Publication of the June 2003 udpate to the Bank Holding Company Supervision Manual - Announcements

Federal Reserve Bulletin, August, 2003

The June 2003 update to the Bank Holding Company Supervision Manual, Supplement No. 24, has been published and is now available. The Manual comprises the Federal Reserve System's regulatory, supervisory, and inspection guidance for bank holding companies. The new supplement includes the following subjects:

1. Interagency Policy Statement on the Internal Audit Function and its Outsourcing. This 2003 policy statement incorporates recent developments in internal auditing and addresses supervisory concerns, policies, practices, and procedures pertaining to the internal audit function and its, outsourcing. Supervisory guidance is provided on the independence of accountants who provide institutions with both internal and external audit services. The policy statement supersedes a 1997 statement.

Provisions of the 2002 Sarbanes-Oxley Act and associated SEC rules are also addressed within the 2003 policy statement. Banking institutions that are subject to section 36 of the Federal Deposit Insurance Act--essentially those with $500 million or more in assets--should comply with the Sarbanes-Oxley Act prohibition on internal audit outsourcing to an external auditor. In addition to FDIC insured depository institutions, the policy statement applies to U.S. financial holding companies (FHCs), bank holding companies (BHCs), and the U.S. operations of foreign banking organizations. The inspection objectives and inspection procedures have been updated to reflect the revised policy statement. (See SR letters 03-5 and 02-20.)

The Sarbanes-Oxley Act also governs extensions of credit to BHC officials. Insider lending restrictions are imposed on public companies. Except for a few exemptions, the act prohibits a publicly owned BHC (public BHC) and its subsidiaries from extending credit, or arranging for another entity to extend credit, in the form of a personal loan to any director or executive officer of the public BHC.

2. A February 7, 2003, Board Interpretation of Regulation K for International Banking Organizations. Effective February 19, 2003, the interpretation applies to the underwriting by foreign banks of securities to be distributed in the United States. The interpretation clarifies that a foreign bank that wishes to engage in such activity must either be a financial holding company (FHC) or have authority to engage in underwriting activity under section 4(c)(8) of the BHC Act. A foreign bank's underwriting of securities to be distributed in the United States is considered an activity conducted in the United States, regardless of the location at which the underwriting risk is assumed and the underwriting fees are booked.

3. The Board's January 6, 2003, Revision to Subpart D of Regulation K, Sections 211.41-43. The definition, detailed components, and computation of the allocated transfer-risk reserve (ATRR) are discussed, as stated in the rule (effective February 10, 2003). The rule also provides that international loan fees are to be accounted for in accordance with GAAP.

4. Board Staff Legal Opinions

a. Providing Insurance Claims Administration and Insurance Risk Management Services. The Board's General Counsel issued a July 10, 2002, opinion that an insurance agency that is owned by an FHC may engage, under section 4(k)(4)(B) of the BHC Act, in certain cited insurance claims administration activities and insurance risk management services when they are conducted by an insurance agent or broker in connection with its other insurance sales.

b. Acting as a Third-Party Administrator on Behalf of an Insurance Company. A BHC that elected to become an FHC asked whether acting as a third-party administrator (TPA), on behalf of an insurance company, is an activity that is permissible for an FHC under the BHC Act. A TPA provides one or more insurance companies with certain administrative and related services that support and assist in the sale of insurance products by the insurance company. The Board's General Counsel issued a July 10, 2002, opinion that opined that an FHC, under section 4(k)(4)(B) of the BHC Act, could provide as a third-party administrator certain listed services to a third-party insurance company in connection with the sale and underwriting of insurance products.

c. Providing Flood Zone Determination Services. On July 9, 2002, the Board's Legal Division issued an opinion on the planned provision of flood zone determination services by a BHC's proposed majority-owned joint venture company. The company would provide mortgage lenders with ongoing flood-zone tracking services in connection with making mortgage loans. The flood determination services would be offered as a separate service in connection with providing real estate appraisals. Board staff confirmed that providing such flood zone determination services is an essential part of mortgage lending and within the scope of permissible activities related to extending credit under section 225.28(b)(2) of Regulation Y.

d. Combined-Balance Discount. On November 26, 2002, the Board's General Counsel issued an opinion for effecting combined-balance discounts. The General Counsel opined that members of a household or family, taken together, may be considered a "customer" for the purposes of the combined-balance discount safe harbor, as found in section 225.7(b) of Regulation Y. The Board's General Counsel determined that the term "customer," as used in that section, may include separate individuals (1) who are all members of the same "immediate family" (as defined in section 225.41(b)(3) of Regulation Y) and (2) who reside at the same address. A combined-balance discount program cannot be operated in an anti-competitive manner.