Flexibility is the main reason a bank holding company is the preferred structure for nearly 90% of U.S. banks. There are a lot of advantages to this type of structure. Learn how they work and how they affect consumers.
Definition and Examples of a Bank Holding Company
A bank holding company (BHC) is a company that controls at least 25% of one or more U.S. banks. They are regulated by the Board of Governors of the Federal Reserve System (FRB) and are often large, complex organizations. It is common for bank holding companies to own many bank subsidiaries. For example, the four largest bank holding companies each own more than 2,000 subsidiaries.
Acronym: BHC
Bank holding companies are easily recognizable. For example, you’ve probably heard of the largest bank holding company in the world, J.P. Morgan Chase & Co., which has more than $3.6 trillion in current assets. Some recognizable subsidiaries of J.P. Morgan Chase & Co. include Washington Mutual, Bear Stearns, Bank One, and Chase Manhattan Bank.
How a Bank Holding Company Works
A holding company, by definition, is a business entity created for the sole purpose of exercising control over other companies. It’s often colloquially referred to as a parent company. Holding companies do not manufacture anything or have active business operations. Instead, they help the subsidiary companies operate more efficiently and profitably while meeting regulatory requirements. More specifically, they move assets and capital around to achieve business goals (as allowable by law). The structure also allows for reduced exposure to risk. These are activities a bank legally can’t do but a bank holding company can. For example, a BHC can purchase toxic assets—investments that are hard to sell—from a subsidiary bank so it can maintain operations. This was common during the financial crisis of 2008 when mortgages were moved from banks to bank holding companies. A BHC can also issue debt, which can be funneled down to subsidiaries to fund growth. Bank holding companies are prohibited from certain activities, such as engaging in proprietary trading and limiting their investments in hedge funds, private equity, and related vehicles.
Pros and Cons of a Bank Holding Company
Pros Explained
Flexibility in growth and acquisition strategy: The structure of a bank holding company allows for growth. For example, BHCs can take assets from a bank and use them in their portfolios. This takes the risk away from the holding bank so it can be more agile in acquiring other financial institutions. It can also help them comply with regulations.Capital and liquidity: A bank holding company can improve the capital position and liquidity of the bank. Some of the moves they can make include shareholder stock repurchases and purchasing problem assets from the bank.Diversification of activities: Bank holding companies can purchase up to 5% of any company, which allows for greater diversification of activities. BHCs can engage in other activities that are not allowed at the bank level, including insurance underwriting, merchant banking, and unlimited broker-dealer operations. Tax advantages: When the parent bank holding company issues debt where the proceeds are contributed to the subsidiary bank as equity capital, interest payments can be a deductible expense. This, in turn, can reduce the tax liability of the holding company.
Cons Explained
High regulatory and operating costs: Governance costs, along with registration and filings required by the Securities and Exchange Commission (SEC), can be quite cumbersome. Has a separate regulator: BHAs are regulated by the Board of Governors of the Federal Reserve System (FRB). More financial reporting: The recordkeeping, accounting, and reporting requirements dictate separate books for the bank and the holding company.
Bank Holding Company vs. Financial Holding Company
A bank holding company (BHC) is different from a financial holding company (FHC). A financial holding company has additional authority to make financial investments. They also can underwrite insurance policies, offer merchant banking services, and deal in and underwrite securities. For a BHC to declare itself an FHC, subsidiary banks must be well-capitalized and have satisfactory or better ratings under the Community Reinvestment Act. The Dodd-Frank Act also increased capital requirements for BHCs to reduce risky activities. It also amended the National Bank Act’s lending limits to include derivative transactions, repurchase agreements, reverse repurchase agreements, securities lending transactions, or securities borrowing transactions as part of “loans and extensions of credit.” The Volcker Rule also was established to ban banking entities from proprietary trading or investing in hedge funds or private equity funds.
