The “Rule”

The decision to become a bank holding company (BHC) opens a new world of business activities that are not available to banks. Although Regulation Y (the Rule) limits BHCs to banking activities and acquisitions of banks or companies that manage or control banks, there are exemptions and specifically permitted activities that temper the severity of the Rule. However, many questions remain as to which activities are exempt or otherwise permitted, and what to do if the targeted activity is neither.

If your BHC is considering a new nonbanking activity or acquisition, there are three roads to possible compliance with the Rule. First, some activities are either exempt from the Rule or expressly permitted by regulation. Second, a BHC may engage in activities that are “financial in nature” if it elects to become a Financial Holding Company (FHC). Lastly, where the proposed activity is neither exempt nor specifically permitted, approval from the Board of Governors of the Federal Reserve (Board) is available for nonbanking activities of BHCs and nonfinancial activities of FHCs.

Exemptions

Certain activities and acquisitions may be exempt, and thus require no prior approval from the Board before commencing the activity. Of course, managing banks is an exempt activity, as are the associated financing activities, such as issuing commercial paper for short term needs and promissory notes for long term needs. Additional examples of exempt activities that require no prior approval include:

  • Internal servicing activities, such as accounting and auditing, advertising and public relations, courier services, and safe deposit business.
  • Temporary foreclosure-related acquisitions of assets or voting securities of a company.
  • Acquisitions of voting securities of a company in good faith in a purely fiduciary capacity.
  • Acquisitions of voting securities that are eligible for investment by national banks.
  • Acquisitions of the securities of any company that does not include greater than 5 percent of any class of the company’s voting securities, so long as the acquisition does not constitute control of the company.
  • Newly begun “Permitted Activities” described below; provided that the BHC (1) meets the criteria for expedited approval (i.e., is currently well capitalized and well managed and has not been a party to any supervisory action within the last 12 months), (2) conducts the activities in compliance with the Board’s orders and regulations, and (3) provides a written notice that describes that activity and certifies the BHC’s compliance with the items in (1) and (2) within 10 days after commencing the activity. Where the BHC does not meet the criteria for expedited approval, the BHC must obtain the Board’s prior approval.

Permitted Activities

By regulation, the nonbanking activities below have been determined to be “so closely related to banking or managing or controlling banks as to be a proper incident thereto.”

  • Extending credit, servicing loans and performing related activities, such as collection agency and credit bureau services.
  • Leasing, but not maintaining or servicing, personal or real property.
  • Providing trust company functions, as long as the trust company is not itself a bank.
  • Providing certain financial and investment advisor activities.
  • Conducting certain securities brokerage services, limited to buying and selling securities only as agent for the customer’s account.
  • Acting as principal, agent or broker for insurance that is directly related to an extension of credit by the BHC or its subsidiary and limited to ensuring repayment of the outstanding balance due on the extension of credit.
  • Underwriting and dealing in U.S. obligations.

Financial Holding Company Election

Provided that a BHC and its depository institution subsidiaries are well capitalized, well managed, and have earned satisfactory Community Reinvestment Act (CRA) ratings, the BHC may file an election to be an FHC. The new FHC may then engage in activities that are “financial in nature or incidental to a financial activity.” The Bank Holding Company Act provides that the Board must define as financial or incidental to financial activity certain activities, such as lending and investing for others, safeguarding financial assets (other than money or securities), providing transfer services for money, and facilitating financial transactions for the accounts of third parties. With a few exceptions, an FHC also may generally engage in or acquire companies participating in the following categories of activities without prior approval by or prior notice to the Board.

  • Pre-1999 Board determinations or regulatory approval. Pursuant to regulation, FHCs may engage in the Permitted Activities listed above. Further, activities that the Board approved before 1999 are permitted. Examples include providing administrative services to mutual funds, check-cashing and wire transmissions, and real estate title abstracting.
  • Activities permitted under the Bank Holding Company Act. Examples of these permitted activities include custody, underwriting and market making in securities, full service insurance sales, and investment advisory services.
  • Activities determined to be financial in nature or incidental to financial activities. Acting as a finder between buyers and sellers of products for transactions that the parties negotiate among themselves is the only activity identified in this category thus far in the regulation. An example of a finder service is hosting an electronic marketplace on the FHC’s website by providing hyperlinks to websites of third parties.

Note that FHCs must provide post-transaction notice to the Board within 30 days after commencing any of the above activities.

While the FHC election allows a BHC to greatly expand its activities, the election also presents some challenges. Transactions with affiliates are still limited because the Board is concerned about intra-group exposures, such as risk concentrations and servicing agreements. Further, any bank within an FHC structure must remain well capitalized and well managed and must maintain a satisfactory CRA rating. If the bank does not, the FHC will be subject to immediate corrective action. Continued noncompliance can result in the FHC being forced to cease any expanded activity allowed by the FHC election or to sell the bank. One should also consider the demands and costs associated with increased regulatory compliance for expanded activities. While these challenges may seem daunting, they may be outweighed by the opportunity to grow market share. Each BHC should make an individual determination as to whether the FHC structure is desirable.

Board Approvals

Both BHCs and FHCs may seek individual approval for other activities. For BHCs, the Board uses a public interest test to determine whether the proposed activity or transaction can be expected to produce benefits to the public (such as increased competition and gains in efficiency and convenience) that outweigh possible adverse effects (such as undue concentration of resources, conflicts of interest, unsound banking practices, and risk to the stability of the U.S. banking or financial system).

For FHCs, the Board will consider the purposes of existing laws and changes in the marketplace in which FHCs compete. The Board will also consider changes in the technology for delivering financial services and whether the activity is necessary or appropriate to allow an FHC and its affiliates to compete effectively, use technology to efficiently deliver information and services, and offer customers available or emerging technology for using financial services.

Takeaway

The exemptions and permitted activities available to a BHC or FHC are complex. Further, activities related to insurance and securities require significant oversight, even when provided by third parties.