities that are forbidden to that this inequality in regulatory bank holding companies under section 4 approach could inflict serious of the BHC Act. In section 4(f)(3), competitive harm on regulated bank Congress found that nonbank banks holding companies as the grandfathered controlled by grandfathered nonbanking entities sought to exploit potential companies may, because of their synergies between banking and relationships with affiliates, be involved commercial products and services. See in conflicts of interest, concentration of Conference Report at 125-126. The basic resources, or other effects adverse to and stated purpose of the restrictions on grandfathered nonbank banks is to bank safety and soundness. Congress minimize these potential anticompetitive also found that nonbank banks may be effects. able to compete unfairly against banks (3) The Board believes that the controlled by bank holding companies specific CEBA limitations should be by combining banking services with implemented in light of these financial services not permissible for Congressional findings and the bank holding companies. Section 4(f)(3) legislative intent reflected in the plain states that the purpose of the nonbank bank limitations is to minimize any such meaning of the terms used in the statute. potential adverse effects or inequities by In those instances when the language of the statute did not provide clear restricting the activities of nonbank banks until further Congressional action guidance, legislative materials and the Congressional intent manifested in the in the area of bank powers could be undertaken. Similarly, the Senate Report overall statutory structure were considered. The Board also notes that prior precedent requires that 1 12 U.S.C. 1843(f)- Such a company is treated as a grandfather exceptions in the BHC Act, bank holding company, however, for purposes of the such as the nonbank bank limitations anti-tying provisions in section 106 of the BHC Act Amendments of 1970 (12 U.S.C. 1971 e ts e q .) and the and particularly the exceptions thereto, insider lending limitations of secton 22(h) of the are to be interpreted narrowly in order Federal Reserve Act (12 U.S.C. 375b). The company to ensure the proper implementation of is also subject to certain examination and Congressional intent.3 enforcement provisions to assure compliance with CEBA. 2 CEBA also prohibits, with certain limited exceptions, a company controlling a grandfathered nonbank bank from acquiring control of an additional bank or thrift institution or acquiring, directly or indirectly after March 5.1987. more than 5 percent of the assets or shares of a bank or thrift institution. 12 U.S.C. 1843(f)(2). (c) Activity limitation .—(1 ) Scope of “activity", (i) The first limitation established under section 4(f)(3) provides that a nonbank bank shall not “engage in any activity in which such bank was not lawfully engaged as of March 5,1987.” The term “activity” as used in this provision of CEBA is not defined. The structure and placement of the CEBA activity restriction within section 4 of the BHC Act and its legislative history do, however, provide direction as to certain transactions that Congress intended to treat as separate activities, thereby providing guidance as to the meaning Congress intended to ascribe to the term generally. First, it is clear that the term “activity” was not meant to refer to banking as a single activity. To the contrary, the term must be viewed as distinguishing between deposit taking and lending activities and treating demand deposit-taking as a separate activity from general deposit taking and commercial lending as separate from the general lending category. (ii) Under the activity limitation, a nonbank bank may engage only in activities in which it was “lawfully engaged” as of March 5,1987. As of that date, a nonbank bank could not have been engaged in both demand deposit taking and commercial lending activity without placing it and its parent holding company in violation of the BHC Act. Thus, under the activity limitations, a nonbank bank could not after March 5, 1987, commence the demand deposit taking or commercial lending activity that it did not conduct as of March 5, 1987. The debates and Senate and Conference Reports on CEBA confirm that Congress intended the activity limitation to prevent a grandfathered nonbank bank from converting itself into a full-service bank by both offering demand deposits and engaging in the business of making commercial loans.45 Thus, these types of transactions provide a clear guide as to the type of banking transactions that would constitute activities under CEBA and the degree of specificity intended by Congress in interpreting that term. (iii) It is also clear that the activity limitation was not intended simply to prevent a nonbank bank from both 4 Conference Report at 124-25: S. Rep. No. 100-19 at 12. 32: H. Rep. No. 99-175. 99th Cong., 1st Sess. 3 (1985) (“the activities limitation is to prevent an institution engaged in a limited range of functions 3 E.g.. M a r y la n d N a tio n a l C o rporation . 73 Federal from expanding into new areas and becoming, in Reserve Bulletin 310, 313-314 (1987). Cf., S p o k a n e & essence, a full-service bank”); 133 Cong. Rec. S4054 In la n d E m pire R a ilr o a d Co. v. U n ite d S ta tes . 