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4000 - Advisory Opinions

Regulation O: Demand Loans at Preferential Interest Rates


August 17, 1981

Barbara I. Gersten, Attorney

This will respond to your telephone inquiry of August 6, 1981. You asked whether, if demand loans made to bank insiders and non-insiders alike are continued at the original interest rate (which was not preferential when the loans were made) such loans would now be considered preferential. You noted that this is a recurring question, especially with regard to small rural banks which may have a policy not to increase the interest rate, whether the loans are to insiders or non-insiders.

Regulation O, in pertinent part, provides that loans to covered insiders and their related interests (1) must be made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions by the bank to other persons not covered by Regulation O (and not employed by the bank), and (2) must not involve more than the normal risk of repayment or present other unfavorable features. (12 C.F.R. § 215.4(a)). In short, a loan is preferential if it can be said that but for insider status, the insider would not have been able to obtain the loan; however, it is permissible to accord an insider a better interest rate than the prevailing rate, if it can be justified (i.e., the insider is credit worthy, collateral is adequate, the bank would accord a similarly situated non-insider the same treatment).

Importantly, the prohibition against preferential insider loans is prospective only. Preferential insider loans outstanding as of March 10, 1979 (the effective date of Regulation O), especially demand loans, should be renegotiated as soon as practicable in accordance with the operative policy of the FDIC and the other agencies administering Regulation O.

We have taken the position that where demand loans made prior to March 10, 1979 were not preferential when made and were made to a class of persons comprising insiders as well as a reasonable number of non-insiders, the loans will not be considered preferential where the bank now raises the interest rate, but to a level less than the prevailing rate. Similarly, with regard to the question you have posed, where the loans were non-preferential when made and were made to insiders as well as a reasonable number of non-insiders, such loans would not now be considered preferential merely because the bank did not raise the interest rate to the prevailing rate.

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