Back to the Parent: Holding Company Liability for Subsidiary Banks - A Discussion of the Net Worth Maintenance Agreement, the Source of Strength Doctrine, and the Prompt Corrective Action Provision

61 Pages Posted: 10 May 2009 Last revised: 4 Oct 2016

Cassandra Havard

University of Baltimore - School of Law

Date Written: April 1, 1995

Abstract

Given the statutory goal of parental accountability, this Article focuses on a narrow issue: Whether parental guarantees are the most effective regulatory tool for shielding the federal deposit insurance fund from losses when insured banking subsidiaries that are members of a multibank holding company system are insolvent. This Article posits that a needed complement to parental guarantees is temporary substantive consolidation of a holding company's affiliated banks. This would require the parent company to combine the assets of its banking siblings to facilitate the reorganization of a financially troubled subsidiary. Temporary enterprise consolidation is a necessary regulatory tool because it provides an early form of intracorporate funding from any healthy banking subsidiary that has contributed to the weakened capital status of the financially troubled banking subsidiary.

Part II of this Article discusses inherent structural problems of the multibank holding company system. It shows how these unique situations become problematic when a banking subsidiary threatens failure. Part III discusses the traditional prereform parental guarantees - the FRB's source of strength condition and the OTS's net worth maintenance agreement. It concludes that both of these regulatory tools, which are essentially identical, have become disfavored by the regulatory agencies and the courts as enforcement methods. The source of strength condition is arguably beyond the statutory authority of the FRB. The implied net worth maintenance obligation often is unenforceable because it is overbroad and vague. Part IV briefly examines several of the inadequacies of the newest parental guarantee - the prompt corrective action provision. Part V serves as background for the use of temporary consolidation in the banking industry by discussing the FDIC's methods of resolving failed financial institutions; it explains how interaffiliate lending and captive funding may generate large loan losses and thereby increase the costs of failures within a multibank system. Part VI recommends an alternative to the prompt corrective action provision: temporary consolidation of troubled or undercapitalized banking subsidiaries within a bank holding company system. This alternative addresses the public policy objective of protecting subsidiary banks and the insurance fund within the framework of the corporate law doctrine of limited liability.

Keywords: parent companies, FDIC, federal deposit insurance fund, banking subsidiaries, multibank holding companies, insolvency, Federal Reserve Bank, regulatory agencies

JEL Classification: K22, K23, K39, K49, G21, G28

Suggested Citation

Havard, Cassandra, Back to the Parent: Holding Company Liability for Subsidiary Banks - A Discussion of the Net Worth Maintenance Agreement, the Source of Strength Doctrine, and the Prompt Corrective Action Provision (April 1, 1995). Cardozo Law Review, Vol. 16, No. 6, 1995; University of Baltimore School of Law Legal Studies Research Paper. Available at SSRN: https://ssrn.com/abstract=1400840

Cassandra Havard (Contact Author)

University of Baltimore - School of Law ( email )

1420 N. Charles Street
Baltimore, MD 21218
United States

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