241 (daily ed. March 27,1987); (Comments of Senator U.S. 344, 350 (1915). Proxmire). 15 activity limitation, the report recognized activities, not to discrete products and a distinction between demand deposits services. (vi) Accordingly, consistent with the and accounts with transaction capability and those without transaction terms and purposes of the legislation capability; and the Congressional intent to minimize unfair competition and the With respect to deposits, the Committee other adverse effects set out in the recognizes that it is legitimate for an CEBA findings, the Board concludes that institution- currently involved m offering the term "activity" as used in section demand deposits or other third party 4(f)(3) means any line of banking or transaction accounts to make use of new technologies that are m the process of nonbanking business. This definition replacing the existing check-based, paper does not, however, envision a productpayment system. Again, however, the by-product approach to the activity Committee does not believe that technology limitation. The Board believes it would be helpful to describe the application of should be used as a lever for an institution that was only incidentally involved in the the activity limitations ia the context oil payment system to transform itself into a the following major categories, of significant offeror of transaction acc©a©8 activities: deposit-taking, lending, trust, capability.8 and other activities engaged in by(iv) Finally, this distinctions between banks. demand and nondemand checkable (2 ) Deposit-taking activities, (i) With accounts and accounts not subject to respect to deposit-taking, the Board withdrawal by check was specifically believes that the activity limitation in recognized by Congress in the section 4(f)(3) generally refers to three redefinition of the term “bank” in CEBA types of activity: demand deposit-taking; to include am ins titration that takes non-demand deposit-taking with a third demand deposits or “deposits that the party payment capability; and time and depositor may withdraw by check or savings deposit-taking without third other means for payment to third parties party payment powers. As previously or others” as well as in varioras discussed, it is clear from the terms and exemptions fmm that definition for trust intent of CEBA that the activity companies, credit card banks, and limitation would prevent, and was certain industrial banks .7 designed to prevent nonbank banks that (v) Thus, an institution that as of prior to the enactment of CEBA had March 5,1987, offered only time and refrained from accepting demand savings accounts that were not deposits in order to avoid coverage as a withdrawable by check for payment to “bank” under the BHC Act, from, starting third parties could not thereafter begin to take these deposits after enactment of offering accounts with transactions CEBA and thus becoming ffaM-service capability, for example, NOW accounts banks. Accordingly, CEBA requires that or other types of transaction accounts. the taking of demand deposits be (3} Lending. As noted, the CEBA treated as a separate activity. activity limitation does not treat lending fii) The Board also considers as a single activity; it dearly nondemand deposits withdrawable by distinguishes between comm®retail and check or other similar means for other types of lending. This distinction is payment to third parties or others to also reflected in the definition of “bank” constitute a separate line off business for in the BHC Act in effect both prior to purposes of applying the activity and after enactment off CEBA as well as limitation. In this regard, the Board has in various <of the exceptions from this previously recognized that this line of definition. In addition, commercial * businesss constitutes a permissible but lending is a specialized form of lending separate activity under section 4 off the involving different techniques and BHC Act. Furthermore, the offering of analysis from other types of lending. accounts with transaction capability Based upon these factors, the Board requires different expertise and systems would view commercial lending as a than non-transaction deposit-taking and separate and distinct activity for purposes off the activity limitation ira represented a distinct new activity that The Board’s decisions traditionally separated banks from thrift section under section 4 off the BHC Act have not and similar institutions. (iii) Support for this view may also begenerally differentiated between types of commercial lending, and thus the found in the House Banking Committee report on proposed legislation prior to CEBA that contained a similar 8 H. Rap. No. 8S-175. 