Under Reg W What Do We Call Loans and Other Extensions of Credit to a Reg W Affiliate: Covered Transactions and Their 10% Collateral Rule

Loans and other extensions of credit to a Reg W affiliate are called covered transactions — specifically, the extension-of-credit category under Section 23A of the Federal Reserve Act and its implementing regulation, Regulation W. The label matters because it triggers a hard 10% ceiling on credit to any single affiliate and requires collateral on the portion above a low threshold. If you lend to an affiliate and don't classify it as a covered transaction, you've mislabeled the exposure the bank examiner will look for first.

This is general educational information about a technical banking rule, not a legal opinion. Regulation W sits in 12 CFR Part 223, and the Federal Reserve can amend interpretations and thresholds; confirm current requirements against the regulation text and your own counsel before structuring a transaction.

Why an Extension of Credit to an Affiliate Is a Covered Transaction, Not an Ordinary Loan

Section 23A dates to the Banking Act of 1933, and its core purpose is to stop a bank from funneling its resources to companies in its own corporate family on better terms than it would offer a stranger. When a bank lends to an affiliate, the loan is treated as a covered transaction — the statutory umbrella term that also captures purchases of affiliate assets, guarantees, and certain securities borrowings.

The category name trips people up because "covered transaction" sounds broader than it is. Under Section 23A, covered transactions come in five statutory buckets: extensions of credit, purchases of assets, investments in affiliate securities, acceptance of affiliate-issued securities as collateral, and certain other dealings the Federal Reserve defines. An extension of credit includes a direct loan, a line of credit, a standby letter of credit, and even an intraday overdraft. The Federal Reserve's own compliance materials treat a daylight overdraft in an affiliate's account as an extension of credit, which surprises operational staff who think of overdrafts as payment-system plumbing rather than credit.

The word "affiliate" is doing heavy lifting here. Under Section 23A and Regulation W's definitional section (12 CFR 223.2), an affiliate is a company that controls the bank, is controlled by the bank, or is under common control with the bank. Control generally means owning, controlling, or holding with power to vote 25% or more of a class of voting securities, or otherwise exercising a controlling influence over management or policies. That 25% figure is the first number worth memorizing because it determines whether the transaction is covered at all.

Here's the practical sting: misclassification is not a paperwork error. If the extension of credit is a covered transaction and the bank didn't apply the quantitative limits, the transaction is unlawful when made, and the bank's board and management carry the exposure. Examiners from the Federal Reserve and the bank's primary federal regulator review Section 23A compliance as part of affiliate-transaction testing, and findings flow into the bank's composite rating. That's why the naming question matters more than it sounds.

The Five Covered-Transaction Categories and Where an Extension of Credit Sits

Picture the statute as a five-door room, with extension of credit as door one. Section 23A's list is closed in the sense that the Federal Reserve can add categories by regulation, and Regulation W's interpretive guidance fills gaps through exemption and definition rather than expansion. Knowing the whole list helps because the same collateral and limit rules apply across all five doors, so a lending officer who understands door one understands the framework.

The table's fifth row is where modern practice gets thorny. The Federal Reserve has used its authority to pull credit derivatives and certain securities-borrowing transactions into the covered-transaction tent, and the collateral rules then ride on top. A banker who assumes only balance-sheet loans count will miss the derivative exposures that Regulation W treats as extensions of credit.

Notice that the second and third rows look like investing, not lending. That's the point: Section 23A treats loading up on affiliate obligations the same as handing the affiliate cash, because both move bank resources into the corporate family. The unified treatment is why practitioners use "covered transactions" as a single label rather than tracking five separate regimes.

One nuance worth flagging: not every transaction with an affiliate is covered. Regulation W's exemptions section (12 CFR 223.41 through 223.43) removes certain ordinary-course dealings, such as specified purchases of assets that are already permissible and transactions with affiliates that are themselves insured depository institutions in some contexts. Exemptions are where experienced compliance staff earn their keep, and they are the one place a summary article can't substitute for the regulation text.

