Abstract
Bank holding companies and its internal capital market have been widely discussed in recent financial literature and especially since the financial crisis which posed the question for regulatory intervention in the financial markets anew. From an economic point of view, the source of financing should not affect the overall firm value or future performance, but empirical evidence suggests that bank holding companies have clear preferences on double leveraging. In this paper, we show the direct effects of equity, debt and double leverage on the firms performance measured by their overall effciency. We show that efficiency is negatively affected by equity financing from parent to subsidiaries and this effect is even more pronounced for the case of double leverage. Our findings indicate that further emphasis from regulators is necessary in order to prevent inefficient fiancing via double leverage, which could be used to circumvent regulatory capital requirements.
Highlights
Bank Holding Companies (BHCs) are characterized by an internal capital market which enables the inter-related entities to exchange funds
We derive the efficiency of Bank Holding Companies from multi-directional efficiency analysis (MEA)
We find that BHCs exhibit, on average, a relative efficiency score of between 0.7 and 0.75, showing a clear improvement potential, with only 10% being fully efficient
Summary
Bank Holding Companies (BHCs) are characterized by an internal capital market which enables the inter-related entities to exchange funds. An internal capital market allows a parent company to finance subsidiaries via equity or debt from internal and external sources. The situation of double leverage arises when a parent firm raises external debt in order to acquire stocks of subsidiaries. Financing via double leverage can directly be detected if a BHC has less equity capital than the sum of banks that it owns. In this case, some of the BHC’s debt will have been down-streamed to the bank as equity.
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