Sometimes a guarantee does not look like a traditional guarantee. Consider the following: a bank pledges its own collateral to secure a borrowing made by an affiliate from a third-party lender. Is this a guarantee by the bank on behalf of the affiliate?
Yes. The Federal Reserve treats a bank’s pledge of collateral to secure an affiliate’s borrowing as a guarantee on behalf of the affiliate for purposes of Regulation W. The covered transaction amount is the lesser of: (i) the market value of the pledged collateral; or (ii) the amount of the borrowing.
This interpretation, confirmed in a 1993 General Counsel opinion, makes economic sense. When the bank pledges its assets to secure an affiliate’s debt, the bank is effectively promising the lender that its assets will be available to satisfy the affiliate’s obligation if the affiliate defaults. That is the functional equivalent of a guarantee.
The measurement as the lesser of collateral value or borrowing amount reflects the actual exposure. If the bank has pledged collateral worth less than the full borrowing, its maximum exposure is the collateral value. If the collateral exceeds the borrowing, the exposure is limited to the borrowing amount because that is all the lender can claim.
DM Tip: Audit all instances where bank assets are pledged to secure obligations of any affiliate. Each such arrangement should be booked as a guarantee for Regulation W purposes, measured at the lesser of collateral market value or the secured obligation amount, and included in quantitative limit calculations.