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From Banking and Finance Law Daily, November 30, 2015

Fed implements conditions on its emergency lending powers

By John M. Pachkowski, J.D.

Acting on a proposal issued in December 2013, the Federal Reserve Board has approved a final rule that amends its emergency lending powers under section 13(3) of the Federal Reserve Act. A memorandum issued by the Fed’s staff recommended that the final rule be approved at Fed’s Nov. 30, 2015, open meeting. The Fed’s December 2013 proposal was developed in consultation with the Secretary of the Treasury.

The final rule implements provisions of the section 1101 of the Dodd-Frank Act which is a congressional response to the nearly $2 trillion that the Fed lent under Federal Reserve Act (FRA) section 13 to address the credit and financial crisis that occurred in late 2008 and early 2009.

The amendments to the Fed’s emergency lending authority in section 13(3) of the Federal Reserve Act (12 U.S.C. §343) required the agency, "as soon as is practicable after the date of enactment of the Dodd-Frank Act," to establish policies and procedures to ensure that any emergency lending program or facility:

  • has broad-based eligibility;

  • provides liquidity to the financial system;

  • does not aid a failing or insolvent financial company;

  • requires collateral that is of sufficient quality to protect taxpayers from losses; and

  • ends in a timely and orderly fashion.

The Dodd-Frank Act also required the Fed to establish procedures to prohibit borrowing from programs and facilities by borrowers that are insolvent. This provision appears to be an effort to avoid a replay of events that occurred with the CIT Group. During the height of the financial crisis in December 2008, the Fed approved CIT Group’s application to become a bank holding company, which would have allowed CIT to avail itself of many of the FRA Section 13(3) emergency lending programs or facilities, as well as programs offered under the Treasury Department’s Troubled Asset Relief Program (TARP). Subsequently, CIT filed for bankruptcy in the fall of 2009, creating a $2.3 billion loss for TARP’s Capital Purchase Program.

Broad-based eligibility. To better reflect the intent of the original proposal and of the Dodd-Frank Act amendments, the final rule incorporates two changes from the original proposal to address this concern. First, the draft final rule provides that, in order for a program to have "broad-based eligibility," at least five persons must be eligible to participate in the facility at the time it is established. The Fed’s staff noted that this additional limitation is consistent with and provides further support to the revisions made by the Dodd-Frank Act that a program should not be for the purpose of aiding a single and specific company.

The second change provided further clarity that a program not be for the purpose of aiding any failing financial firm, the draft final rule has been revised to provide that a program or facility may not be designed to assist "one or more" specific companies to avoid bankruptcy or resolution. The staff noted, "This change is intended to accent that a program or facility would not qualify as a broad-based program or facility if it is designed for the purpose of assisting any number of persons or entities to avoid resolution by grouping any number of specified failing firms in the same facility.

Lending to insolvent borrowers. Although the Fed’s proposal incorporated the Dodd-Frank Act definition of "insolvent," that being if a borrower is in bankruptcy, in resolution under Title II of the Dodd-Frank Act, or otherwise the subject of a federal or state insolvency proceeding, the final rule expanded the circumstances in which a firm would be considered "insolvent." This expanded definition includes situations where a person or entity has generally failed to pay its undisputed obligations as they become due during the 90 days preceding the date of borrowing under the program or facility, as well as situations where the Fed or lending Reserve Bank otherwise has determined that the borrower is insolvent.

The final rule also provides that the Fed and a lending Reserve Bank may rely on a written certification from a potential borrower, or its chief executive officer or equivalent, at the time the person or entity initially borrows under a program or facility that the person or entity is not in bankruptcy or in a resolution or other insolvency proceeding and has not failed to meet its obligations during the preceding 90 days. To help ensure the accuracy of this certification, the draft final rule also adds a new provision that provides that all extensions of credit to a borrower that are outstanding will become immediately due, including all accrued interest, fees, and penalties, if the borrower, or authorized person, has made a knowing material misrepresentation, such as a misrepresentation regarding the solvency of the borrower, in a certification. Finally, the final rule provides that the Fed or lending Reserve Bank will refer a matter involving knowing material misrepresentation to relevant law enforcement authorities for investigation and appropriate criminal or civil action.

Penalty rate. Historically, the Fed has relied on section 14(d) of the Federal Reserve Act to establish a penalty rate on emergency extensions of credit.

The final rule incorporates this practice and provides that the Fed will determine a penalty rate for each emergency credit program or facility and sets forth a non-exhaustive list of factors that it will take into account when establishing the penalty rate. These factors include the condition of the affected markets and the financial system generally, the historical rate of interest for loans of comparable terms and maturity during normal times, the purpose of the program or facility, the risk of repayment, the collateral supporting the credit, and the duration, terms and amount of the credit.

Termination of program or facility. The final rule implements the Dodd-Frank Act requirements that a program or credit be terminated in a timely and orderly fashion. The final provides that a program or facility will terminate no later than one year after the date of the first extension of credit under the program or facility. The Fed may renew the program or facility if it finds, by a vote of at least five members, that unusual and exigent circumstances continue to exist and the Secretary of the Treasury has approved the renewal.

Collateral. Regarding the Dodd-Frank Act collateral requirements, the Fed declined to place limits on the types of collateral that could be used for its emergency lending programs. This limitation was suggested by a number of commenters. The Fed noted that "the Reserve Banks have extensive procedures for, and experience in, selecting and valuing collateral."

Critical tool. In her opening statement, Fed Chair Janet L. Yellen noted, "The ability to engage in emergency lending through broad-based facilities to ensure liquidity in the financial system is a critical tool for responding to broad and unusual market stresses." She added that the final rule "will be applied in a manner that aligns with the intent of the Congress and the Dodd-Frank Act."

Companies: CIT Group

MainStory: TopStory BankHolding DoddFrankAct FederalReserveSystem FinancialStability Loans

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