Nonconsolidated subsidiaries, bank capitalization and risk taking

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.