Nonconsolidated Affiliates, Bank Capitalization, and Risk Taking

CentER Discussion Paper Series No. 2017-003

European Banking Center Discussion Paper Series No. 2017-001

54 Pages Posted: 20 Jan 2017

See all articles by Di Gong

Di Gong

University of International Business and Economics (UIBE) - School of Banking and Finance

Harry Huizinga

Tilburg University - Center for Economic Research (CentER); Centre for Economic Policy Research (CEPR)

Luc Laeven

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Date Written: January 19, 2017

Abstract

This paper is the first to show that financial institutions may be effectively undercapitalized as a result of incomplete consolidation of minority ownership. Using two approaches – consolidating the minority-owned affiliates with the parent or deducting equity investments in minority ownership from the parent’s capital – we find that the effective capitalization ratios of small US bank holding companies (BHCs) are substantially lower than the reported ratios. Empirical evidence suggests that the effectively lower capitalization ratios are associated with higher riskiness at the BHC level. Capital adjustments following pro forma consolidation better capture the additional risks than capital adjustments in the form of equity deductions for investments in minority-owned affiliates. These findings have important implications for the regulation of bank capital.

Keywords: capital regulation, organizational structure, undercapitalization, bank leverage, risk taking

JEL Classification: G21, G32

Suggested Citation

Gong, Di and Huizinga, Harry and Laeven, Luc A., Nonconsolidated Affiliates, Bank Capitalization, and Risk Taking (January 19, 2017). CentER Discussion Paper Series No. 2017-003, European Banking Center Discussion Paper Series No. 2017-001, Available at SSRN: https://ssrn.com/abstract=2902007 or http://dx.doi.org/10.2139/ssrn.2902007

Di Gong (Contact Author)

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

Harry Huizinga

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2623 (Phone)
+31 13 466 3042 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Luc A. Laeven

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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