Bank Regulatory Compliance Update - Issue 188

Guidance on Executive Officer and Director Overdrafts 
by Blair Rugh

Section 215.4(e) of Regulation O prohibits a bank from paying an overdraft on a deposit account of an executive officer or director of the bank, or an executive officer or director of an affiliate of the bank.  On the surface that seems like a pretty simple regulation to understand, but its complexities have confused bankers for years and continue to do so. In normal times, we receive more questions about Regulation O than any other regulation.


The first question is what is an overdraft? An overdraft occurs when a bank pays an  item that is greater than the balance in the account on which it is drawn.  Now, the tricky part. If a bank receives a check in its cash letter, it has until midnight of the day after the day that it received it to return it.  Until the time has past for the bank to return the item, it has not technically paid it. Accordingly, if a bank receives a check on an executive officer's account on a Monday that would overdraw the account, but onTuesday the executive officer makes a deposit to the account in a sufficient amount to cover the check and the bank does not return the check, the account was never overdrawn. Before the midnight deadline, the check was good. The bank's core system may have created a report on Monday night showing an overdraft on the executive officer's account, but, in fact, there was no overdraft. There was a pending item, which if paid against the current balance in the account, would create an overdraft, but at that time there was no overdraft.  On the other hand, if a bank pays a check drawn on the account of an executive officer or director over the counter that overdraws the account, the account is overdrawn. A check taken over the counter cannot be returned.


Next, the regulation applies only to accounts owned by executive officers or directors. It does not apply to relatives of an executive officer or director or a related interest of an executive officer of director.  If I am an executive officer of your bank, the restriction does not apply to accounts owned by my wife or children.  If my wife overdraws her household account, which has caused my heartburn from time to time, and I am not an owner of the account, the bank can treat the overdraft in the same way it would treat an overdraft of any other customer and not with the more stringent rules for executive officers and directors.The same was true when my children were in college.  We encourage executive officers not to be owners of any account that they do not need to be an owner of. You do not need to be a co-owner of an account to make deposits to it, and if you may need to write checks on the account, be a courtesy signer, not an owner.


If I am a director of your bank and I own ABC, Inc., ABC, Inc. is my related interest and is not covered by the overdraft restriction. The bank may process overdrafts on the account of ABC, Inc. just as it would the overdrafts of any other customer. With one exception. If my borrowings from the bank aggregated with the borrowings of all of my related interests exceed $500,000, then, the bank may not make any further extensions of credit to me without the prior approval of the bank's board of directors, and the payment of an overdraft is an extension of credit. If in those circumstances the bank were to pay an overdraft on the account of ABC, Inc., it has not violated the rule on paying overdrafts, but it has violated the rule on extending credit to an insider without the prior approval of the board of directors.


An item that would otherwise overdraw an executive officer's or director's account is not an overdraft if there is a written agreement between the executive officer or director and the bank such that the bank will transfer funds from another deposit account or a credit line of the officer or director to cover the overdraft. Of course, there must be sufficient funds available to cover the transfer.  Regulation O allows a bank to provide a credit line not to exceed $5,000 to its executive officers and directors for overdraft protection, and the credit line will not be treated as an extension of credit. An executive officer or director may have an overdraft credit line greater than $5000, but, in that case, the entire amount is treated as an extension of credit. Therefore, for executive officers, that extension of credit limits the amount that the bank could otherwise lend to him or her.  We recommend that banks strongly encourage all of their executive officers and directors have an overdraft credit line protecting their deposit accounts from overdrafts.  We also recommend that those overdraft credit lines require that they be paid in full with each billing so that they are always available for their purpose.


Regulation O does allow a bank to pay an "inadvertent" overdraft of an executive officer or director provided that the aggregate amount of the overdraft is not greater than $1,000, it is repaid within five business days and the bank charges its normal overdraft charge for each item that overdraws the account. The Federal Reserve has ruled that after three inadvertent overdrafts in a 12-month period the overdrafts cease to be inadvertent. At that point, they become stupid, careless or intentional, but they are not inadvertent and not within the protections for inadvertent overdrafts.


We recommend that banks explain to their executive officers and directors the overdraft rules of Regulation O. We also recommend that a bank encourage its executive officers and directors not to be owners of accounts that they do not need to be owners of and that for the accounts that they do own, that they have a credit line or other overdraft protection on the account.  If banks will do those three things, their Regulation O issues will decrease significantly.

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