WASHINGTON — For bank investors, understanding the Federal Reserve's "control" framework can be somewhat of a guessing game, which poses challenges for institutions trying to raise capital. But the central bank is attempting to make the process clearer.
In a proposal unveiled Tuesday, the agency sought to standardize how those owning less than a quarter of a bank can determine if they hold a "controlling" stake, and therefore must register as a bank holding company. The proposal was approved unanimously by the Fed board.
“Providing all stakeholders with clearer rules of the road for control determinations will responsibly reduce regulatory burden,” Fed Chair Jerome Powell said in a statement prepared for the Fed's board meeting. “As a result, it will be easier for banks, particularly community banks, to raise capital to support lending and investment.”
The Bank Holding Company Act uses three prongs for determining control: owning or controlling at least 25% of a financial institution's stock; controlling the selection of a majority of directors; or having a "controlling influence" over a firm's management or policies. The rules are similar in the case of thrift holding companies.
The first two prongs are pretty cut and dry. But in terms of the third standard the Fed has made decisions on what constitutes as “control” on a case-by-case basis, making it challenging for investors and banks to determine for themselves what triggers holding company requirements and other provisions of the BHCA.
Under a new proposed framework, which the Fed said would codify already existing practices, those owning or controlling stakes would be divided into four tiers, based on how of a bank's voting shares much they owned. The four tiers are: less than 5%, 5-9.99%, 10-14.99%, and 15-24.99%.
For each tier, the framework would establish "presumptions of control" based on various factors such as the size of a company’s total equity investment and director representation.
“The framework would focus on certain relationships between the companies that are important in determining whether the overall relationship provides a company the ability to exercise a controlling influence over another company,” the notice of proposed rulemaking says.
The proposed regulation is “generally consistent with the Board’s current control framework,” but does suggest several targeted policy adjustments, said Vice Chair for Supervision Randal Quarles in his opening statement.
“The complexity and relative lack of transparency of the Board’s case-by-case approach to control can impose a substantial compliance and uncertainty burden on both banking organizations and investors in banking organizations,” he said.
The framework would also create a presumption of “noncontrol,” which would apply to a company that owns less than 5% of the voting securities of another company.
While the proposed framework would address the vast majority of investors and banks, it also grants the Fed discretion to review rare cases, according to a senior Federal Reserve official.
Investors and banks have long requested more insight into the Fed’s control framework, claiming that the uncertainty could have unintended negative consequences and deter investments. Community banks in particular have struggled with the agency’s determinations of control, because often they rely on “few significant investors to raise capital,” the Fed said in its proposal.
Quarles suggested last year that the Fed might consider codifying and publicizing its framework for determining when a company is deemed to be in control of another.
“Under the Board's control framework — built up piecemeal over many decades — the practical determinants of when one company is deemed to control another are now quite a bit more ornate than the basic standards set forth in the statute and in some cases cannot be discovered except through supplication to someone who has spent a long apprenticeship in the art of Fed interpretation,” he said during a January 2018 speech.
