SRC Insights: Second Quarter 2007

The Financial Services Regulatory Relief Act of 2006

by Chris Hahne, Assistant Examiner

On October 13, 2006, President Bush signed into law the Financial Services Regulatory Relief Act of 2006 (act).¹ The act is the result of five years of legislative, regulatory, and industry input; Congressional negotiation; and an extensive review of the various federal banking agencies (the agencies) and their guidance. While the final version of the act does not contain some of the broader items that the industry sought, it does contain a number of items that should provide some regulatory relief to financial institutions.

A number of the act's provisions update how the agencies conduct their business, while others clarify or amend portions of the Gramm-Leach-Bliley Act (GLBA). Additionally, the act allows the Federal Reserve to pay interest on certain reserve balances held on deposit at Federal Reserve Banks and gives the Board of Governors of the Federal Reserve greater flexibility in setting reserve requirements. Other provisions modify the regulatory standards for certain types of financial transactions and expand and clarify federal authorities and procedures in sharing data, retaining records, and scheduling examinations.

A brief description of the more salient points that directly affect both regulators and the banking industry are discussed below, followed by a cursory overview of other select provisions of the act. It should be noted that some of the interim rules stated in the act are currently open for public comment.

Key Provisions of the Act
The act includes the following key provisions:

Authorizes the payment of interest on institution balances held at Federal Reserve Banks
Increases the flexibility of the Federal Reserve to set institution reserve ratios against transaction accounts
Allows the use of "pass through" accounts for state member and nonmember banks
Extends the examination cycle for certain depository institutions
Reduces reporting requirements for financial institutions related to insider lending
Expands the enforcement authority and removal activities of the federal banking agencies

A brief summary of some of the key elements in these provisions follows. However, all of the changes in the act, including those discussed below, must be considered in their full context and in conjunction with existing laws and regulations.

Interest on reserves and reserve ratios. Among the act's most important provisions are two that relate to reserve requirements. Effective October 1, 2011, the Federal Reserve is authorized to pay interest on reserve balances held by depository institutions in Federal Reserve Banks (Section 201). The act also gives discretion to the Board of Governors (Board) to lower the required reserve ratios for transaction accounts (Section 202).

Additionally, Section 603 provides for member banks of the Federal Reserve System to count as reserves the deposits in other banks that are "passed through" by those banks to the Federal Reserve as required reserve requirements; nonmember depository institutions are already able to do this.

Examination cycles. Perhaps one of the most significant aspects of the act is Section 605, which increases the asset threshold from $250 million to $500 million for community banks to qualify for an 18-month on-site safety and soundness examination cycle. The expanded examination cycle will be available for institutions that are well-capitalized and well-managed, have a composite CAMELS rating of 1 or 2, and meet certain other qualifying criteria.²

Prior to this legislation, depository institutions with greater than $250 million in assets were examined on an annual basis. This change in examination cycles may affect the supervision of a number of depository institutions within the Third District. Federal Reserve Chairman Ben S. Bernanke recently stated that this change in examination cycles "will allow about 1,200 federally-insured institutions to qualify for an extended examination cycle without compromising the safety and soundness" of the institutions.³

Insider lending. Section 601 of the act amends the Federal Reserve Act and Bank Holding Company Act by reducing reporting requirements for loans made to insiders who are subject to Regulation O.⁴ Though the amendment does not provide any change to the requirements covering extensions of credit, the act repeals certain regulatory reporting requirements for loans to bank executive officers and principal shareholders. Specifically, the following reporting requirements have been repealed:

The report to the board of directors that is required by Section 215.9 when an executive officer becomes indebted to another institution
The report that the institution must file under Section 215.10 all extensions of credit made to executive officers since the previous report of condition
The report to the board of directors that is required by Subpart B of Regulation O, when an executive officer or principal shareholder becomes indebted to a correspondent bank

Enforcement provisions. The act includes a variety of enforcement-related provisions that generally serve to enhance the enforcement and removal authority of the agencies.

