4000 - Advisory Opinions
Bank Acceptance of Loan Guarantee From Foreign Affiliate Subject to § 23A of Federal Reserve Act
September 27, 1995
Gerald J. Gervino, Senior Attorney
Sheldon Reisman, Regional Counsel of our New York office has requested that I review your opinion concerning ("Bank"). You had provided this opinion to Mr. Nicholas J. Ketcha our Regional Director in New York.
A letter to the Board of Directors of the Bank from our Regional Director dated December 23, 1994 raised a question of an apparent violation of Section 23A of the Federal Reserve Act, 12 U.S.C. 371c ("Section 23A"), with respect to loan guarantees accepted by the Bank from a foreign affiliated bank. The letter indicated that the guarantees were covered extensions of credit under Section 23A. They further aggregated in excess of 10 percent of the bank's capital. Our Regional Director also indicated that the guarantees must have been made on terms and conditions that are consistent with safe and sound banking practices.
You have disputed that position in your opinion. Basically, you indicate that the language of the Act and the changes to it made in 1982, deal with guarantees made by the bank, not guarantees in favor of the bank. This is true. The idea of an affiliate of the bank providing guarantees to the bank on behalf of third party borrowers is not one that is ordinarily considered.
The Board of Governors of the Federal Reserve System considered this question in 1934. They then concluded that an "accommodation" indorsement of an affiliate of a bank does not constitute the transaction a "loan or extension of credit" to the affiliate within the meaning of Section 23A. It questioned the desirability of a bank making a loan upon which it is deemed necessary to obtain the accommodation indorsement of an affiliate, in some circumstances at least, would appear to be questionable. Digest of 1934 Federal Reserve Bulletin 391, Published Interpretations of the Board of Governors of the Federal Reserve System ¶ 4010.
The FDIC faced this problem with respect to affiliated bank standby letters of credit prior to the 1982 amendments to Section 23A. In that case, the affiliated foreign banks were securing loans to customers with their standby letters of credit to their FDIC insured subsidiary American banks. The American banks were extending credit to overseas customers of its foreign affiliates with no documentation other than the standby letter of credit from the affiliate foreign bank.
This practice, in effect, created a greater reliance upon the creditworthiness of the foreign affiliated bank, since the bank was receiving a direct obligation incurred for the purpose of inducing the bank to make its loan. Where the bank merely accepts a security of the affiliate as collateral provided by a borrower, the foreign bank affiliate is not a party to the transaction, nor necessarily has any knowledge or control over the pledge. Here, the foreign bank affiliate is likely to be the moving party if any number of loans are so guaranteed. The guarantee is in fact a more dangerous feature of the transaction than the use of affiliate securities to collateralize the loan, since the guarantee is in the exclusive control of the foreign bank affiliate.
The 1934 Board of Governors opinion on accommodation endorsements, whether valid today or not, is not in point, since it was meant to deal with accommodation endorsements made for formal reasons. The Board of Governors more contemporary expression has informally used as an example, the accommodation endorsement made by a member bank discounting paper received from a nonmember of the Federal Reserve System. We cannot understand how an American bank, lending within its expertise, should need the guarantee of a foreign bank to make a loan. Similarly, we do not understand why a foreign bank would be obligating itself on a third party obligation, unless it receives consideration.
In our view, the facts that you have described in your memorandum indicate that an extension of credit has been made to the foreign affiliate bank. This extension of credit appears regulated by the provisions of Section 23A(a) and (c) of the Federal Reserve Act.
If you have any further questions, please write or call me at (202) 898-3723. My Fax number is (202) 898-3715.