The Federal Reserve establishes standards designed to ensure that banking organizations

operate in a safe and sound manner and in accordance with applicable law.

tions are consistent with sections 23A and 23B of the Federal Reserve Act, as implemented by the Federal Reserve Board’s Regulation W. Since the GLB Act increased the range of affiliations permitted to banking organizations, sections 23A and 23B play an increasingly important role in limiting the risk to depository institutions from these broader affiliations. Among other things, section 23A prohibits a bank from purchasing an affiliate’s low-quality assets. In addition, it limits a bank’s loans and other extensions of credit to any single affiliate to 10 percent of the bank’s capital and surplus, and it limits loans and other extensions of credit to all affiliates in the aggregate to 20 percent of the bank’s capital and surplus. Section 23B requires that all transactions between a bank and its affiliates be on terms that are substantially the same, or at least as favorable, as those prevailing at the time for comparable transactions with nonaffiliated companies. The Federal Reserve Board is the only banking agency that has the author-

ity to exempt any bank from these requirements. During the course of an examination, examiners review a banking organization’s intercompany transactions for compliance with these statutes and Regulation W.

Regulatory Functions

As a bank regulator, the Federal Reserve establishes standards designed to ensure that banking organizations operate in a safe and sound manner

and in accordance with applicable law. These standards may take the form of regulations, rules, policy guidelines, or supervisory interpretations and may be established under specific provisions of a law or under more general legal authority. Regulatory standards may be either restrictive (limiting the scope of a banking organization’s activities) or permissive (authorizing banking organizations to engage in certain activities). (For a complete list of Federal Reserve regulations, see appendix A.)

In many cases, the Federal Reserve Board’s regulations are adopted to implement specific legislative initiatives or requirements passed by Congress. These statutory provisions may have been adopted by Congress to respond to past crises or problems or to update the nation’s banking laws to respond to changes in the marketplace. For example, in response to the savings and loan crisis and financial difficulties in the banking industry in the late 1980s and early 1990s, Congress enacted several laws to improve the condition of individual institutions and of the overall banking industry, including the Competitive Equality Banking Act of 1987; the Financial Institutions Reform, Recovery, and Enforcement Act of 1989; and the Federal Deposit Insurance Corporation Improvement Act of 1991. These legislative initiatives restricted banking practices, limited supervisors’ discretion in dealing with weak banks, imposed new regulatory require- ments—including prompt corrective action—and strengthened supervisory oversight overall.

The Federal Reserve is responsible for changes in the control of bank holding companies and state member banks.

Reserve before acquiring more than 5 percent of the shares of an additional bank or bank holding company. All bank holding companies must file certain reports with the Federal Reserve System.

When considering applications to acquire a bank or a bank holding company, the Federal Reserve is required to take into account the likely effects of the acquisition on competition, the convenience and needs of the communities to be served, the financial and managerial resources and future prospects of the companies and banks involved, and the effectiveness of the company’s policies to combat money laundering. In the case of an interstate bank acquisition, the Federal Reserve also must consider certain other factors and may not approve the acquisition if the resulting organization would control more than 10 percent of all deposits held by insured depository institutions. When a foreign bank seeks to acquire a U.S. bank, the Federal Reserve also must consider whether the foreign banking organization is subject to comprehensive supervision or regulation on a consolidated basis by its home-country supervisor.

Bank Mergers

Another responsibility of the Federal Reserve is to act on proposed bank mergers when the resulting institution would be a state member bank. The Bank Merger Act of 1960 sets forth the factors to be considered in evaluating merger applications. These factors are similar to those that must be considered in reviewing bank acquisition proposals by bank holding companies. To ensure that all merger applications are evaluated in a uniform manner, the act requires that the responsible agency request reports from the Department of Justice and from the other approving banking agencies addressing the competitive impact of the transaction.

Other Changes in Bank Control

The Change in Bank Control Act of 1978 authorizes the federal bank regulatory agencies to deny proposals by a single “person” (which includes an individual or an entity), or several persons acting in concert, to acquire control of an insured bank or a bank holding company. The Federal Reserve is responsible for approving changes in the control of bank holding companies and state member banks, and the FDIC and the OCC are responsible for approving changes in the control of insured state nonmember and national banks, respectively. In considering a proposal under the act, the Federal Reserve must review several factors, including the financial condition, competence, experience, and integrity of the acquiring person or group of persons; the effect of the transaction on competition; and the adequacy of the information provided by the acquiring party.

As authorized by the GLB Act, the Federal Reserve Board’s regulations allow a bank holding company or a foreign banking organization to become a financial holding company and engage in an expanded array of financial activities if the company meets certain capital, managerial, and other criteria. Permissible activities for financial holding companies include conducting securities underwriting and dealing, serving as an insurance agent and underwriter, and engaging in merchant banking. Other permissible activities include those that the Federal Reserve Board, after consulting with the Secretary of the Treasury, determines to be financial in nature or incidental to financial activities. Financial holding companies also may engage to a limited extent in a nonfinancial activity if the Board determines that the activity is complementary to one or more of the company’s financial activities and would not pose a substantial risk to the safety or soundness of depository institutions or the financial system.

Capital Adequacy Standards

A key goal of banking regulation is to ensure that banks maintain sufficient capital to absorb reasonably likely losses. In 1989, the federal banking regulators adopted a common standard for measuring capital adequacy that is broadly based on the risks of an institution’s investments. This common standard, in turn, was based on the 1988 agreement “International Convergence of Capital Measurement and Capital Standards” (commonly known as the Basel Accord) developed by the Basel Committee on Banking Supervision. This committee, which is associated with the Bank for International Settlements headquartered in Switzerland, is composed of representatives of the central banks or bank supervisory authorities from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States.

The risk-based capital standards require institutions that assume greater risk to hold higher levels of capital. Moreover, these standards take into account risks associated with activities that are not included on a bank’s balance sheet, such as the risks arising from commitments to make loans. Because they have been accepted by the bank supervisory authorities of most of the countries with major international banking centers, these standards promote safety and soundness and reduce competitive inequities among banking organizations operating within an increasingly global market.

Recognizing that the existing risk-based capital standards were in need of significant enhancements to address the activities of complex bank-

A key goal of banking regulation is to ensure that banks maintain sufficient capital to absorb reasonably likely losses.