Working Paper: CEPR ID: DP10992
Authors: Di Gong; Harry Huizinga; Luc Laeven
Abstract: Bank holding companies may be effectively undercapitalized as a result of incomplete consolidation of minority ownership. Using two approaches -- consolidating the minority-owned subsidiaries into the parent or deducting equity investments in minority ownership from the parent?s capital -- we find that the effective capital ratios of US bank holding companies are substantially lower than the reported ratios. Empirical evidence suggests that the undercapitalization is associated with higher risk taking at the bank holding company level. These findings indicate that incomplete consolidation of minority-owned financial institutions constitutes a loophole in capital regulation.
Keywords: Bank leverage; Capital regulation; Organizational structure; Risk taking; Undercapitalization
JEL Codes: G21; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Incomplete consolidation of minority-owned subsidiaries (G34) | lower effective capital ratios (G32) |
| lower effective capital ratios (G32) | increased risk-taking (G41) |
| lower effective capitalization (G31) | higher risk (z-score) (C46) |
| deduction method (C51) | underestimation of effective capital ratio (G32) |
| decompression method (Y60) | more accurate capital ratios (G32) |
| gap between reported capital ratios and decompressed capital ratios (G32) | lower z-score (C46) |