The 10% Per-Affiliate Limit and the 20% All-Affiliates Limit, With a Worked Calculation

Two caps govern covered transactions, and both are measured against the bank's capital and surplus. The first: covered transactions with any one affiliate may not exceed 10% of capital and surplus. The second: covered transactions with all affiliates in the aggregate may not exceed 20% of capital and surplus. Both percentages come straight from Section 23A(a)(1) and are restated in Regulation W.

Run the arithmetic on a mid-sized community bank with $50 million in capital and surplus. The per-affiliate ceiling is $5 million — a term loan of $5,000,001 to the holding company is over the line even if collateral is perfect. The aggregate ceiling is $10 million, so once the bank has lent $4 million to its parent, $3 million to a sister trust company, and $2.5 million to an affiliated insurance agency, it has $9.5 million of aggregate capacity and only $500,000 of headroom regardless of any single counterparty's unused per-affiliate room. A banker who monitors only per-affiliate exposure is measuring the wrong denominate.

Per-affiliate limit: 10% of capital and surplus, measured at the time the transaction is entered into or renewed. All-affiliates limit: 20% of capital and surplus, same measurement point. Headroom rule: the binding constraint is whichever limit first runs out, and both must be tested before closing.

The "at the time" language is a quiet trap. The Federal Reserve's Section 23A framework measures compliance when the transaction is consummated, not on a continuous basis — but a bank that loses capital in a bad quarter can find itself out of compliance with existing credit lines that were fine when drawn. Prudent institutions build internal buffers below the statutory caps so a capital decline doesn't create an instantaneous violation of the 10% or 20% ceiling.

A common misreading: the 10% and 20% figures are often described as "of capital stock and surplus," and staff occasionally substitute total assets or regulatory capital in the wrong slot. Regulation W specifically defines capital and surplus by reference to the bank's capital calculations in the Federal Reserve's regulatory framework, and the denominators differ from the risk-based capital ratios the bank reports elsewhere. Get the denominator wrong and every calculation downstream is wrong.

Collateral: The Portion Above 10% Must Be Fully Secured Under Section 23A

Collateral is the part of Section 23A that turns a limit into a lending discipline. Under the statute, the portion of a covered transaction that exceeds 10% of the bank's capital and surplus must be fully collateralized. Think of it as two tiers: the first 10% of capital and surplus in covered transactions per affiliate can run unsecured, and everything above that must be secured by eligible collateral valued under the statute's own schedule, not the bank's loan-to-value convention.

The eligible-collateral schedule lives in Section 23A(c) and Regulation W. The basic ratios are worth committing to memory: for loans secured by obligations of the United States or its agencies, the bank must hold collateral equal to 100% of the exposure; for other eligible collateral, the requirement is 110%; and the statute permits higher margins where the Federal Reserve sets them for particular collateral types. A dollar of affiliate exposure therefore can require as little as a dollar of Treasury collateral or as much as $1.10 of other qualifying assets.

That margin difference has a real funding cost. Price a $10 million covered transaction against a $1 million unsecured allowance and you're securing $9 million. Using Treasuries at a 100% ratio means pledging $9 million of securities; using eligible non-Treasury collateral at 110% means pledging $9.9 million. The incremental $900,000 of pledged bonds is a cost a lending relationship manager usually doesn't see on the credit memo, because the loan officer prices the asset while treasury prices the collateral.

Regulation W also requires the collateral to be perfected and to be valued on an ongoing basis under the regulation's rules, and the bank must have a documented procedure for monitoring the value. A pledge agreement that isn't filed, or a securities account where the bank lacks control, doesn't satisfy the statute even if the intent is there. This is a classic examination finding: the bank believed it was secured, and the examiner found the perfection step missing.

Failure looks like an affiliate credit line that grows on demand without the collateral schedule being refreshed. Suppose the holding company draws a $6 million revolver against a $5 million per-affiliate ceiling; the extra $1 million now needs to comply with the collateral rules, and if the pledge isn't documented on the draw date, the transaction is unlawful the moment it hits the bank's books, not at the next quarter's compliance review.

What Banks Must Do Before Booking the Loan: A Closing Checklist in Sequence

Before booking any extension of credit to an affiliate, run the transaction through four gates in order, because each gate depends on the answer to the one before it.

