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Nonconsolidated Affiliates, Bank Capitalization, and Risk Taking

Author

Listed:
  • Gong, Di

    (Tilburg University, Center For Economic Research)

  • Huizinga, Harry

    (Tilburg University, Center For Economic Research)

  • Laeven, L.A.H.

    (Tilburg University, Center For Economic Research)

Abstract

This paper is the first to show that financial institutions may be effectively undercapitalized as a result of incomplete consolidation of minority ownership. Using two approaches – consolidating the minority-owned affiliates with the parent or deducting equity investments in minority ownership from the parent’s capital – we find that the effective capitalization ratios of small US bank holding companies (BHCs) are substantially lower than the reported ratios. Empirical evidence suggests that the effectively lower capitalization ratios are associated with higher riskiness at the BHC level. Capital adjustments following pro forma consolidation better capture the additional risks than capital adjustments in the form of equity deductions for investments in minority-owned affiliates. These findings have important implications for the regulation of bank capital.

Suggested Citation

  • Gong, Di & Huizinga, Harry & Laeven, L.A.H., 2017. "Nonconsolidated Affiliates, Bank Capitalization, and Risk Taking," Discussion Paper 2017-003, Tilburg University, Center for Economic Research.
  • Handle: RePEc:tiu:tiucen:b9f9357a-fbce-4fc4-a487-206e1be13110
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    References listed on IDEAS

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    More about this item

    Keywords

    capital regulation; organizational structure; undercapitalization; bank leverage; risk taking;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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