99th> Qmg^ le t S e ss. U prohibition on new activities for (198515 Conference Report at 124-125; S. Rep. No. 1007 See 12 U.S.C. 1841(c)(2) (D). (F). (H), oifcd ill. nonbank banks. In discussing the 19 at 32. accepting demand deposits and making commercial loans; it has a broader scope and purpose. If Congress had meant the term to refer to just these two activities, it would have used the restriction it used in another section of CEBA dealing with nonbank banks owned by bank holding companies which has this result, i.e., the nonbank bank could not engage in any activity that would have caused it to become a bank under the prior bank definition in the Act. See 12 U.S.C. 1843(g)(1)(A). Indeed, an earlier version of CEBA under consideration by the Senate Banking Committee contained such a provision for nonbank banks owned by commercial holding companies, which was deleted in favor of the broader activity limitation actually enacted. Committee Print No. 1 , (Feb. 17,1987). In this regard, both the Senate Report and Conference Report refer to demand deposit-taking and commercial lending as examples of activities that could be affected by the activity limitation, not as the sole activities to be limited by the provision.5* (iv) Finally, additional guidance as to the meaning of the term “activity” is provided by the statutory context in which the term appears. The activity limitation is contained in section 4 of the BHC Act, which regulates the investments and activities of bank holding companies and their nonbank subsidiaries. The Board believes it reasonable to conclude that by placing the CEBA activity limitation in section 4 of the BHC Act, Congress meant that Board and judicial-decisions regarding the meaning of the term “activity” in that section be looked to for guidance. This is particularly appropriate given the fact that grandfathered nonbank banks, whether owned by bank holding companies or unregulated holding companies, were treated as nonbank companies and not banks before enactment of CEBA. (v) This interpretation of the term activity draws support from comments by Senator Proxmire during the Senate’s consideration of the provision that the term was not intended to apply “on a product-by-product, customer-by customer basis.” 133 Cong. Rec. S4054-5 (daily ed. March 27,1987). This is the same manner in which the Board has interpreted the term activity in the nonbanking provision of section 4 as referring to generic categories of 16 Board weald v ie w commercial teadmg as a single activity for purposes of CEBA. TfeuSv a Bombamk bank that made commercial loans as of March 5* 1287, could make amy type of commercial loan thereafter. (i) Commercial lending. For purposes of the activity limitation, a commercial loan is d e fie d in accordance with the Supreme Court's decision in Board of Governors v. Dimension Financial Corporation, 474 U.£L 3S1 (1986), as a direct loam to a business cmtomer for the pmrpose of providing fcmds for that customer’s business. In this regard, the Board notes that whether a particular transaction is a commercial loan must be determined not from the face of the instrument, but from the application of the definition of commercial loan in the Dimension dedsiom to that transaction. Thus, certain transactions of the type fflsemtioned in the Board’s railing at issue in Dimension and m the Senate and Conference Reports in the CEBA legislation! 6 would be commercial loans if they meat the test for commercial loans established in Dimension. Under this test, a commercial loan would not include, for example, an open-market investment in a commercial entity that does not involve a borrower-lender relationship or negotiation of credit terms, such as a money market transaction. (ii) Other lending. Based upon the guidance in the Act as to the degree of specificity required rn applying the activity limitation with respect to lending, the Board believes that, in addition to commercial fending, there are three other types of fending activities: consumer mortgage lending, consumer credit card lending, and other consumer lending. Mortgage fending and credit card fending are recognized, discrete lines of banking and business activity, involving techniques and processes that are different from and more specrafizecMhan those required for general consumer lending. For example, these activities are, in many cases, conducted by specialized institutions, such as mortgage companies and credit card institutions, or through separate organizational structures within an institution, particularly in the case of mortgage fending. Additionally, the Board’s decisions under section 4 of the Act have recognized mortgage banking and credit card lending as separate activities for bank holding companies. The Board’s Regulation Y reflects this 151S. Rep. No. 103-19 at 31; C o n fe e a c e Repair! af 123. specialization, noting as examples of permissible lending activity: consumer finance, credit card and mortgage lending. 