Regulation O and Loans to Executive Officers

Issue/Inquiry

For loans to key officers, Regulation O requires a notice to be provided to key officers stipulating that the extension of credit will, at the option of the Bank, become due and payable at any time that the officer is indebted to any other bank(s) in an aggregate amount greater than the amount specified in the regulation. When should this notice be provided? Since banks are no longer required to collect information regarding loans to officers from other banks, what are the options for obtaining this information from key officers?

Response Summary

Since this Regulation O requirement is a condition of the extension of credit, the language prescribing it should appear in the loan agreement or promissory note evidencing the credit, which should be issued when the credit is extended. It is no longer necessary under Regulation O for executive officers to report the credit they receive from other banks, but the Federal Reserve has indicated that a bank may take any reasonably prudent step to ensure the effectiveness of the “due on demand” clause.

Response Detail

Under Regulation O, an extension of credit by a financial institution to an executive officer must be made subject to the condition in writing that it will, at the option of the financial institution, become due and payable at any time that the officer is indebted to any other bank in an aggregate amount greater than the amount of credit that the financial institution is authorized by the regulation to extend to the officer. 12 CFR 215.5(d)(4).

The regulatory limit for loans to executive officers is generally $25,000 or 2.5% of a financial institution’s unimpaired capital and surplus, and is not to exceed $100,000; however, there are exceptions for loans for purposes such as purchasing a residence or paying for the education of the officer’s children. 12 CFR 215.5(c).

As such, a loan to an executive officer of the Bank must include a “due on demand” clause, allowing the Bank to demand payment in the event that the officer becomes indebted to another bank in an amount greater than the Bank could extend to the officer under Regulation O. Since this is a condition of the extension of credit, the language prescribing it should be made part of the loan agreement or promissory note and be issued when the credit evidenced by the document or instrument is extended.

At one time, an executive officer was required to report loans obtained by the officer from other banks to its financial institution, as per section 215.9 of Regulation O. When this requirement was removed by Section 601 of the Financial Service Regulatory Relief Act of 2006 (Pub. L. 109-351), some in the industry asked that the demand clause requirement be removed as well, since there was now no effective way of enforcing it. The Federal Reserve Board, however, said that a bank may choose to ensure its effectiveness in any reasonably prudent way, such as mandating a periodic report from the executive officer or obtaining the information only when the executive officer’s creditworthiness had dropped materially. Federal Reserve System, 12 CFR 215 (Regulation O, Docket R-1271).

We believe that the simplest and surest way of enforcing the “due on demand” requirement for executive officers is to require executive officers to report each extension of credit made to them by another bank, which the Bank will log and keep track of.

This response is for informational purposes only and is not intended for legal guidance.

This entry was posted on Monday, November 4th, 2019 at 6:00 am.