January 1997

Bank Organizational Form and the Risks of Expanded Activities (WP 97-1)

This publication is a part of:

Collection: Economics Working Paper

Abstract

Debate about the effects of permitting U.S. commercial banks to expand their range of activities has intensified in recent years. Opponents worry that banks, with access to a federal safety net, will use any new opportunities to take greater risks and increase their likelihood of failure at possible cost to the FDIC and taxpayers. Opponents also fear that the safety net might give banks a competitive advantage relative to nonbank rivals. Others argue that the risks of expanded activities are overstated and increased risks associated with them can be mitigated by constraints on organizational form and firewalls.

The purpose of this paper is to review the arguments and evidence on two critical questions: Are constraints on bank organizational form, in conjunction with firewalls, needed to shield banks, the FDIC, and taxpayers from any additional risks associated with expanded activities? If so, what is the best structural option — the universal bank, the bank subsidiary, or the holding company?

The available evidence does not clearly show that any one of the three basic models is distinctly superior to the others. The two alternatives with subsidiaries appear to afford greater insulation, and so have a slight advantage over the universal bank model. Both types of subsidiary models appear capable of insulating banks from any risks associated with expanded activities and limiting the leakage of any subsidy to nonbank subsidiaries and affiliates. But each of the subsidiary structures has advantages and disadvantages, and so it is not possible to conclude that either subsidiary structure dominates the other.

Author

Gary Whalen