12 CFR 225.25(b)(1). Finally, CEBA itself recognizes the specialized nature of credit card lending by exempting an institution specializing in that activity from the bank definition. For purpose of the activity limitation, a consumer mortgage loan will mean any loan to an individual that is secured by real estate and that is not a commercial loan. A credit card loan would be any loan made to an individual by means of a credit card that is not a commercial loan. (41 Trust activities. Under section 4 of the Act, the Board has historically treated trust activities as a single activity and has not differentiated the function on the basis of whether the customer was an individual or a business. See 12 CFR 225.25(b)(3). Similarly, the trust company exemption from the bank definition in CEBA makes no distinction between various types of trust activities. Accordingly, the Board would view trust activities as a separate activity without additional differentiation for purposes of the activity limitation in section 4(f)(3). (5) Other activities. With respect to activities other than the various traditional deposit-taking, lending or trust activities, the Board believes it appropriate, for the reasons discussed above, to apply the activity limitation in section 4(f)(3) as the term “activity" generally applies in other provisions of section 4 of the BHC Act. Thus, a grandfathered nonbank bank could not, for example, commence after March 5, 1987, any of the following activities (unless it was engaged in such an activity as of that date): discount securities brokerage, full-service securities brokerage investment advisory services, underwriting or dealing in government securities as permissible for member banks, foreign exchange transaction services, real or personal property leasing, courier services, data processing for third parties, insurance agency activities,9 real estate development, real estate brokerage, real estate syndication, insurance underwriting, management consulting, futures commission merchant, or activities of the general 9 In this area, section 4 of the Act does not treat all insurance agency activities as a single activity. Thus, for example, the Act treats the sale of creditrelated life, accident and health insurance as a separate activity from general insurance agency activities. See 12 n S.C. 1843(c)(8). 17 type listed in § 225.25(b) of Regulation Y. (6 ) Meaning of “engagedin". In order to be “engaged in" an activity, a nonbank bank must demonstrate that it had a program in place to provide a particular product or service included within the grandfathered activity to a customer and that it was in fact offering the product or service to customers as of March 5,1987. Thus, a nonbank bank is not engaged in an activity as of March 5, 1987, if the product or service in question was in a planning state as of that date and had not been offered or delivered to a customer. Consistent with prior Board interpretations of the term activity in the grandfather provisions of section 4, the Board does not believe that a company may be engaged in an activity on the basis of a single isolated transaction that was not part of a program to offer the particular product or to conduct in the activity on an ongoing basis. For example, a nonbank bank that held an interest in a single real estate project would not thereby be engaged in real estate development for purposes of this provision, unless evidence was presented indicating the interest was held under a program to commence a real estate development business. (7) Meaning of “as of". The Board believes that the grandfather date “as of March 5,1987” as used throughout section 4(f)(3) should refer to activities engaged in on March 5,1987, or a reasonably short period preceding this date not exceeding 13 months. 133 Cong. Rec. S3957 (daily ed. March 26,1987). (Remarks of Senators Dodd and Proxmire). Activities that the institution had terminated prior to March 5,1988, however, would not be considered to have been conducted or engaged in "as o f’ March 5. For example, if within 13 months of March 5,1987, the nonbank bank had terminated its commercial lending activity in order to avoid the “bank” definition in the Act, the nonbank bank could not recommence that activity after enactment of CEBA. (d) Cross-marketing limitation.—(1 ) In general. Section 4(f)(3) also limits cross marketing activities by nonbank banks and their affiliates. Under this provision, a nonbank bank may not offer or market a product or setvice of an affiliate unless the product or service may be offered by bank holding companies generally under section 4(c)(8) of the BHC Act. In addition, a nonbank bank may not permit any of its products or services to be offered or marketed by or through a nonbank affiliate unless the affiliate engages only in activities permissible for a bank holding company under section 4(c)(8). These limitations are subject to an exception for products or services that were being so offered or marketed as of March 5,1987, but only in the 3ame manner in which they were being offered or marketed as of that date. (2 ) Examples of impermissible cross marketing. The Conference Report illustrates the application of this limitation to the following two covered transactions: (i) products and services of an affiliate that bank holding companies may not offer under the BHC Act, and (ii) products and services of the nonbank bank. In the first case, the restrictions would prohibit, for example, a company from marketing life insurance or automotive supplies through its affiliate nonbank bank because these products are not generally permissible under the BHC Act. Conference Report at 126. In the second case, a nonbank bank may not permit its products or services to be offered or marketed through a life insurance affiliate or automobile parts retailer because these affiliates engage in activities prohibited under the BHC Act. Id. (3) Permissible cross-marketing. On the