(AP Photo/Mark Lennihan)

American International Group (AIG) has begun the process of downgrading its thrift unit to a trust bank.

The move is the first apparent action by AIG following its July 2 acceptance of its designation as a systemically important financial institution (SIFI).

AIG first disclosed last October that it was planning to divest the thrift, which is based in Wilmington, Delaware.

AIG CEO Robert Benmosche said it was doing so because of restrictions operating a thrift would impose on the company’s operations through the Volcker rule.

It delayed doing so, however, because until it became a SIFI earlier this month, operating a thrift was the only way it could stay federally regulated after the government sold all its stock in AIG last fall.

It has been regulated by the Federal Reserve Bank of New York as a thrift holding company since September. The New York Fed is apparently the consolidated regulator of AIG as a SIFI.

A number of insurers that operate thrifts have deregistered their thrifts, with a few notable deregistrations in 2012. These include Prudential Insurance, Northwestern Mutual, Massachusetts Mutual Insurance Company and W.R. Berkley.

The Principal Financial Group, Inc. is in the process of doing so, and says it is on track to s to have the deregistration process completed by year-end. Once the Fed agrees that The Principal may deregister its four savings & loan holding companies, The Principal Financial Group will no longer be subject to Fed supervision, a spokeswoman for the company said today. It hopes to do this after the Principal Bank has been approved as a limited purpose trust savings bank. Principal Bank, however, will continue to be regulated by the Office of Comptroller of the Currency (OCC), she stated.  

When a thrift downgrades to a trust bank, it is barred from offering commercial loans, maintaining or accepting demand deposits or deposits that the depositor may withdraw by check for payment to third parties. Furthermore, it is not allowed to establish an account with any Federal Reserve Board Bank nor seek to exercise discount or borrowing privileges with the Fed.

It also must hold at least 99 percent of its deposit in a trust or fiduciary capacity, except for the amount needed to maintain deposit insurance with the Federal Deposit Insurance Corporation.

In a July 24 letter to customers, obtained by the National Underwriter, AIG Federal Savings Bank said it would no longer be servicing retail deposit accounts as of September 30. The letter said all accounts will be automatically closed as of that date and any funds, “Including all interest due on your account(s), will be returned to customers.” 

An AIG spokesman, Jon Diat, confirmed the action. “AIG Federal Savings Bank is currently undergoing an orderly transition from a traditional savings bank to a trust-only thrift,” he said.

AIG is in a silent period since it reports earnings Thursday, so it is unclear whether the decision to downgrade to a trust bank was made because AIG was unable to sell the bank. American Banker said last October that AIG “reportedly has discussed a sale of the unit with several banks.”

It was therefore unable to comment on Benmosche’s statements last October that, despite divesting the thrift, AIG would like to remain in the mortgage lending business.

Benmosche strongly supports federal regulation. In his comments last October during a CNBC interview, the AIG president and CEO also said he welcomes federal regulation “because we want someone over our shoulder,” especially after what happened in 2008, when AIG required a huge federal bailout because it insured an estimated $2.77 trillion of what turned out to be troubled mortgage securities.

Effectively, Benmosche said, he wants the Fed to give AIG credibility in the marketplace through vigorous oversight. To get that credibility, Benmosche said AIG would have to show the Fed a strong balance sheet so that AIG will be permitted to pay a dividend to its shareholders.

But the McCarran-Ferguson Act of 1945 mandates state oversight of insurance companies unless a federal law specifically says otherwise. And, the Federal Reserve Board has been barred by law from overseeing insurance holding companies since the Gramm-Leach-Bliley Act was enacted in 1999.

In his comments on CNBC, Benmosche said AIG would sell its thrift because long-term assets held by insurers would be restricted by the Volcker rule, which severely limits proprietary trading.

Benmosche said proprietary trading is critical for insurers because of the long-term nature of their liabilities, and the thrift is relatively small, with $1 billion in deposits, and therefore not much of a money maker.

AIG Bank was started May 15, 2000 and has approximately 30 employees. Officials said it is unclear whether the change will result in layoffs at the Wilmington facility.