Nonconsolidated affiliates, bank capitalization, and risk taking

Research output: Contribution to journalArticleScientificpeer-review

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.
Original languageEnglish
Pages (from-to)109-129
JournalJournal of Banking & Finance
Volume97
DOIs
Publication statusPublished - Dec 2018

Fingerprint

Capitalization
Minorities
Risk taking
Equity
Ownership
Bank holding companies
Consolidation
Risk capital
Deduction
Empirical evidence
Bank capital
Riskiness
Financial institutions

Keywords

  • capital regulation
  • organizational structure
  • undercapitalization
  • bank leverage
  • risk taking

Cite this

@article{645b4f512e264060b96f8a178432b36d,
title = "Nonconsolidated affiliates, bank capitalization, and risk taking",
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",
author = "D. Gong and Harry Huizinga and Luc Laeven",
year = "2018",
month = "12",
doi = "10.1016/j.jbankfin.2018.09.019",
language = "English",
volume = "97",
pages = "109--129",
journal = "Journal of Banking and Finance",
issn = "0378-4266",
publisher = "Elsevier Science BV",

}

Nonconsolidated affiliates, bank capitalization, and risk taking. / Gong, D.; Huizinga, Harry; Laeven, Luc.

In: Journal of Banking & Finance, Vol. 97, 12.2018, p. 109-129.

Research output: Contribution to journalArticleScientificpeer-review

TY - JOUR

T1 - Nonconsolidated affiliates, bank capitalization, and risk taking

AU - Gong, D.

AU - Huizinga, Harry

AU - Laeven, Luc

PY - 2018/12

Y1 - 2018/12

N2 - 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.

AB - 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.

KW - capital regulation

KW - organizational structure

KW - undercapitalization

KW - bank leverage

KW - risk taking

U2 - 10.1016/j.jbankfin.2018.09.019

DO - 10.1016/j.jbankfin.2018.09.019

M3 - Article

VL - 97

SP - 109

EP - 129

JO - Journal of Banking and Finance

JF - Journal of Banking and Finance

SN - 0378-4266

ER -