Bank Holding Company Diversification and the Risk of Capital Impairment

Abstract

The 1970 Amendments to the Bank Holding Company Act have empowered the Federal Reserve Board to determine whether the bank holding company expansions into nonbank activities meet the "proper incident" test. This paper presents an analytical device whereby regulators applying this test can evaluate the effects that each proposed nonbank expansion has upon the holding company's probability of capital impairment and debt capacity. Several regulatory implications are derived. The procedure is simulated and the separate effects of diversification and debt financing are measured. While the holding companies studied diversified effectively, the benefits were largely thwarted by considerable debt financing.