1: Confirm the counterparty is an affiliate under 12 CFR 223.2. Check the ownership percentage of voting securities and any controlling-influence documentation; a 24.9% stake without control mechanisms may fall outside the definition, and a 26% stake without a documented control assessment still gets pulled in by the 25% control threshold. 2: Confirm the transaction is an extension of credit rather than an exempt dealing. Examine 12 CFR 223.41–223.43 against the specific transaction terms; documented exemptions need a filed record, not a committee recollection. 3: Compute the per-affiliate and aggregate headroom against capital and surplus as of the closing date. Test both, and size the transaction to the smaller of the two remaining limits. 4: For the covered portion above 10% of capital and surplus, perfect eligible collateral at the statutory margin — 100% for Treasury and agency obligations, 110% for other eligible collateral — and confirm the pledge is documented before the credit is funded.

If the first gate comes back unclear, stop. Classification questions about control are resolved by examining the facts, not by assuming a minority stake is outside the rule; a 24.9% equity position accompanied by board seats and veto rights over major decisions can support a controlling-influence finding, which changes the answer for every transaction the bank has with that counterparty.

If the third gate leaves too little headroom, don't fund against the ceiling and plan to fix it later. A transaction over the statutory limit is a Section 23A violation at consummation, and "we'll cure it by the next reporting date" isn't a cure the regulation recognizes. The usual move is to downsize the credit, negotiate a participation that removes the exposure from the affiliate numerator where the rules allow, or fund the affiliate's need from a non-bank source.

The fourth gate fails most often on perfection mechanics. Training the closing team on the eligible-collateral schedule and the margin requirement before the first deal beats discovering at examination that the bank's collateral files are missing the control agreements. Build the checklist into the loan-operating-system approval workflow so no affiliate credit closes without the four gates documented.

Inside the 25% Control Test: When a Minority Stake Still Makes a Company an Affiliate

The 25% voting-securities threshold is a floor, not a definition. Regulation W's control test also treats a company as an affiliate if the bank or its parent controls the company "in any manner," and the Federal Reserve's interpretive guidance has found control in positions well short of 25% where the facts show a controlling influence. That means the "is it an affiliate" question needs a facts-and-circumstances analysis, and the analysis drives whether the credit is a covered transaction at all.

The practical implication is that private-equity and venture structures create affiliate risk that doesn't appear on the org chart. If the bank's holding company owns 22% of a fintech and the fintech's operating agreement gives the holder a board seat plus a veto on budgets and executive hires, the fintech may be an affiliate under the control test even though the nominal equity is under the threshold. Every dollar the bank lends that company becomes a covered transaction, with the 10% and 20% limits applying to a counterparty management never flagged.

Here's an edge case worth a specific number. Imagine a bank with $40 million in capital and surplus holding a 20% stake in an unaffiliated specialty lender, plus a $2 million loan to that lender. If the Federal Reserve later determines the bank exercises controlling influence over the specialty lender, the $2 million loan becomes a covered transaction with a per-affiliate ceiling of $4 million — the bank is suddenly at 50% of its headroom through a position it thought was a passive investment. The exposure doesn't change; the classification does.

The cure for this risk is documentary, not transactional. Maintain a control assessment for every significant equity investment, refresh it when governance rights change, and escalate any investment where the bank holds board seats or veto rights to compliance before the bank extends credit. Regulatory guidance on controlling influence has shifted over the years, so confirm current interpretation with counsel rather than relying on a template from a prior exam cycle.

How the Federal Reserve Measures Capital and Surplus: The Denominator That Moves the Limits

The percentage limits are only as stable as their denominator, and capital and surplus in Section 23A means the bank's regulatory capital accounts with some specific adjustments that differ from what appears on the call report's equity line. Regulation W's definitions tie capital and surplus to the bank's capital stock, surplus, and undivided profits, and practitioners generally compute the figure from the bank's regulatory capital components rather than a line item labeled "equity." The Federal Reserve's supervision manuals describe the numerator and denominator approach, and examiners recompute the figure independently during affiliate-transaction testing.

