Related Organizations

Introduction

This booklet is designed as a reference tool and examination guide to assist bankers and examiners in understanding the various types of related organizations, risks that may be associated with these organizations, and the responsibilities of a bank’s board of directors and management to institute strong and effective corporate practices governing the bank’s relationships with these organizations.

As used in this booklet, the term "related organizations" refers to various types of entities related to a national bank, typically by common ownership or control, including certain advisory relationships. Generally, related organizations are affiliates or subsidiaries, each with its own legal definition. Related organizations can include bank holding companies, operating subsidiaries, financial subsidiaries, statutory subsidiaries, chain banking organizations, community development corporations, and related interests of principal shareholders.

The OCC’s supervision by risk approach takes into account current and planned activities of all related entities, including nonbank subsidiaries and affiliates, to determine how much risk they pose to the bank. Studies have shown that inappropriate relationships with related organizations, including insider abuse, rank high on the list of causes of bank problems. Improperly managed relationships with related organizations have been a factor in numerous bank failures.

Related organizations have become increasingly important to banks in recent years as the scope of activities they conduct has expanded and their geographic locations have multiplied. The passage of the Gramm-Leach- Bliley Act of 1999 (GLBA) removed some of the previous barriers between banking and other financial activities and services. For example, now a "financial subsidiary" of a national bank may conduct certain activities that are not otherwise authorized for the bank itself, such as underwriting securities of all types, provided that the activities are financial in nature or incidental to a financial activity. The new opportunities for transactions with related organizations may introduce new risks that need to be understood and properly managed.

Related organizations can provide opportunities for product diversification, augmentation of the customer base, geographic expansion or joint investment, and increased consolidated earnings. Conversely, a bank’s relationship with a related organization can create conflicts of interest and present complex corporate governance and risk management issues. These issues, if not properly addressed, can lead to a reduction in the bank’s or parent company’s income stream or capital.

Sections 23A and 23B of the Federal Reserve Act (12 USC 371c and 371c-1), as implemented by Regulation W (12 CFR 223), contain quantitative and qualitative restrictions on a bank’s transactions with its affiliates. While these provisions primarily protect a bank from suffering credit losses on loans to affiliates, a bank’s relationship with its affiliates also may introduce other material risks, including reputation and strategic risks. The board and management must remain aware of and appropriately manage these types of risk.

GLBA also codified the concept of "functional regulation," establishing a regulatory framework for certain activities conducted within banks and through functionally regulated subsidiaries and affiliates. While GLBA altered the Office of the Comptroller of the Currency’s direct responsibility over functionally regulated entities and activities, the Office of the Comptroller of the Currency (OCC) maintains a vital interest in and responsibilities for understanding all risks affecting national banks, including those posed by related organizations that are functionally regulated by other regulators. A discussion of the functional regulation framework is in this booklet’s "Supervision of Related Organizations" section.

An effective and sound corporate governance structure must include policies and procedures identifying board and management expectations, roles, and responsibilities pertaining to related organizations. The board and management are responsible for ensuring that all dealings between the bank and its related organizations serve the bank’s best interests and are appropriately monitored and controlled. Such relationships should be subject to robust corporate governance practices and risk management policies. No matter what the legal relationship is between a bank and its related organizations, a prudent financial and managerial relationship must exist. The bank’s board of directors should adopt appropriate policies and procedures to ensure that the bank’s relationship with its affiliates and other related organizations is sound and appropriately documented. Also, the board should appropriately monitor and manage any conflicts of interest that arise between related organizations and any of the bank’s directors, members of management, and principal shareholders.

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