WASHINGTON — For all the hoops companies have to jump through to own a bank, the expectation that they must be able to bankroll their subsidiaries in the event of trouble has never been totally clear.

Until now.

Banking regulators are working on a proposal that would require parent firms to act as a "source of strength" for their banking subsidiaries. While such a requirement to some degree has been present for bank holding companies, other types of parents — including thrift holding companies and industrial loan companies — have never faced such a formal mandate.

"For some companies, this will be a wakeup call," said Karen Shaw Petrou, managing partner for Federal Financial Analytics. "It's one of those things you take for granted in the bank holding company context. But the thrift holding company area was different. … It was an opportunity for regulatory arbitrage. Dodd-Frank seeks to correct that by extending the source-of-strength construct to any depository institution parent."

The proposal is required by the Dodd-Frank Act, but remains one of a multitude of items that regulators have yet to address as they continue to grapple with bigger ticket items such as mortgage underwriting standards and the "Volcker Rule."

Industry observers said the plan is likely to have a large impact on thrifts and ILCs, as well as other firms that own banks with limited-purpose charters. The proposal is likely to require such parents to prove they can inject cash into a struggling bank under their control — and ensure that they can't drain the bank's liquidity if the parent gets into trouble.

The proposal will effectively boost regulators' authority over large nonfinancial firms that operate limited charters, including ILCs, which are regulated by the Federal Deposit Insurance Corp. That includes commercial companies such as Target, Toyota and BMW.

"The FDIC historically has not been very active in supervising ILC parents. That is likely to change," said Sanford "Sandy" Brown, a partner at Bracewell & Giuliani in Dallas. "If one of those organizations gets into trouble, you'd probably expect some sort of directive from the regulators to the holding company."

Gil Schwartz, a partner at Schwartz and Ballen and a former attorney at the Federal Reserve Board, said the law could also open the door to source-of-strength requirements for minority owners, since the provision applies to parents with "control" over an institution. Typically, those that own more than 10% of a bank are deemed to have a controlling influence that is then subject to heightened regulation.

"The issue is: Who controls the bank? A bank holding company presumably controls the depository institution. With an industrial loan company, you could have several different companies having significant interest," he said. "Technically speaking, someone that has 10% or more interest in an industrial loan company would be deemed to be 'in control' of that entity."

The Fed is writing the rule with the FDIC and Office of the Comptroller of the Currency, which both supervise different types of limited-purpose charters that are exempt from holding-company registration. Technically, the provision in Dodd-Frank became effective July 2011, even though the banking agencies have yet to issue an implementing regulation for it.

An OCC spokesman declined to give details about the rulemaking since it is still being drafted. "It is an interagency effort that is well underway," the spokesman said.

Dodd-Frank imposed the source-of-strength requirement essentially to codify practices that have been in effect for years through the Fed's oversight of bank holding companies. Under the law, "source of financial strength" means "the ability of a company that directly or indirectly owns or controls an insured depository institution to provide financial assistance to such insured depository institution in the event of the financial distress of the insured depository institution."

Some business strategies involve parents trying to shield themselves from the risk of a failing subsidiary unit.

But bank regulators have long held that the process has to work both ways, ensuring the subsidiary is walled off from a troubled parent. During the crisis, regulators feared that flailing firms might look toward their subsidiaries for financial help.

"Part of the reason why banks historically set up operating subsidiaries was to be able to cut off the risk associated with them," Brown said. "If the op sub got in trouble, their exposure was limited to their investment in the operating subsidiary. But in banking, even for the most well-capitalized institutions, they're still playing 90% with other people's money."

Several observers said they expect the impact of a source-of-strength rule to be limited for the bank holding companies already under the Fed's watch, and some said thrift parents have also already incorporated the doctrine into their company structure.

"I don't know if there will be a wholesale change in how holding companies view their responsibilities," Brown said. "Even a lot of the thrift holding companies already have agreed to certain capital and net-worth maintenance requirements and are otherwise expected to provide financial strength to their subsidiary thrifts."

But before Dodd-Frank, the authority of the regulators to force parents to stand by their subsidiaries was on shaky ground.

The Fed unveiled a formal policy in the late eighties saying that holding companies that fail to aid a struggling subsidiary, even though they have the funds available, are not practicing safe and sound banking. But the central bank lacked an expressed mandate from Congress to impose such a standard. In 1990, a Dallas banking company, Mcorp, sued after the Fed had tried to force it to inject money into its failing subsidiaries, and the court sided with the holding company.

"The result of that litigation was that the validity of the source of strength doctrine was very much up in the air," said Dwight Smith, a partner at Morrison Foerster. "Certainly since that case the Federal Reserve has never formally taken an enforcement action. However, all that said, the Federal Reserve does think that source of strength survives. And if you look at consent orders, for example, source of strength is in there. Pre-Dodd-Frank, there is some question as to whether the Federal Reserve could enforce the doctrine in a federal court."

Meanwhile, thrifts parents' obligation to be a source of strength was even more uncertain. The now-defunct Office of Thrift Supervision at one point had proposed a doctrine similar to the Fed's, but abandoned it after sharp opposition from the industry. (Under Dodd-Frank, the OTS was closed, thrift subsidiaries are regulated by the OCC and the thrift parents are regulated by the Fed.)

"Through the early 2000s, the OTS had specifically rejected the concept," said Smith, who used to work at the regulator.

But many said the biggest impact will likely be on parents of specialty banks — such as ILCs, trust companies and limited credit-card banks — that are exempt from holding company registration and the ban on nonfinancial bank owners.

The exemptions were at the center of a pre-crisis policy debate over whether nonfinancial firms should own banks, sparked by Wal-Mart's unsuccessful ILC bids. Some had proposed in what became Dodd-Frank eliminating the nonfinancial parent loophole, but the 2010 law instead set a more benign three-year freeze on new nonfinancial owners, and asked the Government Accountability Office to study the issue. But it also subjected such parents to the same source-of-strength rules as everyone else.

The FDIC had previously sought to apply source-of-strength rules to ILC owners through certain regulatory proposals and in individual applications. ILC representatives say parents have followed strict source-of-strength principles for years.

"The industrial banks and their parent companies had no objection to that at all when it was being put into the law," said George Sutton, an attorney at Jones Waldo in Utah, where most ILCs are based. "With respect to the industrial banks, it exists in most cases in a meaningful way."

But others said the source-of-strength provision in Dodd-Frank could give regulators greater ability to supervise nonfinancial parents.

"The fact is that you're forcing these folks to stand behind their subsidiary," Schwartz said. "The bank regulator could take the position that in order to ensure that you have sufficient resources to support the subsidiary that they want to come in and examine your financial resources."

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