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4000 - Advisory Opinions

Regulation O: Presumption of Preferential Extension of Credit Where Only Bank Insiders Qualify for Favorable Rates


November 19, 1992

Pamela E.F. LeCren, Counsel

The following is in response to your September 2, 1992 request that the Washington, D.C. office of the FDIC's Legal Division review a determination by the FDIC's Dallas Regional Office that certain extensions of credit made by your client, [Bank A], violate Regulation O (12 C.F.R. 215). The loans in question were determined by the regional office to have been made on preferential terms because the directors received a more favorable interest rate than any other bank borrowers.

According to your letter, the bank made a number of loans to certain directors of the bank at the announced prime rate for Chase Manhattan Bank ("Chase Rate"). The bank has its own prime rate which is approximately 100 basis points higher ("Bank Rate"). You indicate that although the Bank Rate is made available to loan customers other than directors, to date only directors of the bank have been extended loans at the Chase Rate. This is so because no other borrowers qualify for the lower Chase Rate. You indicate that the loans are not preferential because the Chase Rate is available to other customers of the bank who have approximately the same financial condition, income and collateral as the bank's directors, but, simply put, no other customers are similarly situated. You indicate that each of the bank's directors is the bank's "best" customer and that he/she was invited to sit on the board of directors because of his/her special attributes, attributes which also warrant the bank extending a better rate on director loans. Among those attributes you list the following: creditworthiness, position as a business leader, and contacts in the community. You describe the bank's directors as a group as being among the few successful, prominent and influential business leaders in the community of [X]. You indicate that if the bank is unable to make Chase Rate loans to its directors, the bank may be unable to recruit directors or its directors may take their loan business elsewhere. (The bank's sister bank, [Bank B], makes the Chase Rate available to all of its similarly situated borrowers. [Bank B] has in fact made Chase Rate loans to directors as well as non- directors.) Finally, you urge the FDIC to conclude in any event that the Chase Rate and the Bank Rate are substantially the same.

As you are aware, Regulation O requires, among other things, that any extension of credit by an insured nonmember bank to any of its directors be made on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions by the bank with other persons who are not bank insiders. (§ 215.4(a)). A bank is not required by Regulation O to extend to its directors terms that are less favorable than those extended to others nor must the terms that are extended to a director be identical to those extended to other borrowers in order for the loans to satisfy the requirements of Regulation O. The terms of a loan are to be examined as a package. If, however, a particular term is given to a director that is not given to any other borrowers not associated with the bank and that term is more favorable than those extended to other non-insider borrowers, the FDIC must do a careful analysis of the bank's lending practices in order to determine if Regulation O has been violated.1

In determining whether a violation of Regulation O has occurred, the examiner must review comparable extensions of credit to non-insiders for the purpose of determining whether the overall package of terms associated with the comparable extensions of credit are substantially the same as the overall package of terms made available to the bank insiders who have obtained loans. This analysis is not a science, however, generally speaking if similarly situated insider borrowers and non-insider borrowers receive the same type of extensions of credit under terms and conditions (including interest rate) that are substantively equal, then there is no violation.

In essence you argue that your client does not have any similarly situated non-insider borrowers, i.e., that the directors are a class unto themselves and that the only comparable transactions are transactions with other directors. Although we are reluctant to adopt a posture that would not allow a bank to make a loan to a director based upon circumstances unique to that director, we are equally reluctant to adopt a posture that allows a bank to label its directors as more creditworthy than other customers. In short, we cannot accept without further inquiry a statement that there are no borrowers as worthy of the Chase Rate as the bank's directors.

When the FDIC discovers a situation in which bank directors receive a rate of interest on their loans that is more favorable than the rate given to any other non-insider borrower, it is legitimate for the FDIC to infer in the first instance that the criteria for eligibility for the more favorable rate may have been artificially drawn so that only the bank's directors would qualify. The inference of a violation is equally justified if the directors do not negotiate the terms of their loans individually but are simply extended the more favorable terms. This is especially so if the same terms are extended to all of the directors despite what may be some differences among the directors as to their creditworthiness. In such a case the presumption that the favorable term is based upon position is inescapable.2 What is more, if a particular type of loan is made to bank insiders but the bank does not normally make that type of loan, the loan may be said to be preferential and in violation of Regulation O by the mere fact that the loan was made at all.

We are not in a position to second guess the regional office in its analysis of the loans in question as this office has not reviewed the bank's loan files nor are we familiar with the bank's eligibility criteria for the Chase Rate and whether that criteria gives an advantage to board directors. If the regional office is satisfied that the terms and conditions under which the director loans are made available are not substantially the same, when taken as a whole, as the terms and conditions under which comparable loans are made available to non-insider borrowers, this office will not offer a different opinion. While we acknowledge that it is possible that two loans can differ in their stated interest rate by 100 basis points without the loan which has a more favorable interest rate being determined to be preferential, that conclusion is dependent on an overall comparison of the loans and the bank's overall lending practice (i.e., the prevailing terms and conditions offered by the bank).

1FDIC 86--117k (May 28, 1987), Par. 5090. Go back to Text

2FDIC 86--92k (March 17, 1987), Par. 5086. Go back to Text

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