What is an investment banking company?

Definition / Examples of a Bank Holding Company

A Bank Holding Company (BHC) is a legal entity that owns one or more banks. The flexible BHC structure can help improve the capital position of the subsidiary bank. It also allows for greater diversification than is permitted by bank utilization. Overall, the Bank Holding Company structure provides more agile growth, financial benefits, and better compliance with government regulation.

How a Bank Holding Company Works

A Bank Holding Company is established with the purpose of exercising control over other companies. It is often commonly referred to as the parent company. Parent companies do not manufacture anything or have active business operations. Instead, parent companies assist their subsidiaries in operating more efficiently and profitably while complying with regulatory requirements.

Specifically, parent companies move assets and capital to achieve business goals (as permitted by law). This structure also allows for reduced risk exposure. These are activities that the legal bank cannot engage in but a Bank Holding Company can.

For instance, a Bank Holding Company can purchase toxic assets – investments that are difficult to sell – from its subsidiary bank so that it can continue operations. This was common during the financial crisis of 2008 when mortgages were transferred from banks to Bank Holding Companies. A Bank Holding Company can also issue debt, which can be directed to subsidiaries to fund growth.

Note: Bank Holding Companies must mitigate risk exposure or, in other words, refrain from engaging in speculative activities.

Advantages and Disadvantages of a Bank Holding Company

Advantages:

• Flexibility in Growth and Acquisition Strategy: The Bank Holding Company structure allows for growth. For example, Bank Holding Companies can take assets from the bank and use them in their portfolios. This removes risks from the parent bank so it can be more agile in acquiring other financial institutions. It can also aid in compliance with regulations.
• Capital and Liquidity: A Bank Holding Company can enhance the capital and liquidity position of the bank. Some steps they can take include repurchasing shareholder equity and acquiring troubled assets from the bank.
• Diversification of Activities: Bank Holding Companies can purchase up to 5% of any company, allowing for greater diversification of activities. Bank Holding Companies can engage in other activities not allowed at the bank level, including underwriting insurance, commercial banking services, and unlimited brokerage operations.
• Tax Advantages: When the parent Bank Holding Company issues debt where its revenues are recorded as contributed capital in the subsidiary bank, interest payments can be treated as a deductible expense. This, in turn, can reduce the tax liabilities of the Bank Holding Company.

Disadvantages:

• High Operating and Regulatory Costs: Governance costs, along with registration and reporting requirements from the Securities and Exchange Commission (SEC), can be quite burdensome.
• Separate Oversight: Bank Holding Companies are regulated by the Board of Governors of the Federal Reserve System (FRB).
• More Financial Reporting: Custody, accounting, and reporting requirements necessitate separate books for the bank and the parent company.

Bank Holding Company vs. Financial Holding Company

A Bank Holding Company (BHC) differs from a Financial Holding Company (FHC). The Financial Holding Company has additional authority to engage in financial investments. They can also engage in underwriting and providing commercial banking services, trading, and selling securities.

For a Bank Holding Company to declare itself as a Financial Holding Company, its subsidiary banks must be well capitalized and have satisfactory or better ratings under the Community Reinvestment Act.

Events

Note

The sixth section of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 increased regulations for investment banking firms, savings and loan companies, and depository institutions. The Federal Reserve must examine the acquisitions of non-bank companies by investment banking firms to determine whether the purchase poses a threat to the stability of the country’s financial system. This measure ensures the identification and management of threats to U.S. financial stability before they cause any instability.

The Dodd-Frank Act also increased capital requirements for investment banking firms to reduce risky activities. It also amended lending limits in the National Bank Act to include derivative transactions, repurchase agreements, reverse repurchase agreements, securities lending transactions, or securities borrowing transactions as part of “loans and credit extensions.”

The Volcker Rule was also established to prevent banking entities from proprietary trading or investing in hedge funds or private equity funds.

Takeaway

– 90% of banks in the United States have a corporate structure as investment banking firms.

– An investment banking firm is a separate entity from the banks it owns, giving it greater flexibility in conducting business.

– An investment banking firm can help improve the capital and liquidity position of the bank while complying with regulatory requirements.

– Investment banking firms are becoming more complex and larger.

Source: https://www.thebalancemoney.com/what-is-a-bank-holding-company-5221282