Are Bank Holding Companies a Source of Strength to Their Banking Subsidiaries?

I present evidence that the cross-guarantee authority granted to the FDIC by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 has unexpectedly strengthened the Federal Reserve's source-of-strength doctrine. In particular, I find that a bank affiliated with a multi-bank holding company is significantly safer than either a stand-alone bank or a bank affiliated with a one-bank holding company. Not only does affiliation reduce the probability of future financial distress, but distressed affiliated banks are more likely to receive capital injections and recover more quickly than other banks. Moreover, the effects of affiliation are strengthened for an expanding bank holding company. However, the effects of affiliation are weakened when the parent has less than full ownership of the subsidiary. Most interestingly, my results show that these differences in behavior across affiliation did not exist before 1989, when the cross-guarantee authority was introduced. The author thanks Jonathan Guryan and seminar participants at the Federal Reserve Bank of Chicago and the University of Illinois Department of Finance for constructive comments and Martin Castellano for excellent research assistance. The author assumes responsibility for any remaining errors. Ashcraft: Research and Market Analysis Group, Federal Reserve Bank of New York (e-mail: [email protected]). The views expressed in the paper are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.