Tuesday, 23 October 2007

Section 23A of the Federal Reserve Act


Wow, that's an appetising title. This is not even by the lamentably low standards of this blog a sexy post, but the news is interesting. RGE via Naked Capitalism reports that the FED is permitting large banks to borrow money versus collateral and to lend it on to their affiliates. Section 23A refers to the intergroup lending: normally banks can't lend on large amounts of money to non-bank affiliates. This stops a group holding company using a bank within the group to access the FED window or raise deposits which are then lent on to a broker/dealer. As IRA put it:

Section 23A is one of the most important parts of the Federal Reserve Act. It prohibits "covered transactions" with any one affiliate of a Fed member bank in excess of 10% of the bank's capital and surplus, and up to 20% in aggregate for all bank affiliates. The purpose of the section is to protect the capital of the bank, even if that means allowing non-bank units or the parent holding company to be decapitalized or even fail in a "market resolution."

So far we know that the FED has granted Section 23A exemptions to Citi, JPMorgan, BofA, Barclays, RBS and Deutsche. This is potentially significant: it means that the FED is sufficiently worried about the consequences of the broker/dealers having to dump assets because they can't fund that they are willing to suspend a key regulation. At best it creates serious moral hazard, allowing firms to avoid the losses on dumping assets in the current market. At worst it means that if the problem gets really serious, the broker/dealers will bring the banks down.

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