United States

Author: | Published: 30 Sep 2004
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General regulatory framework

How is the business of banking regulated in the US?

To say that the bank regulatory framework is complex is an understatement. Four main federal banking agencies regulate banks and, if the institution is chartered by one of the states, there will also be a state regulatory agency involved. The Office of the Comptroller of the Currency (OCC) regulates all national banks. State-chartered banks are regulated either by the Federal Deposit Insurance Corporation (FDIC) or the Board of Governors of the Federal Reserve System (FRB), depending upon whether the bank elects to become a member of the Federal Reserve System. The Office of Thrift Supervision will regulate all state and federally chartered savings and loan associations. If the bank or savings and loan association is chartered by one of the states, a state banking agency will also regulate and supervise the institution.

Bank regulation in the US is comprehensive, and governs virtually all aspects of the activities of such institutions.

What approvals are required in connection with banking activities?

Specific licences and approvals are required to establish a bank. These include an authorization from the agency that will charter the institution (either the OCC or OTS if a nationally chartered bank or savings institution and the state if state-chartered), as well as an approval from the FDIC to accept deposits. Separate approvals will be required to establish branches in new locations, to merge with or acquire other banks or financial institutions, and to engage in specific activities outside a pre-approved laundry list of permissible activities. Approval will be required before exercising trust or fiduciary powers.

What supervisory powers do the regulatory authorities have over banking institutions?

The banking regulatory authorities routinely examine the activities and condition of banking institutions to determine whether or not they are being operated in accordance with statutory and regulatory requirements and in a safe and sound manner. Banks must routinely file reports with the agencies regarding their activities and condition. To the extent that the regulatory authorities determine that corrective action is required, they have been given a panoply of enforcement tools.

Much of the corrective action taken by the regulatory authorities is informal, arising from the ongoing dialogue between the institution and the regulator, but the authorities may use formal enforcement actions if there is a violation of law, rule or regulation, violation of an agreement or commitment to the regulator, or the institution is in an unsafe or unsound condition or is engaging in unsafe or unsound banking practices. These powers include the ability to issue cease-and-desist orders, require that certain actions be stopped or conditions be corrected; impose civil money penalties that could range up to $1 million per day per violation; issue removal and prohibition orders, requiring the removal of managers, officers, directors or other employees and prohibiting them from participating in the affairs of a financial institution; or revoke the deposit insurance of the institution, thus effectively requiring it to cease operations. Before the initiation of a formal enforcement action, however, the regulators are required to provide prior notice of the basis for the action, and the affected party has the opportunity for a hearing.

The US has adopted a prompt corrective action regime, where the regulatory authorities are required to impose certain restrictions on the activities and operations of an institution if it fails to meet required capital standards. Institutions are characterized as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized depending upon the capital level. Institutions should remain well capitalized to avoid the restrictions on activities. To be well-capitalized, an institution should have a ratio of tier I capital (primarily common equity and non-cumulative preferred stock) to total assets of not less than 5%, a ratio of tier I capital to risk-adjusted assets of not less than 6%, and a ratio of total capital to risk-adjusted assets of not less than 10%. A critically undercapitalized institution (one with a ratio of tier I capital to total assets of less than 2%) will generally be closed.

What regulatory regime governs the conduct of business with customers?

To list all of the regulatory requirements relating to dealing with customers would be virtually impossible in a summary such as this. The more important regulations include:

  • Truth in lending, requiring accurate disclosure of the interest rates and charges on extensions of credit to consumers.
  • Truth in savings, requiring the accurate disclosure of interest rates and fees on deposits received from consumers.
  • State interest and usury limits, setting out maximum permissible interest rates that may be charged on certain types of loans.
  • Limitations on loans to one borrower, limiting the amount of loans or other extensions of credit that may be made to a single borrower and its related parties.
  • State and federal privacy laws, limiting the use of information obtained from consumers.
  • Fair lending laws, prohibiting discrimination in providing loans.
  • The Community Reinvestment Act, which requires banking institutions to assess and meet the credit needs of their communities, including low- and moderate-income neighbourhoods.
  • Extensive restrictions to transactions with affiliated parties.

Supervisory requirements

What are the capital requirements applicable to banking institutions in the US?

Banks in the US are subject to the risk-based capital requirements derived from the Basel Accord, supplemented by a leverage test. In general, banks are expected to maintain a ratio of tier I capital to risk-adjusted assets of not less than 6%, a ratio of total capital to risk-adjusted assets of not less than 10%, and a ratio of tier I capital to total (non-risk-adjusted assets) of not less than 5%. The regulators impose an ever-increasing scheme of restrictions as banks fall below these standards.

What effect will Basel II have on banking institutions in the US?

The Basel II requirements will apply only to the large, internationally active financial institutions in the US. Other large institutions may elect to comply with the Basel II requirements if they wish, but compliance will not be mandatory. Smaller institutions will not be expected to comply. The Basel II requirements will become applicable for these large institutions on January 1 2007. The US regulators continue to discuss whether there should be adjustments to the Basel II requirements for US institutions.

Do the supervisory requirements include operational and organizational requirements relating to internal controls and operational risks?

Internal controls and operational risks are part of the evaluation of every financial institution and are incorporated into the on-site supervision carried out by the regulatory agencies. Since 1991 each financial institution has been required to certify as to the adequacy of its systems and controls, and the regulators evaluate the adequacy of such systems as part of their overall evaluation of the strength of the institution. These requirements have been strengthened as a result of the Sarbanes-Oxley Act passed as a result of several of the corporate accounting scandals of 2002 and 2003.