other hand, a nonbank bank could offer to its customers consumer loans from an affiliated mortgage banking or consumer finance company. These affiliates could likewise offer their customers the nonbank bank’s products or services provided the affiliates engaged only in activities permitted for bank holding companies under the closely-related-to-banking standard of section 4(c)(8) of the BHC Act. If the affiliate is engaged in both permissible and impermissible activities within the meaning of section 4(c)(8) of the BHC Act, however, the affiliate could not offer or market the nonbank bank’s products or services. (4) Product approach to cross marketing restriction, (i) Unlike the activity restrictions, the cross-marketing restrictions of CEBA apply by their terms to individual products and services. Thus, an affiliate of a nonbank bank that was engaged in activities that are not permissible for bank holding companies and that was marketing a particular product or service of a nonbank bank on the grandfather date could continue to market that product and, as discussed below, could change the terms and conditions of the loan. The nonbank affiliate could not, however, begin to offer or market another product or service of the nonbank bank. (ii) The Board believes that the term “product or service” must be interpreted in light of its accepted ordinary commercial usage. In some instances, commercial usage has identified a group of products so closely related that they constitute a product line (e.g., certificates of deposit) and differences in versions of the product (e.g., a oneyear certificate of deposit) simply represent a difference in the terms of the product. 10 This approach is consistent with the treatment in CEBA’s legislative history of certificates of deposit as a product line rather than each particular type of CD as a separate product. 11 (iii) In the area of consumer lending, the Board believes the following provide examples of different consumer loan products: mortgage loans to finance the purchase of the borrower’s residence, unsecured consumer loans, consumer installment loans secured by the personal property to be purchased [e.g. automobile, boat or home appliance loans), o f second mortgage loans. 12 Under this interpretation, a nonbank bank that offered automobile loans through a nonbank affiliate on the grandfather date could market boat loans, appliance loans or any type of secured consumer installment loan through that affiliate. It could not however, market unsecured consumer loans, home mortgage loans or other types of consumer loans. (iv) In other areas, the Board believes that the determination as to what constitutes a product or service should be made on a case-by-case basis consistent with the principles that the terms “product or service” must be interpreted in accordance with their ■0 American Bankers Association, B an kin g i erm in o lo g y (1981). 11 During the Senate debates on CEBA, Senator Proxmire in response to a statement from Senator Cranston that the joint-marketing restrictions do not lock into place the specific terms or conditions of the particular grandfathered product or service, stated: That is correct. For example, if a nonbank bank w as jointly marketing on March 5,1987, a 3 year, $5,000 certificate of deposit, this bill Would not prohibit offering in the same manner a 1 year, $2,000 certificate of deposit with a different interest rate. 133 Cong. Rec. S3959 (daily ed. March 28,1987). 12 In this regard, the Supreme Court in U f itte d S ta te s v. P h ila d e lp h ia N atronsti Bemk, stated tfeafi "the principal banking products are of counts various types of credit, for example: unsecured personal and business loans, mortgage loans, loans secured by securities or accounts receivable, automobile installment and consumer goads, installment loans, tuition financing, bank credit cards, revolving credit funds." 374 U.S. 321. 328 (1963). 18 ordinary commercial usage and must be narrower in scope than the definition of activity. Essentially, the concept applied in this analysis is one of permitting the continuation of the specific product marketing activity that was undertaken as of March 5,1987. Thus, for example, while insurance underwriting may constitute a separate activity under CEBA, a nonbank bank could not market a life insurance policy issued by the affiliate if on the grandfather date it had only marketed homeowners’ policies issued by the affiliate. (5) Change in terms and conditions permitted, (i) The cross-marketing restrictions would not limit the ability of the institution to change the specific terms and conditions of a particular grandfathered product or service. The Conference Report indicates a legislative intent not to lock into place the specific terms or conditions of a grandfathered product or service. Conference Report at 126. For example, a nonbank bank marketing a three-year, $5,000 certificate of deposit through an affiliate under the exemption could offer a one-year $2,000 certificate of deposit with a different interest rate after the grandfather date. See footnote 11 above. Modifications that alter the type of prmfcct, however, are not permitted. Thus, a moffibanfe bash that marketed through affiliates on