What it means
Many large banks are owned through a holding company, which is a parent entity that holds shares in one or more banks and other subsidiaries. The Bank Holding Company Act gives the Federal Reserve the power to supervise these parents, and Regulation Y is where the detailed rules are found.
The Federal Reserve cares because problems at a parent can spill over into the bank. Regulation Y sets the process for forming a holding company and for acquiring banks.
A company that wants to become a bank holding company, or to buy another bank, generally has to apply and obtain approval. The Federal Reserve considers factors such as financial strength, management quality, competition and the community record of the banks involved.
The rule also limits activities. Historically a bank holding company could engage in banking and activities that are closely related to banking, such as certain lending and data processing.
A holding company that meets standards for strength can elect to become a financial holding company, which allows a wider range of financial activities such as insurance and securities. Control is a central idea.
Owning 25% or more of any class of voting shares in a bank is control under the law, and lower stakes can also count as control depending on the facts. The rule includes a process for individuals who want to acquire control of a bank to give notice to the Federal Reserve.
The rule includes capital requirements for holding companies too, and it expresses the source of strength principle that the parent should support its bank subsidiaries in difficulty. For investors and executives, this means a holding company cannot treat its bank as a separate piece of property to be stripped for cash.
Regulators expect the group to back the bank. The scale of the rule becomes clear in a merger.
Even when two banks agree a price, the buyer needs regulatory approval, and the application must show that the combined group will be financially sound and will serve its communities. Deal teams therefore build a regulatory approval period into the timetable and the financing, since delays can be costly.
In practice
Real-world examples.
Example
A regional bank holding company wants to buy a smaller bank for $120,000,000. It files an application with the Federal Reserve that sets out the strategic case, its financial strength and the effect on competition in the markets involved.
Example
An investor group plans to purchase 30% of the voting shares of a community bank. Because the stake is above the 25% control line, the group must obtain approval from the Federal Reserve before completing the purchase.
Example
A bank holding company decides to add an insurance agency. It elects to become a financial holding company after showing that its banks are well capitalised and well managed.
Case study
Seen in the real world.
Redwood Financial Group is an illustrative, fictional bank holding company with three small banks. It wanted to merge them into one charter and to acquire a wealth management firm to broaden its services.
The legal team mapped the transaction against Regulation Y. They filed for approval of the merger, confirmed that the group qualified to elect financial holding company status for the wealth business and updated its capital plan. Approval took several months, longer than the executives expected. The illustrative lesson is that a deal timetable should include regulatory review of the structure, not just negotiation with the seller.
Redwood also made sure its board understood the source of strength expectation before closing. It agreed to keep a reserve of liquid assets at the parent, so that the group could support any of its banks without selling assets in a hurry.
Watch out
Common mistakes.
- Thinking only banks are regulated, when the parent holding company is supervised too.
- Assuming a stake of less than 25% can never amount to control, when other facts can lead the Federal Reserve to treat a smaller holding as control.
- Treating a financial holding company as an ordinary holding company, when it has extra permitted activities and extra requirements.
Questions
People also ask.
What is a bank holding company?
It is a company that owns or controls one or more banks and is supervised by the Federal Reserve, whatever the size of the group.
What is source of strength?
It is the expectation that a holding company will use its resources to support a troubled subsidiary bank, rather than leaving the bank to rely on deposit insurance alone.
Does the rule require approval for every acquisition?
Not every one, but many acquisitions of banks or control of banks require approval or advance notice.
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