What are the anti-money laundering obligations of financial institutions?

The US has long required banks to report large cash transactions and advise the legal and regulatory authorities of possible illegal transactions, but the obligations have been substantially increased as a result of the terrorist activities of September 11 2001. As a result of the passage of the so-called USA PATRIOT Act, banks are required to substantially strengthen their know-your-customer procedures, enhance their anti-money-laundering programmes, designate a responsible compliance officer, and implement extensive training and effective internal auditing function.

Regulation of owners of financial institutions

What approval requirements exist before one may obtain control of a financial institution?

As a general matter, companies that control banking institutions are required to register with and are subject to the examination and supervision of the FRB. Companies include corporations, partnerships and virtually any other form of business enterprise. Control is defined as the ownership of 25% or more of any class of voting stock of the institution, directly or indirectly, the power to select a majority of the board of directors of the institution or the power to exercise a controlling influence over the management or policies of the institution. Before a company may acquire control, it must receive the prior approval of the FRB.

Companies that control savings and loan institutions are required to register with and obtain the approval of the OTS before obtaining control. Control is defined similarly to that set out above.

Individuals seeking to obtain control over a financial institution must first file a notice with the appropriate federal banking regulatory authority. The regulator has a limited period to consider the notice, and may deny the notice if the proposal fails to satisfy managerial and financial criteria. Control for the purposes of this statute is defined in the same manner as outlined above; however, control will be presumed at the 10% level (rather than at 25%) if the institution has publicly traded shares or if the holder would become the largest stockholder of the institution.

What activity restrictions are imposed on controlling owners of financial institutions?

Companies that control banks are known as bank holding companies, and may only engage in banking, in managing and controlling banks, and in other activities so closely related to the foregoing as to be a proper incident thereto. The list of permissible activities includes a variety of credit related functions (such as lending and leasing), certain securities brokerage activities, limited data processing activities and other activities and services commonly performed by banks in the US.

Bank holding companies that are well capitalized, well managed and meet certain other financial requirements may become financial holding companies, and may also engage in a variety of insurance and securities activities (including underwriting) and other financial activities.

Bank holding companies are required to obtain prior approval from the FRB before merging with or acquiring 5% or more of the shares of another bank holding company or bank. Approvals may be required before engaging in certain activities, depending upon the condition of the bank holding company and whether or not the activity is on the laundry list of permissible activities for bank or financial holding companies.

Companies that control savings institutions are known as savings and loan holding companies. Under current law, only companies engaged in financial activities (similar to those permissible for financial holding companies) may acquire control of savings and loan associations, effectively limiting the activities of such institutions. However, this is a recent addition to the legal framework of the US. A number of companies acquired savings institutions before the effective date of this law, and are not bound by this restriction.

Certain specialized financial institutions, such as credit card banks, industrial loan companies and trust companies, while still offering an array of banking services, are not covered by the bank and savings and loan holding company restrictions outlined above.

There are no activity restrictions imposed on individuals that may control financial institutions.

States may impose approval requirements for individuals or entities before obtaining control of state-chartered institutions.

Investor protection

Have there been any recent significant changes to insolvency legislation in your jurisdiction, or are any such changes proposed?

There have been no significant changes to the insolvency regime in the US in several years, either as they may affect corporate entities, financial institutions or individuals. The US has separate bankruptcy and receivership provisions that apply to banking institutions, and that those provisions differ in meaningful ways from the provisions that apply to corporate entities.

Does your jurisdiction operate a deposit protection or guarantee scheme protecting retail depositors from loss in the event of insolvency of an authorized bank?

The US has an extensive deposit insurance scheme administered by the FDIC. Banks and savings institutions are, with extremely limited exceptions, required to participate in this system. As a general matter, deposits in a bank are insured in amounts up to $100,000 per depositor.

If a bank or savings institution becomes insolvent, the FDIC will appoint a receiver of the institution, and will be required to handle the receivership. As a practical matter, insured depositors will have access to their funds (up to the amount of the deposit insurance) without interruption after the failure, as the FDIC will generally immediately arrange for another financial institution to assume those deposit liabilities. The FDIC has broad powers to sell the failed institution or its assets, to determine claims against the institution and otherwise administer its affairs. In administering the affairs of the insolvent institution, the proceeds received from the sale of the assets will be allocated among various classes of creditors, with depositors among the highest priorities. It is possible that a depositor may receive more than $100,000 for a large deposit if the proceeds of the assets are enough. However, as the assets of the institution are rarely enough to cover the claims of all depositors, it is likely that a general unsecured creditor of a bank will suffer some loss as a result of the failure.

Does your jurisdiction have an ombudsman scheme, arbitration scheme or similar scheme for the resolution of disputes between a bank and its retail customers other than through formal legal proceedings?

The US does not have a mandatory ombudsman or arbitration scheme for the resolution of bank/customer disputes. Banks may establish ombudsmen if they wish to help avoid formal legal proceedings, and banks and customers may agree to use arbitration in connection with disputes. Arbitration clauses are commonly included in bank/customer agreements and have generally been upheld by the courts.

Author biography

John Douglas

Alston & Bird

John Douglas heads the bank regulatory practice at Alston & Bird, and practices from the firm's Washington DC and Atlanta offices. As former general counsel of the FDIC, his practice involves advising clients in navigating the complex regulatory structure in the US. As examples, he assisted six international banks and a card association in the formation of a large global payments processing company. He represented senior officers of Riggs Bank, Credit Lyonnais and Freddie Mac in dealing with regulatory enforcement actions, and is advising The Bank of New York in an $800 million dispute with the FDIC over the failure of NextBank.



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