March 5 ,1S0J7, only certificates of deposit could not commence marketing MMDA's or MOW accounts after the grandfather date. (ii) General changes in the character of the product or service as the result of market or technological innovation are similarly permitted to the extent that they do not transform a grandfathered product into a new product. Thus, an unsecured line of credit could not be modified to include a lien on the borrower’s residence without becoming a new product (6 ) Meaning o f "offer or m a r k e t In the Board’s opinion, the terms “offer or market” in the cross-marketing restrictions refer to the presentation to a customer of an institution’s products or service thorough aay type of program, including telemarketing, advertising brochures, direct mailing, personal solicitation, customer referrals, or jointmarketing agreements or presentations. An institution must have offered or actually marketed the product or service on March 5 or shortly before that date (as discussed above) to qualify for the grandfather privilege. Thus, if the cross marketing program was in the planning stage on Match 5,1987, the program would not quality for grandfather of a particular product or service may treatment under CEBA. (7) Limitations on cross-marketing tobest be accomplished by applying the limitation to the particular facts in each “in the same manner” fi) The crosscase consistent with the staled purpose marketing restriction in section 4(f)(3) of this provision of CEBA and the contains a grandfather provistoss that permits products or sendees that would general principle that grandfather restrictions and exceptions to general otherwise be prohibited from being offered or marketed under the provision prohibitions must be narrowly construed to continue to be offered or marketed by in order to prevent the exception from nullifying the rale. Essentially, as in the a particular entity if the products of scops of the term ‘'product or service” services were being so offered or marketed as of March 5, 1987, but “only the guiding principle of Congressional in the same manner m which they were intent with respect to this te m is to permit only the continuation of the being offered or marketed as of that sepcific types of cross-marketing date.” Thus, to qualify for the activity that were undertaken as of grandfather provision, the manner of March 5,1987. offering or marketing the otherwise (8 ) Eligibility for cross-marketing prohibited product or service mast remain the same as on the grandfather grandfather exemption. The Conference date. Report also clarifies that entitlement to an exemption to continue to crosspi} In interpreting this provision, the Board notes that Congress designed th® market products and services otherwise prohibited by the statute applies only to joint-marketing restrictions to prevent the specific company that was engaged the significant risk to the public posed in the activity as of March 5,1987. by the conduct of such activities by insured banks affiliated with companies Conference Report* at 126. Thus, an engaged in general commerce, to ensure affiliate that was not engaged in cross objectivity in the' credit-grant tog process marketing products or services as of the and to “minimize the unfa If competitive grandfather date may not commence advantage that grandfathered these activities under the exemption commercial companies owmng nonbank even if such activities were being banks might otherwise engage over conducted by another affiliate. Id.: see regulated bank holding companies and also S. Rep. No. 100-19 at 33-34. our competing commercial companies (e) Eligibility for grandfathered nonbank bank status. In reviewing the that have m&subsidiary bank.'* reports required by CEBA, the Board Preference Report at 125—126. The notes that a number of institutions that Board be-Beves- that determinations regarding the mareree? of cross-marketing had not commenced business operations 19 on August 10,1987, the date of enactment of CEBA, claimed grandfather privileges under section 4(F)(3) of CEBA. To qualify for grandfather privileges under section 4(f)(3), the institution must have "bec[ojme a bank as a result of the enactment of (CEBA)” and must have been controlled by a nonbanking company on March 5,1987. 12 U.S.C. 1843(f)(1)(A). An institution that did not have FBIC insurance on August 10, 1987, and that did not accept demand deposits or transaction accounts or engage in the business of commercial fending on that date, would not have become a ''bank** as a result of enactment of CEBA. Thus, institutions that had not commenced operations on August 10,1987, could not qualify for grandfather privileges under section 4(f)(3) of CEBA. This view is supported by the activity limitations of section 4(f)(3), which, as noted, limit the activities of grandfathered nonbank banks to those in which they were lawfully engaged as of March 5, 1987. A nonbank bank that had not commenced conducting business activities on March 5,1887: could not after enactment of CEBA engage in any activities under this provision. Board of Governors of the Federal Reserve System, September 21,1988. William W. Wiles, Secretary of the Board. [FR Doc. 8S-21983 Filed 9-27-88; 8:45 amj SJLUItfS ©002