The funding of subsidiaries equity, double leverage and the risk of bank holding companies

Banking groups exploit double leverage when ‘debt is issued by the parent company and the proceeds are invested in subsidiaries as equity’. Financial authorities have frequently raised concerns about the issue of double leverage because this type of intra†firm financing appears to allow for both the arbitrage of capital and the assumption of risk. This article focuses on the relationship between double leverage and risk†taking within banking groups. First, we discuss this relationship based on an examination of balance sheet figures. Second, we analyze a large sample of United States Bank Holding Companies (BHCs) from 1990–2014. The results show that BHCs are more prone to risk when they increase their double leverage, namely, when the stake of the parent within subsidiaries is larger than the stand†alone capital of the parent. This paper's primary implication for policymakers is that the regulators of complex financial entities should more efficiently address the issue of double leverage, thereby limiting the potential negative consequences that arise from corporate instability.