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4000 - Advisory Opinions

Regulation O: Extension of Credit


October 30, 1989

Pamela E. F. LeCren, Senior Attorney

I have reviewed your letter to John Douglas, General Counsel, FDIC, requesting an opinion on the interpretation of § 215.3(f) of Federal Reserve Board Regulation O (12 C.F.R. 215.3(f)) made applicable to insured nonmember banks by § 18(j)(2) of the Federal Deposit Insurance Act (12 U.S.C. 1818(j)(2)). Section 215.3(f) provides that an extension of credit is considered made to a person covered by Regulation O "to the extent that the proceeds of the extension of credit are used for the tangible economic benefit of, or are transferred to, such a person."

In your letter you generally describe a situation in which an unnamed bank has made an extension of credit to a company that provides management services to a related interest of a principal shareholder of the bank. You further indicate that the extension of credit was for "working capital" purposes and that some of the proceeds of the extension of credit were used by the borrower to extinguish "a legal obligation" of the borrower to the related interest. Your letter invites the FDIC to concur in your opinion that the simple transfer of loan proceeds to a related interest of a bank insider (and equally the fact that a related interest of a bank insider benefited from an extension of credit) should not trigger the application of § 215.3(f) thus subjecting the extension of credit to Regulation O.

We are unable to render an opinion on the specific fact situation raised in hour letter as we have not been provided sufficient information. We can, however, respond generally on the issue of the application of § 215.3(f).

This office has had occasion to indicate that, generally speaking, if the proceeds of an extension of credit are transferred to someone covered by Regulation O, or if someone covered by Regulation O receives a direct or indirect economic benefit from an extension of credit, that extension of credit will be considered made to such covered person. This position is consistent with a decision issued by the FDIC's Board of Directors in which it was indicated that an extension of credit which indirectly benefited a related interest of a principal shareholder was covered by Regulation O (FDIC Docket No. FDIC--85--2k, FDIC Enforcement Decisions, vol. 2, Par. 5063, p.6614) and a Board decision in which it was indicated that the benefit conferred on a covered person by an extension of credit need not be part of a scheme designed to benefit covered persons in order for the extension to be brought within § 215.3(f). All that is necessary is that there was in fact a benefit to a covered person. (FDIC Docket No. 84--23b, FDIC--84--67k, FDIC Enforcement Decisions, vol. 2, Par. 5061, p.6515.)

The latter decision involved loans to persons who purchased stock issued by a related interest of an insider with the proceeds of a loan from the insider's bank. The proceeds were clearly transferred to the related interest and the loan was tantamount to an infusion of capital which directly benefited the related interest. In the Board's opinion it was not material that the purchasers also benefited from the loan and that there was no "scheme" to benefit persons subject to Regulation O.

In applying the "tangible economic benefit" language found in § 215.3(f) staff has had occasion to "step back'' from a strict application of the general rule in circumstances in which third parties (i.e., consumers) have obtained loans from a bank and used the proceeds to purchase goods or services from a person covered by Regulation O. We have thus contrasted consumer purchases with situations in which proceeds of a loan are used to pay the interest and/or principal owed by a covered person to the bank and situations in which the proceeds of a loan are used by the debtor to buy out the interest of a covered person in a venture. The exception has been applied, however, to consumer purchases only if the loan was extended on an arms-length basis (e.g., the insider did not arrange for the loan to be made), the loan conformed to safe and sound banking practices, and the borrower is creditworthy. We have adopted this treatment of consumer relationships on the theory that Regulation O should not be construed to prevent arms-length consumer purchases which are not detrimental to the bank and which are not likely to have arisen solely as a result of an insider's influence on the bank's lending practices.

In that vein we have said that if, for example, an insider's related interest which is a car dealership obtains financing for the bulk of its sales through the insider's bank (i.e., obtains a commitment from the bank to lend to the car dealer's customers, refers all or substantially all of its customers to the bank to obtain financing which is in fact forthcoming, etc.) the loans should be covered under Regulation O as they were extended for the tangible economic benefit of the insider's related interest.

Conversely, if a consumer obtains a loan on an arm's-length basis from a bank for the purchase of an automobile which happens to be purchased from a related interest of a bank insider, the loan would not be covered by Regulation O absent some unusual circumstances.

I hope the above is helpful. If you have any further questions, please do not hesitate to call me at (202) 898-3730.

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