Insider Lending

What Is Insider Lending?

Insider lending occurs when a bank makes a loan to one or more of its own officers or directors. Many countries, including the U.S., require that the provisions of these loans match those given to comparable bank customers. This is done to ensure fairness and limit access to bank funds by insiders.

Insider lending should not be confused with insider trading.

Understanding Insider Lending

An insider, as defined by the Federal Deposit Insurance Corporation (FDIC), is an executive, director, or principal shareholder of a member bank. Loans made to these individuals are known as insider lending and are regulated by the FDIC under Regulation O.

The Federal Deposit Insurance Corporation Improvement Act of 1991 mandated new restrictions on the loan provisions offered to bank insiders. The restrictions include requiring the same loan rates, repayment terms, and evaluation of the insider borrower's ability to repay the loan as those extended to non-insider, non-employee borrowers, with the exception of special terms that are offered to all non-insider employees of the bank in question.

For example, if a bank offers a special interest rate or waives certain loan fees for all employees, then it may offer that same special consideration to an inside borrower, even though it doesn't offer those same special rates or fee reductions to non-insider, non-employee borrowers.

Banks are limited in the amount of insider credit that they can extend. The amount is 15% of unimpaired capital and unimpaired surplus if the loans are not fully secured. If the loans are fully secured then an additional 10% is allowed. It is advisable that a bank use the same loan limits for insider loans as it does for non-insider loans. Some recourse loans and secured loans may not count toward this limit.

What Is an Insider?

In the financial world, it can be difficult to determine who is an insider, particularly since the terms "director," "executive," and "principal shareholder" can have different meanings in different financial institutions. Furthermore, insider lending would also apply to individuals who hold these positions in affiliate companies.

In general, a person is not a director if they do not have voting rights and are not elected by shareholders. Most financial institutions have the title of "director" for many individuals in the firm. A principal shareholder is anyone who owns more than 10% of the voting rights of a company through shares.

An affiliate would not qualify for insider lending if it has more than 10% of unconsolidated assets in the company that controls the bank and itself is not controlled by another company.

Restrictions on Insider Lending

When an insider loan will bring the combined amount of credit offered to that insider to more than $500,000, or more than the greater of $25,000, or 5% of the bank's unimpaired surplus or unimpaired capital, the bank's board of directors must vote to approve the loan. The insider seeking the loan may not participate in this vote.

A bank can loan money or extend a line of credit to its executive officer if that loan is used to finance or refinance the officer's home or to fund the education of their children. Loans for other purposes cannot be made in an amount in excess of 2.5% of the bank's unimpaired surplus or unimpaired capital, or $25,000, up to $100,000. This limit also applies to partnerships of executive officers, so that if one executive officer borrows $35,000, the other partner may borrow only $65,000.

A bank cannot pay an overdraft on an account at that bank made by the director, the executive officer, or an affiliate without a written plan for the extension of credit or a written transfer of funds from another account at the bank.