What Is Regulation F?
Regulation F is a set of Federal Reserve rules that establishes limits on the risks banks may take on in their business dealings with other financial institutions. The regulation applies to all banks that have deposits that are insured by the Federal Deposit Insurance Company (FDIC).
The regulation requires that banks establish internal rules that control the degree of credit and liquidity risks that they undertake in their transactions with other banks. It also limits the amount of credit exposure between banks to 25% of the bank's capital in most cases.
- Regulation F requires banks to minimize the risks they undertake when they do business with other banks.
- The rule applies to all banks that have federally-insured deposits.
- The intent of the rule is to limit the risk of losses in federally-insured deposits.
Understanding Regulation F
The intent of Regulation F is to limit the potential risk that the failure of a depository institution might bring to insured institutions covered by the FDIC.
The regulation covers the collection of checks and various other services that larger banks handle for smaller ones. Banks might enter such agreements in order to operate more efficiently, while smaller banks may lack the resources to offer such services on their own.
In addition, the regulation covers certain types of transactions in the financial markets. Interest rate swaps and repurchase agreements fall under this regulation.
Regulation F allows banks that are highly capitalized have higher levels of credit exposure.
Regulation F Limits
The regulation establishes general limits based on a bank's capital regarding overnight credit exposure to other banking institutions. It requires institutions such as savings associations, banks, and branches of foreign banks that have deposits insured by FDIC to create internal policies to evaluate and control their exposure to the depository institutions they do business with.
Banks must also create policies to account for operational, liquidity, and credit risks when choosing other institutions to do business with.
The Federal Reserve allows for a waiver of the rules for small institutions reliant on bigger banks' services.
Banks can break the 25% capital credit exposure limit if the bank can show that the institution it does business with is adequately capitalized. Transactions can be excluded from the calculated credit exposure limit if those transactions carry a low risk of loss. This includes transactions fully secured by readily marketable collateral or government securities.
Banks may apply for a waiver to ignore restrictions set by Regulation F. This can occur if the primary federal supervisor of the bank informs the Federal Reserve Board that the bank would not have access to necessary services if it did not open itself to exposure beyond the regulatory limits.
For example, if a small bank needs the check collection services of a larger bank but its exposure exceeds the limit, the small bank might seek a waiver if it has no other options available to provide the service.
Banks that are not insured depositary institutions are typically not subject to the rules of Regulation F.