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4000 - Advisory Opinions

Regulation O: Prohibition on Preferential Loans


June 19, 1980

Pamela E. F. LeCren, Attorney

In response to your May 6, 1980 letter requesting information as to the basis upon which Regulation O (12 C.F.R. Part 215) prohibits preferential loans to bank officers, please be advised that the regulation is based upon section 22(h) of the Federal Reserve Act (12 U.S.C. § 375(b)). Section 22(h), which was added to the Federal Reserve Act by section 104 of the Financial Institutions Regulatory and Interest Rate Act of 1978 ("FIRIRCA") specifically provides that a member bank may not make preferential loans to its directors, executive officers, principal shareholders or their related interest. Section 108 of FIRIRCA made that prohibition applicable to nonmember insured banks to the same extent as though they were member banks.

The statute does not by its terms prohibit preferential loans to other employees. As evidenced by the following statement taken from the House Report accompanying FIRIRCA, the apparent intent of Congress was to insulate banks from the harmful effects of self-dealing, i.e., loans to insiders.

Active officers who hold their positions at the pleasure of the board and shareowners are subject to influence and therefore are not usually in a position to evaluate and reject those credits on the same basis as the credit requests of other bank customers. In a situation of this nature, active management will often vigorously defend the unsound loans or other self-dealing practices perpetrated upon the bank by the owners.1

Presumably there was little or no perceived harm in permitting employee benefits (including preferential loans) to be extended to persons not in a position to influence or control the bank and its policies. The House Report reflects the fact that the Committee had before it ample evidence linking a high incidence of bank failure with insider abuses. Whether or not a court of law would uphold the statute if it were challenged, as you suggest, for being discriminatory (bank insiders are denied fringe benefits available to employees in other industries) is a matter of speculation. In all probability the statute would be upheld under the rational basis test normally utilized in considering whether or not an economic measure is constitutional. Suffice it to say that, until such time as the statute would be successfully challenged, the regulation is fully supported by federal law and member and nonmember insured banks are subject thereto.

1 H.R. Rep. 95-1383, 95th Cong., 2d Sess. 10 (1978). Go back to Text

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