Leveraged Lending

Conflicts Of Interest

The legal and regulatory issues raised by leveraged transactions are numerous and complex. When a banking company plays multiple roles in leveraged finance, the interests of different customers or divisions of the institution may conflict. For example, a lender may be reluctant to employ an aggressive collection strategy with a problem borrower because of the potential impact on the value of an affiliated organization’s equity interest. A lender may face pressures to provide financial or other privileged client information that could benefit an affiliated equity investor. Banks should develop appropriate policies to address potential conflicts of interest. Banks should also track aggregate totals for borrowers and sponsors to which they have a lending and equity relationship. Banks should also establish limits for such relationships.

To ensure that potential conflicts are avoided and laws and regulations are adhered to, an independent compliance function should include a review of leveraged financing activity. Banks also need to establish policies, internal controls, and risk management procedures governing complex structure finance transactions, as discussed in OCC Bulletin 2004-22. The bulletin incorporates the types of internal controls and risk management procedures that can assist financial institutions in identifying and addressing the reputation, legal and other risks associated with complex structured transactions. Among other things, it provides that financial institutions should have effective policies and procedures in place to identify those complex structured finance transactions that may involve heightened reputation and legal risk, to ensure that these transactions receive enhanced scrutiny by the institution, and to ensure that the institution does not participate in illegal or inappropriate transactions. It also emphasizes the critical role of an institution’s board of directors and senior management in establishing a corporate-wide culture that fosters integrity, compliance with the law, and overall good business ethics.

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