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4000 - Advisory Opinions

Request for Opinion on Compensating Balance Arrangement as Violation of Title VIII of FIRA and 18 U.S.C. 656


April 8, 1980

Barbara I. Gersten, Attorney

This responds to a request for an opinion on whether a compensating balance arrangement described in Regional Director Sexton's letter of January 24, 1980 to John J. Early, former Director, Division of Bank Supervision, is in violation of Title VIII of the Financial Institutions Regulatory and Interest Rate Control Act of 1978 ("FIRIRCA") and 18 U.S.C. § 656.

The facts presented do not fully develop the information necessary for the Legal Division to preliminarily determine whether a violation of Title VIII exists. It appears that a violation of section 656 may exist, however, the ultimate determination rests with the U.S. Attorneys charged with enforcement of Title 18.

I. Factual Background.

The related business interest of a director of Bank A obtained a direct loan from Bank C, a national bank correspondent of Bank A. Bank C requested and obtained from Bank A a compensating demand balance equal to 8% of the loan to the related interest of Bank A's director. The arrangement was documented in writing. Bank A apparently contends that the compensating balance is a flow-through of collected funds the director has at Bank A, and that it is not accurately construed as bank funds. A regional office investigation revealed no backup compensating balance arrangement at Bank A. Funds of the director's interest maintained at Bank A average less than 10% of the compensating balance required by Bank C. In total and on the average, however, all deposits controlled by the director at Bank A are slightly in excess of the balance required at Bank C. Bank A does not require compensating balances on its loans to its directors. The regional office has reported this matter to the United States Attorney as a possible violation of 18 U.S.C. § 656.

II. Possible Violation of Title VIII.

Title VIII of FIRIRCA ("Correspondent Accounts") (12 U.S.C. § 1972), which amends Section 106(b) of the Bank Holding Company Act Amendments of 1970, in pertinent part provides that extensions of credit may not be made to executive officers, directors and principal shareholders of a bank by its correspondent bank unless the extension of credit is made on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment or present other unfavorable features (i.e., the extension of credit must not be "preferential"). The statute does not expressly prohibit preferential extensions of credit to related interests of persons subject to the prohibitions of Title VIII.

The instant case involves a loan made to the related interest of a director of Bank A. If it can be shown that the director received a tangible economic benefit from the extension of credit to the related interest, then the extension of credit may be deemed to have been made to the director and thus would come within the prohibitions of Title VIII. The facts as stated do not go to this evidentiary question.

For a Title VIII violation to exist, it must be assumed that the extension of credit was for the director's benefit and further, that it was made after the March 10, 1979 effective date of Title VIII, or that it was made before that date and is subject to renewal. Such renewable extensions of credit are treated as new extensions of credit at the time of renewal, and must comport with Title VIII. It must further be established that the extension of credit is preferential.

In the instant case, the extension of credit to the director's related interest may be characterized as preferential by comparing it with other similar transactions. It may perhaps be shown that but for the compensating balance, Bank C would not have extended credit to the Bank A director. The stated facts do not establish this sufficiently so that the existence of a Title VIII violation may be determined. The fact that the extension of credit to the related interest is directly tied to the maintenance of a compensating balance is not determinative in assessing a violation of the Title VIII prohibitions, which appear in section 106(b)(2)(B) of the Bank Holding Company Act Amendments of 1970. Although the Title VIII prohibitions are inserted here as an amendment to the Act, they are unrelated to the pre-existing anti-tying provisions found in section 106(b)(1). That section provides in general that extensions of credit may not be conditioned upon the customer's use of another service provided by the lending bank. Traditionally, under section 106(b)(1) the use of compensating balances in connection with the maintenance of correspondent accounts has been sanctioned.

III. Possible Violation of 18 U.S.C. § 656.

Section 656 provides in pertinent part that a director who willfully misapplies bank funds shall be fined and/or imprisoned. Use of an inter-bank deposit as a compensating balance for a loan to an official of the depositing bank has been found to constitute misapplication under section 656.1

If the compensating balance arrangement between Bank A and Bank C is a necessary condition for the extension of credit by Bank C to an interest of Bank A's director, it may constitute a violation of section 656 if Bank A lacks economic justification for maintaining the correspondent balance at Bank C (i.e., Bank C is not performing usual banking services for Bank A). If this is the case, the arrangement results in a diversion of income from Bank A for which the Bank A director apparently has been responsible, and thus constitutes a misapplication of bank funds by the director.2 Any determination the Legal Division may make with respect to the application of section 656 is not binding, as enforcement of Title 18 of the U.S. Code rests with the U.S. Attorneys who ultimately determine whether a given set of facts constitute evidence that the section has been violated.

IV. Conclusion.

The facts presented are not sufficient to determine whether violations of Title VIII and/or section 656 exist. To establish a Title VIII violation in the instant case, it must be shown that the extension of credit to the director's related interest benefitted him in a tangible economic way and was made on preferential terms. It appears that a violation of section 656 may exist if maintenance of the compensating balance constitutes a diversion of income from Bank A. The final determination, however, rests with the U.S. Attorney as to the section 656 violation.

1 U.S. v. Brookshire, 514 F.2d 786 (C.A. Okla. 1975). The case is extensively cited. Go back to Text

2 Importantly, to establish a section 656 violation, it is not necessary to show that the extension of credit to the director is preferential. Go back to Text

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