For a bank holding company structure, the capital and surplus figure used is the bank's, not the holding company's consolidated capital. That distinction matters in a group where the parent carries most of the group's capital: the insured bank's own capital and surplus set the 10% and 20% limits on the bank's covered transactions, and a thinly capitalized bank inside a well-capitalized group has less affiliate capacity than the group's balance sheet suggests. A bank with $30 million in capital and surplus inside a group with $400 million of consolidated equity has a $3 million per-affiliate ceiling, full stop.

Seasonal and event-driven capital moves create planning problems. A bank that pays a large dividend to its parent reduces its capital and surplus on the same day the dividend leaves, which shrinks the affiliate headroom immediately — including for the very transaction that funded the dividend. A bank that takes a large infrequent charge at year-end can drop below the level that supported existing affiliate commitments. Neither event is exotic; both are routine consequences of how the denominator works.

Measurement timing is the last piece. The limits are tested when a covered transaction is entered into or renewed, and the Federal Reserve's framework doesn't demand continuous recalculation of existing exempt positions as capital moves. But a bank that books a new draw each month against a revolver effectively re-enters the transaction monthly, so capital changes feed through faster than a banker might assume. Build the capital and surplus figure into the credit approval system on a quarterly refresh, and re-test headroom before any discretionary draw on a committed affiliate line.

Common Misclassifications That Create Unlawful Affiliate Credit, With the Fix for Each

Most Section 23A violations originate in how a transaction was labeled rather than how it was priced. The transaction type is fine; the file just calls it something else, and the limits never get applied. Here are four recurring examples, each with a specific fix.

The daylight overdraft. An affiliate's account goes negative during the day and is covered by the bank's payment-system credit. The operations team treats it as settlement mechanics. Fix: classify intraday affiliate overdrafts as extensions of credit, measure them against the per-affiliate ceiling, and either collateralize the covered portion or set intraday exposure caps on affiliate accounts. The guarantee that looks like a fee. The bank issues a standby letter of credit for an affiliate's counterparty and collects a fee. The credit department treats it as off-balance-sheet fee income. Fix: Section 23A treats a standby letter of credit as an extension of credit, so include the face amount in the affiliate exposure calculation and in the collateral analysis. The asset purchase that looks like a sale. The bank buys loans from an affiliate and books a gain. The accountants record it as a purchase. Fix: a purchase of affiliate assets is a covered transaction, not an ordinary purchase, so the same limits and collateral rules apply. The "temporary" draw. An affiliate draws above the documented line and management plans to repay within the week. Fix: the transaction is measured when entered into, and a draw in excess of the limit is unlawful on the draw date, not on the repayment date.

The asset-purchase example carries an arithmetic edge case. A bank at 95% of its 10% per-affiliate ceiling that buys a $700,000 loan portfolio from the same affiliate breaches the limit at closing, even if the transaction is profitable and the portfolio is high quality. The right question before closing isn't "is this a good asset?" but "where does this land against the headroom?" The fix is to size the purchase to the remaining capacity or to find a route out of the covered-transaction definition through the exemption provisions.

Exemptions deserve more respect than they usually get. Regulation W's exemptions permit certain ordinary-course transactions — including specified purchases of assets that are already permissible under other rules — without applying the 10% and 20% caps, but they require documented analysis and, in some provisions, records of the exemption claimed. A compliance officer who claims an exemption in a conversation rather than a memo has left the bank without a defense at examination. The fix is a one-page exemption file for every affiliate transaction that relies on one.

Covered Transactions Versus the 23B Arm's-Length Rule: The Label Confusion Explained

The most commonly confused term is Section 23B, and the confusion is expensive because the two rules are tested differently. Section 23A and Regulation W impose the quantitative limits and collateral requirements on covered transactions. Section 23B and its regulations impose a qualitative standard: covered transactions must be on terms substantially the same, or at least as favorable to the bank, as those of comparable transactions with non-affiliates — the market-terms rule.

The practical result is that a transaction can satisfy the 10% limit and the collateral schedule and still fail Section 23B because the pricing is off-market. A $3 million loan to an affiliate well under the per-affiliate ceiling, fully collateralized with Treasuries, still creates a Section 23B problem if the rate is below what the bank would charge an unrelated borrower with the same risk profile. The rules stack: 23A tests size and security, 23B tests fairness of terms.

