WASHINGTON -- The Federal Reserve on Wednesday proposed changing its regulations on discount window advances to limit extensions of credit to troubled banks.

The rules would carry out section 142 of the Federal Deposit Insurance Corporation Improvement Act, which makes the Fed liable for certain losses to the Bank Insurance Fund. This occurs when a bank staves off failure through discount window borrowings, fails anyway, and then ends up costing more to resolve.

Congress passed the law to discourage the Fed from propping up troubled banks for long periods. This assistance, law-makers said, increases taxpayer costs if the bank eventually fails, because it increases operating losses an scares away uninsured, unsecured depositors and creditors from the bank.

Grudging Approval

The Fed board unanimously approved the rules, albeit begrudgingly. The governors added this new law to the list of those they dislike because they require the central bank to "hard-wire" its policies, in the words of Fed Vice Chairman David W. Mullins.

"To the extent we do this, we eliminate the ability to exercise judgment on individual cases," added Fed Governor John P. LaWare. "I just don't like what the statute forces us to do."

According to section 142, when the Fed lends to an undercapitalized lender that is not deemed "viable" after it has borrowed for 60 out of 120 days, or when it lends to a critically undercapitalized lender five days after it gets this rating, the Fed becomes liable for losses to the FDIC caused by the advances. In addition, the Fed must report this liability to Congress.

Amendments to Reg A

The board proposed four amendments to Regulation A, which guides loans to depository institutions. The proposal would:

* Require district banks to consult with the board about credit that could result in Fed liability to the FDIC.

* Adopt "prompt corrective action" capital categories to determine which banks are undercapitalized and critically undercapitalized for this rule.

* As the law allows, exempt from the liability rule most undercapitalized institutions that have submitted capital restoration plans, as long as the primary federal regulator has accepted the plan and the lender is complying with it.

* Assess all district banks on a pro rata basis for the liabilities, rather than only the bank that causes it.

Also in its meeting Wednesday, the Fed approved a new interagency policy statement carrying out legislation that requires lenders to give agencies advance notice when closing branches. The rule was proposed earlier by each of the agencies.

The final statement follows the initial proposal, with a few major exceptions. In response to complaints from the industry, the agencies have excluded automated teller machines, as well as branches being relocated or consolidated through an acquisition, from the requirement.

Finally, the Fed approved a rule imposing daylight overdraft penalties on bankers' banks that do not hold reserves, Edge Act corporations, and limited-purpose trust companies.

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