"Bank Parents About to Receive a Big 'Wake-Up Call'" (Aug. 20) discussed the potential impact of a source of strength regulation on owners of federally insured banks exempt from the Bank Holding Company Act, including industrial banks. I hope the following will clarify some of the points in that article.
The source of strength doctrine was created by the Federal Reserve Board and originally applied to bank holding companies. But it lacked any basis in law and was weakened by the legal conundrum that a holding company with a failing bank subsidiary was at risk of being sued by shareholders for wasting corporate assets if the company contributed assets to the bank.
More importantly, in practice, the source of strength doctrine is largely meaningless as applied to a typical bank holding company. The Bank Holding Company Act favors shell holding companies. A BHC can't control any other kind of business unless it is a financial holding company. The draft Volcker Rule regulation doesn't even allow a bank affiliate to hold more cash than it needs for short-term debt obligations.
I am very cynical on this point because when I was a regulator during the 1980s we closed about a third of the banks (by number, not assets) in my state and every one had a holding company regulated by the Fed. In only one instance was the holding company able to do anything about the failing condition of its bank subsidiary. The one exception was a bank subsidiary of Citicorp (as it was named then). All the other holding companies had no assets other than the bank stock and no ability to raise new capital. They were helpless bystanders.
In practice, the source of strength doctrine as applied by the Fed only means the holding company will not create problems for the bank. In substance the doctrine as applied to a BHC is as useless—some might say fraudulent—as a penniless person guaranteeing a multimillion dollar debt.
In contrast, the typical holding company of an industrial bank has plenty of resources to support a subsidiary bank. Many industrial banks make up a small fraction of the parent's total assets. Capital is just not an issue for these banks. All the capital they may ever need is a phone call away. That is one reason why industrial banks have been the best capitalized group of banks in the nation for the past 20 years or more. And many industrial bank parents have entered into binding contracts with the FDIC guaranteeing their banks' capital and liquidity. These may be the only holding companies in the nation legally obligated to support their banks. This is a source of strength with real meaning both legally and in terms of the parent's ability to meet its obligations.
So contrary to some statements quoted in the article, a source of strength regulation will not be a shock or a "wake-up call" for industrial bank parents. It will only formalize what has been the status quo since they organized their banks.
George Sutton, a former Utah commissioner of financial institutions, is an attorney at the law firm of Jones Waldo in Salt Lake City who represents Utah industrial banks.