Both statutes trace to the 1933 Banking Act, though 23B was added later and written to close the pricing gap 23A left open. The regulation implementing 23B lives alongside Regulation W in the Federal Reserve's rules and shares the affiliate definitions, which is why practitioners often lump the two together in conversation. The Federal Reserve routinely examines both in the same affiliate-transaction review, and its supervision materials describe the market-terms test with the same prominence as the quantitative limits.

The label discipline is simple. When someone asks whether a loan to an affiliate is permitted, the complete answer has two parts: it's a covered transaction subject to 10% and 20% limits and collateral rules, and it's an affiliate transaction subject to arm's-length terms under 23B. Answering only the first part is the misuse to watch for, because a transaction that clears the size limits still fails if the loan terms favor the affiliate.

FAQ

Are loans to an affiliate always covered transactions?

No. The covered-transaction label attaches only when the counterparty meets the affiliate definition under 12 CFR 223.2. A company the bank has no control relationship with, no common control, and no 25% voting-interest link to is outside Section 23A entirely. Confirm the counterparty's ownership and control facts before applying the limits; a 20% stake with no board seat or veto rights may not create an affiliate, while a smaller stake with governance rights might.

Is a standby letter of credit an extension of credit under Reg W?

Yes. Regulation W treats a standby letter of credit issued for an affiliate's benefit as an extension of credit, which brings the face amount into the per-affiliate and aggregate limits. The same logic covers guarantees and intraday overdrafts, which is why the exposure calculation needs to include off-balance-sheet affiliate items. Many violations start in the operations area precisely because letter-of-credit fee income doesn't look like a loan on the income statement.

What happens if a bank exceeds the 10% per-affiliate limit?

The transaction is unlawful when entered into, and the Federal Reserve can require corrective action, impose restrictions, or refer the matter for enforcement. The violation occurs at the time of the transaction rather than being cured by later repayment. This is why the measurement runs against capital and surplus on the closing date and why prudent banks keep internal buffers below the statutory 10% and 20% caps. Consult counsel immediately if you find an over-limit transaction already on the books.

How are the 10% and 20% limits computed?

Both are percentages of the bank's capital and surplus, not the holding company's consolidated capital. Per-affiliate exposure is capped at 10%, and aggregate exposure across all affiliates is capped at 20%. For a bank with $50 million in capital and surplus, that means $5 million to any one affiliate and $10 million across the group. The binding constraint is whichever limit leaves less room at the time of the transaction.

Does the collateral requirement apply to the whole loan or just part of it?

Only the portion above 10% of capital and surplus must be collateralized. A bank with $50 million in capital and surplus can carry $5 million of unsecured affiliate exposure and must fully secure everything above that figure. Eligible collateral is pledged at the statutory margin — 100% for Treasury and agency obligations, 110% for other eligible collateral. Perfection and ongoing valuation are separate requirements that examiners test.

Can an exemption remove a loan from the covered-transaction rules?

Some transactions qualify for exemptions under Regulation W, and those exemptions can keep ordinary-course dealings out of the 10% and 20% calculation. But claiming one requires analysis against the specific exemption provision and, for several provisions, a documented record. A conversation-based exemption claim won't survive examination. Read 12 CFR 223.41 through 223.43 and confirm with counsel before relying on an exemption for a material transaction.

What is the difference between 23A and 23B for affiliate loans?

Section 23A and Regulation W supply the quantitative limits and collateral rules; Section 23B requires market terms substantially as favorable as comparable non-affiliate transactions. A loan can clear every 23A number and still violate 23B on pricing. Both are tested in the same Federal Reserve affiliate-transaction review, so a complete compliance file needs the size-and-security analysis and the fairness-of-terms analysis.

This article is general educational information about Regulation W and Section 23A, not a legal opinion or compliance certification. Affiliate-transaction rules depend on a bank's specific ownership structure, capital position, and the facts of each transaction, and interpretations can change; work with qualified banking counsel or your primary federal regulator before structuring or correcting affiliate credit.