Section 708-Expands the removal and prohibition authority of the federal banking agencies when an institution-affiliated party is the subject of any information, indictment, or complaint, including coverage of individuals who attempt to become involved with an insured depository institution after being so charged. Additionally, the statute clarifies that the removal or prohibition extends to any depository institution, not just the institution for which the institution-affiliated party currently serves.
Section 710-Extends the automatic prohibition on participation in the banking industry if a person is found convicted of a criminal offense involving dishonesty, breach of trust, or money laundering to include noninsured national and state member banks and uninsured offices of foreign banks. Also prohibits an individual so convicted from participating in the affairs of a domestic bank holding company (BHC) or an edge or agreement corporation without the consent of the Board of Governors and from participating in the affairs of a savings and loan holding company or any of its nonthrift subsidiaries without the consent of the Office of Thrift Supervision (OTS). Gives the Board of Governors greater discretion to prevent convicted individuals from participating in the affairs of a nonbank subsidiary of a BHC. Provides the Board of Governors and the OTS permission to grant exceptions from this prohibition to BHCs and savings and loan holding companies, respectively.
Section 702-Among other provisions, clarifies that the agencies may enforce any condition imposed in writing in connection with any application or any Written Agreement entered into between the agency and a depository institution or institution-affiliated party (IAP) (particularly those in which the IAP or controlling shareholder agrees to provide capital to the depository institution) without the requirement that the agency must prove that there is unjust enrichment by the IAP or limiting recovery to five percent of the depository institution's assets at the time the institution became undercapitalized.
Section 715-Among other provisions, clarifies that the federal banking agencies may initiate an enforcement action by notice or order against any institution-affiliated party, regardless of whether the institution-affiliated party resigned from the depository institution.

There are a number of other provisions that are included in the act that affect the banking industry. Highlights of some of the more significant provisions are described below.

Broker Relief
Section 101 of the act directs the Securities and Exchange Commission (SEC) and the Federal Reserve, in consultation with the other federal banking agencies, to adopt final rules to implement the exceptions to the definition of "broker" under Section 3(a)(4) of the Securities and Exchange Act of 1934 as amended by GLBA. While the SEC has longstanding proposed rules that have generated significant controversy in the industry, they have not been implemented. The SEC announced in September 2006 that final rules would be issued by early summer 2007.

The new rulemaking process provides depository institutions the opportunity to align more closely with the specific exemptions in GLBA and the bank securities transactional services common in the industry at the time of GLBA's enactment. In addition, federal savings associations were exempted by the act from investment advisor and broker-dealer regulations to the same extent that banks are otherwise exempt.

Other Noteworthy Provisions
Section 604 directs the agencies to review certain information and schedules required to be filed in a report of condition every five years to determine whether the continued collection of such information or schedules is no longer necessary or appropriate.

Section 728 of the act directs eight federal regulators (the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Federal Trade Commission, the National Credit Union Administration, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Securities and Exchange Commission) (the privacy agencies) to develop model privacy notice forms to implement the privacy provisions of GLBA.

The act specifies that the model forms must be comprehensible to consumers, with a clear format and design; provide for clear and conspicuous disclosures; enable consumers to easily identify the sharing practices of a financial institution and compare privacy practices among financial institutions; and be succinct, with an easily readable font. On March 21, 2007, the privacy agencies announced a proposed rulemaking for the model forms they developed, for which they are seeking comments.⁵

Under the act's safe harbor provision, financial institutions adopting the model forms will be deemed compliant with the GLBA notice requirements. Because the model forms will supersede the sample clauses currently contained in GLBA, the safe harbor for the sample clauses will expire for notices provided more than one year after the date of publication of a final rule for the model forms. Financial institutions wanting to take advantage of the safe harbor should therefore adopt the model forms once the privacy agencies announce their final rule.

Finally, sections 1001 and 1002 of the act direct that the Comptroller General conduct a study and report to Congress on various matters pertaining to anti-money laundering reporting issues; regulatory oversight and charter options for depository institutions based on size, complexity, and diversity; and possible efficiencies from consolidation of financial regulators and charter simplification.

Conclusion
The Financial Services Relief Act of 2006 contains a number of provisions aimed at reducing the overall regulatory burden on depository institutions. The goal is to provide some level of regulatory relief, a gain of efficiencies, and assistance to improve productivity for financial institutions and the federal banking agencies.

¹ The full text of the Financial Services Regulatory Relief Act of 2006 is available online.
² See 12 CFR 4.6 and 4.7 (OCC), 12 CFR 208.64 and 211.26 (Board), 12 CFR 337.12 and 347.211 (FDIC), and 12 CFR 563.171 (OTS).
³ "Banking Regulation and Supervision: Balancing Benefits and Costs," The Federal Reserve Board, Remarks by Chairman Ben S. Bernanke before the Annual Convention of the American Bankers Association in Phoenix, Arizona and the Annual Convention of America's Community Bankers, San Diego, California, October 16, 2006.
⁴ The full text of Regulation O, Loans to Executive Officers, Directors and Principal Shareholders of Member Banks.
⁵ The proposed rulemaking can be viewed on the Board's website.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.

SRC Insights: Second Quarter 2007

The Financial Services Regulatory Relief Act of 2006

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