What Is Regulation O? Lending Limits to Insiders

Regulation O, implemented by the Federal Reserve Board, establishes rules governing extensions of credit by banks to their insiders. It prevents self-dealing and conflicts of interest when banks lend money to individuals connected with the institution. It ensures transactions with insiders are on an arm’s-length basis, like those with non-insider customers. This framework safeguards financial institutions and promotes public confidence in the banking system.

Defining Covered Individuals and Entities

Regulation O defines who is considered an “insider” to whom these restrictions apply. An insider includes executive officers, directors, and principal shareholders of the bank, and their “related interests.” An executive officer participates in or has authority over major policymaking functions of the bank, regardless of title or compensation.

A director is any director of the company or bank. A principal shareholder is any person who directly or indirectly owns, controls, or can vote more than 10% of any class of voting securities of the bank. Shares owned or controlled by immediate family members are attributed to the individual for determining principal shareholder status.

The term “related interest” includes entities controlled by insiders. A company is a related interest if an insider controls it by owning 25% or more of voting securities, controlling the election of a majority of directors, or exercising controlling influence over management or policies. Political or campaign committees controlled by an insider or benefiting an insider are also related interests.

Key Lending Restrictions

Regulation O imposes restrictions on credit to insiders and their related interests to prevent preferential treatment. Loans to insiders must be made on substantially the same terms, including interest rates and collateral requirements, as those offered to non-insider borrowers. Underwriting procedures must be as stringent as for other customers, and the loan must not pose more than normal repayment risk. This ensures fairness and sound lending practices.

Aggregate lending limits restrict the total credit a bank can extend to insiders. Credit to any single insider and their related interests cannot exceed the bank’s legal lending limit, generally 15% of unimpaired capital and surplus for unsecured loans. An additional 10% may be extended if loans are fully secured by readily marketable collateral, for a total secured limit of 25%. The total credit extended to all insiders, collectively, and their related interests is limited to the bank’s unimpaired capital and surplus. Banks with deposits less than $100 million may qualify for a higher aggregate limit, up to two times their unimpaired capital and surplus.

Board approval is required for certain insider loans. Approval is necessary if an extension of credit, aggregated with other outstanding credit to an insider and their related interests, exceeds the higher of $25,000 or 5% of the bank’s unimpaired capital and surplus. Approval is also mandated if the aggregate credit to an insider and their related interests exceeds $500,000. When considering such loans, the interested insider must abstain from the vote, and their abstention must be documented in the board minutes.

Collateral requirements apply to loans made to executive officers. Loans to executive officers must be secured by readily marketable collateral. Exceptions exist for purposes such as children’s education or primary residence, if secured by a first lien. For other purposes, aggregate loans to an executive officer cannot exceed the higher of 2.5% of the bank’s unimpaired capital and surplus or $25,000, capped at $100,000. These loans must be reported to the board of directors and require the executive officer to provide a current financial statement.

Regulation O addresses overdrafts for executive officers and directors. Banks are prohibited from paying an overdraft on an account of an executive officer or director. Exceptions exist if the payment is made in accordance with a written, preauthorized, interest-bearing extension of credit plan, or a written, preauthorized transfer of funds from another account. Minor, inadvertent overdrafts ($1,000 or less) may be permitted if the account is not overdrawn for more than five business days and fees are consistent with other customers.

Bank Compliance and Oversight

Banks must establish internal policies and procedures for Regulation O adherence. These procedures include identifying insiders and their related interests. Banks must track all outstanding loans and extensions of credit to these individuals and entities. This requires record-keeping of credit terms and documentation of board approvals for loans exceeding thresholds.

Internal monitoring and reporting are key to compliance. Banks should regularly review insider loan portfolios and report compliance status to bank management and the board of directors. This oversight helps detect potential violations early and allows for corrective actions. Regular internal audits and loan reviews also contribute to compliance.

Federal banking regulators examine for compliance with Regulation O during supervisory processes. Adherence is a core aspect of sound banking practices. Non-compliance can expose banks to compliance, operational, and reputational risks. Inadvertent violations can lead to examination findings requiring enhanced risk management practices. Compliance is important for banks to avoid potential supervisory consequences.