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4000 - Advisory Opinions
Request for Opinion on Compensating Balance
Arrangement as Violation of Title VIII of FIRA and 18 U.S.C. 656
FDIC-80-7
April 8, 1980
Barbara I. Gersten, Attorney
This responds to a request for an opinion on whether a compensating
balance arrangement described in Regional Director Sexton's letter of
January 24, 1980 to John J. Early, former Director, Division of Bank
Supervision, is in violation of Title VIII of the Financial
Institutions Regulatory and Interest Rate Control Act of 1978
("FIRIRCA") and 18 U.S.C. § 656.
The facts presented do not fully develop the information necessary
for the Legal Division to preliminarily determine whether a violation
of Title VIII exists. It appears that a violation of section 656 may
exist, however, the ultimate determination rests with the U.S.
Attorneys charged with enforcement of Title 18.
{{4-28-89 p.4043}}
I. Factual Background.
The related business interest of a director of Bank A obtained a
direct loan from Bank C, a national bank correspondent of Bank A. Bank
C requested and obtained from Bank A a compensating demand balance
equal to 8% of the loan to the related interest of Bank A's director.
The arrangement was documented in writing. Bank A apparently contends
that the compensating balance is a flow-through of collected funds the
director has at Bank A, and that it is not accurately construed as bank
funds. A regional office investigation revealed no backup compensating
balance arrangement at Bank A. Funds of the director's interest
maintained at Bank A average less than 10% of the compensating balance
required by Bank C. In total and on the average, however, all deposits
controlled by the director at Bank A are slightly in excess of the
balance required at Bank C. Bank A does not require compensating
balances on its loans to its directors. The regional office has
reported this matter to the United States Attorney as a possible
violation of 18 U.S.C. § 656.
II. Possible Violation of Title VIII.
Title VIII of FIRIRCA ("Correspondent Accounts") (12 U.S.C.
§ 1972), which amends Section 106(b) of the Bank Holding Company Act
Amendments of 1970, in pertinent part provides that extensions of
credit may not be made to executive officers, directors and principal
shareholders of a bank by its correspondent bank unless the extension
of credit is made on substantially the same terms as those prevailing
at the time for comparable transactions with other persons and does not
involve more than the normal risk of repayment or present other
unfavorable features (i.e., the extension of credit must not
be "preferential"). The statute does not expressly prohibit
preferential extensions of credit to related interests of persons
subject to the prohibitions of Title VIII.
The instant case involves a loan made to the related interest of a
director of Bank A. If it can be shown that the director received a
tangible economic benefit from the extension of credit to the related
interest, then the extension of credit may be deemed to have been made
to the director and thus would come within the prohibitions of Title
VIII. The facts as stated do not go to this evidentiary question.
For a Title VIII violation to exist, it must be assumed that the
extension of credit was for the director's benefit and further, that it
was made after the March 10, 1979 effective date of Title VIII, or that
it was made before that date and is subject to renewal. Such renewable
extensions of credit are treated as new extensions of credit at the
time of renewal, and must comport with Title VIII. It must further be
established that the extension of credit is preferential.
In the instant case, the extension of credit to the director's
related interest may be characterized as preferential by comparing it
with other similar transactions. It may perhaps be shown that but for
the compensating balance, Bank C would not have extended credit to the
Bank A director. The stated facts do not establish this sufficiently so
that the existence of a Title VIII violation may be determined. The
fact that the extension of credit to the related interest is directly
tied to the maintenance of a compensating balance is not determinative
in assessing a violation of the Title VIII prohibitions, which appear
in section 106(b)(2)(B) of the Bank Holding Company Act Amendments of
1970. Although the Title VIII prohibitions are inserted here as an
amendment to the Act, they are unrelated to the pre-existing anti-tying
provisions found in section 106(b)(1). That section provides in general
that extensions of credit may not be conditioned upon the customer's
use of another service provided by the lending bank. Traditionally,
under section 106(b)(1) the use of compensating balances in connection
with the maintenance of correspondent accounts has been sanctioned.
III. Possible Violation of 18 U.S.C. § 656.
Section 656 provides in pertinent part that a director who willfully
misapplies bank funds shall be fined and/or imprisoned. Use of an
inter-bank deposit as a compensating balance for a loan to an official
of the depositing bank has been found to constitute misapplication
under section 656. 1
{{4-28-89 p.4044}}
If the compensating balance arrangement between Bank A and Bank C is
a necessary condition for the extension of credit by Bank C to an
interest of Bank A's director, it may constitute a violation of section
656 if Bank A lacks economic justification for maintaining the
correspondent balance at Bank C (i.e., Bank C is not
performing usual banking services for Bank A). If this is the case, the
arrangement results in a diversion of income from Bank A for which the
Bank A director apparently has been responsible, and thus constitutes a
misapplication of bank funds by the
director. 2
Any determination the Legal Division may make with respect to the
application of section 656 is not binding, as enforcement of Title 18
of the U.S. Code rests with the U.S. Attorneys who ultimately determine
whether a given set of facts constitute evidence that the section has
been violated.
IV. Conclusion.
The facts presented are not sufficient to determine whether
violations of Title VIII and/or section 656 exist. To establish a Title
VIII violation in the instant case, it must be shown that the extension
of credit to the director's related interest benefitted him in a
tangible economic way and was made on preferential terms. It appears
that a violation of section 656 may exist if maintenance of the
compensating balance constitutes a diversion of income from Bank A. The
final determination, however, rests with the U.S. Attorney as to the
section 656 violation.
1 U.S. v. Brookshire, 514 F.2d 786 (C.A.
Okla. 1975). The case is extensively cited. Go Back to Text
2 Importantly, to establish a section 656 violation, it is not
necessary to show that the extension of credit to the director is
preferential. Go Back to Text
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