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Tamar Frankel is a law professor at Boston University School of Law.
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Why We Need to Restructure the Big Bank Holding Companies

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Many contributors helped bring about the most recent financial crisis, bank holding companies among them. The problems with bank holding companies stem less from lax rules or weak enforcement than from the way they are structured.

Bank holding companies are currently structured as financial malls of “shops” offering financial intermediations: brokerage, underwriting, mutual and trust funds, insurance, a securitization machine, custody services and a bank. In regular malls, each store is owned and regulated separately. Customers and investors determine a shop’s success and failure. By contrast, bank holding companies own all of the mall’s shops and collect their revenues. Their top management teams reward the shops’ executives and employees.

This structure creates two big problems. First, large bank holding companies defy effective management. They are complex and act globally, making it hard for management to control risky transactions. Management must also act under conflicting pressures. On one hand, they are expected to limit risk in order to protect government-insured deposits. On the other, they are expected to perform for investors and generate higher revenues, which might involve taking on more risk.

The structure of large bank holding companies also defies effective regulation. The shops’ regulators, and the policies of those regulators, differ. The objective of the Securities and Exchange Commission is to protect investors by requiring companies to provide proper disclosures and abide by fiduciary duties, rather than to ensure the safety and soundness of the intermediaries. By contrast, bank regulators are less concerned with protecting investors than with bank safety and soundness and protecting the Federal Deposit Insurance Corp. and depositors. The raging debate about whether bank holding companies should be allowed to trade securities on their own accounts demonstrates the issue. 

What should be done to protect the country from the risks taken by the large bank holding companies? I propose that we allow shareholders of each subsidiary, or shop in the mall, to choose its management and judge its performance. The banking holding company would become a servicer to its subsidiaries, thereby maintaining the benefits of the current system while reducing inefficient, risky behavior.

Breaking up bank holding companies into their unique services would allow for more effective management, risk controls, innovations and profitable services, facilitating market regulation. Each subsidiary would also be regulated in accordance with its form of services. If collaboration among the units was beneficial (such as combining services or offering a full-service package), the collaboration would be facilitated and legalized.

Restructuring holding companies this way would reduce the power concentration their management and regulators hold over any other financial services in the mall. The services would have to raise funds in the markets and enable the markets, rather than the holding companies, to decide which businesses perform best.

Skeptics might argue that business lines currently ensconced in bank holding companies might not survive as stand-alone entities, and that their failure could in turn raise borrowing costs. Yet there are 1,352 stand-alone U.S. banks, and some of them are doing quite well—better than the colossus holding companies. If certain subsidiaries fail, there is no threat to the entire financial system 

Others might ask if dismantling bank holding companies is necessary so long as risks are appropriately segregated within subsidiaries. But the truth is that most rules are not as effective as sound structure; self-interest and habits are often stronger than restrictive rules. Without a structural change supported by market pressures, the chances are that bankers' interactions, favoritism and fixed beliefs will overcome regulation.

We should not wait for bank holding companies to pose danger to the financial system or fail at an enormous cost to shareholders and the country before implementing the proposed structure. This can be done with minimal legal changes or government interference. Major shareholders can demand restructuring, while some entrepreneurial bank managers might break off to form new, more prosperous holding companies that operate under the new system.

To be sure, bank holding companies are shrinking—but they are not restructuring as they should. Hopefully, leaders in the banking industry will reconsider and choose the restructuring road.

Tamar Frankel is a law professor and Michaels research scholar at Boston University School of Law. A full version of this article was published in Bank & Financial Services Policy Report, Vol. 32, No. 7, July 2013.

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Comments (5)
This proposal is ivory-tower fantasy, of the Statist variation, at its finest. I love that the action proposed is to "allow shareholders of each subsidiary, or shop in the mall, to choose its management and judge its performance." Is not the bank holding company the shareholder now? By what mechanism does Ms. Frankel want to devolve the operating subsidies? Will it be mandated by government - and if so, what what constitutional authority? Who will determine the capital structures and management policies of these businesses? Who will determine on what terms they interact with each other? I suspect that the answer to each of these questions is "government bureaucrats aided by university professors", and therefore I fear for my country.
Posted by Bob Newton | Thursday, July 10 2014 at 2:26PM ET
As I read this, the Professor proposes spliting up the businesses under independent boards each subject to election by the same set of shareholdersa. Looks like just completing the spinoffs would make the most sense. I still believe the logical way to address too big to fail is with progressively higher capital ratios. This demands better performance as the institution grows to maintain the same ROE. And it will encourage spinoffs to lower required capital ratios. Only mergers producing true economic benefits would be considered and spinoffs into smaller, more effective organizations would become routine.
Posted by pdf70101862 | Thursday, July 10 2014 at 2:44PM ET
This article is one of the most pertinent warnings about possible fallout that may be caused by bank holding companies (BHC). With present status and structure of bank holding companies we have huge financial intermediaries with heterogeneous business models. The suggested approach to their restructuring raises topical issue of how destructive may be systemic risks originated from BHCs' activities and how they further be exacerbated without proper disclosures of the activities of their subsidiaries. However, while it will be quite costly for the BHC to split "shareholdership" among its subsidiaries, why not to think about more homogeneous business models, taking into account examples of Citigroup and other industry giants in the post-crisis era when they were actively selling their unrelated businesses. Homogeneous models will also ease BHCs' regulation that may further favor accuracy in risk-taking by banks and risk supervision by regulators including the enhanced capabilities of risk diagnostic and identification. This will ultimately result in facilitating market regulation, which is correctly maintained by the author. On the other side, BHC will be less burdened with regulatory costs by employing lesser regulatory compliance staff keeping only those with banking (and not financial) compliance.
Posted by Eduard Dzhagityan | Thursday, July 10 2014 at 2:52PM ET
All of these prescriptions to make the industry perform contortions while jumping through flaming hoops for the sake of preserving an improper government subsidy and its accompanying straitjacket of regulations is completely wrong-headed.

As I have said many times in these pages, if you want the industry to be restructured along economically efficient and commercially successful lines, just remove all forms of deposit insurance and all regulation beyond the requirement to deal honestly and publish fair, transparent financial statements. The industry's customers, shareholders, and managers will take care of the rest. I propose a repeal of deposit insurance to take effect three years after the bill's enactment, to provide sufficient time for the restructuring.

This proposal has only one negative side effect - it will increase unemployment among regulatory bureaucrats and the industry of consultants who help banks to deal with them at enormous cost. But since these people are elites, they should have no trouble finding new jobs in the private sector.
Posted by Bob Newton | Thursday, July 10 2014 at 3:21PM ET
Both the article and the comments are hard to follow. If I understand Professor Frankel's proposal, holding companies are already legally structured as she suggests. Federally insured depository banks are stand alone entities with their own boards and the regulators I work with insist that a bank maintain clear bright lines between itself and its affiliates. The banks have their own regulators separate from the insurance, securities and holding company regulators overseeing affiliate companies. The only model I know of where the bank's regulator also regulates the holding company is the industrial banks and state chartered banks that elect to be Fed members. Under the industrial bank model, the bank's regulators have authority over the parent to ensure its relationship and dealings with the bank are appropriate. The main problem with the current holding company regulation is that by limiting the kinds of business activities a holding company can undertake the Bank Holding Company Act favors shell or weak holding companies. How can a holding company not be closely involved in the operation of a subsidiary bank if the bank is the only or a primary asset of the holding company? TBTF is an issue of size, not structure.
Posted by gsutton | Thursday, July 10 2014 at 5:26PM ET
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