WORKING PAPER SERIES

Banks’ Nonbank Affiliations

Jonathan Pogach

Federal Deposit Insurance Corporation

Haluk Unal

University of Maryland and 

Federal Deposit Insurance Corporation

January 2018

Last Updated: November 2020

Previously circulated as “The Dark-Side of Banks’ Nonbank Business: Internal Dividends in Bank 

Holding Companies”

FDIC CFR WP 2018-01

fdic.gov/cfr

NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical comment. The analysis, 

conclusions, and opinions set forth here are those of the author(s) alone and do not necessarily reflect the views of the 

Federal Deposit Insurance Corporation. References in publications to this paper (other than acknowledgement) should be 

cleared with the author(s) to protect the tentative character of these papers.
Banks' Nonbank Aliations *

Jonathan Pogach Haluk Unal

November 27, 2020

Abstract

In this paper, we highlight the liquidity and capital pressures nonbank aliates can create

on banks residing within the same bank holding company (BHC). We show in a simple model

that when banks benet from a lower cost of funds than their aliates or parents and nonbanks

benet from lesser regulation, the BHC reallocates capital from the bank to the nonbank

through internal dividends. We use the timing of the passage of the Gramm Leach Bliley Act

in 1999, which removed restrictions on BHC aliation with certain types of nonbanks, to test

model predictions. A dierence-in-dierences analysis shows that BHCs funded expansion

into lesser regulated investment banking through internal bank dividends, while BHCs that

expanded into more regulated insurance-underwriting did not.

Keywords and phrases: Bank holding companies, nonbanks, dividends, internal capital

markets, risk management

JEL Codes: D22, G21, G31, G35, G38, L25

*The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do not necessarily

reect the views of the Federal Deposit Insurance Corporation. The authors thank participants at the AFA 2018

Annual Meeting, the 28th Annual Conference on Financial Economics and Accounting, the Chicago Financial

Institutions Conference 2018, 18th Annual FDIC-JFSR Bank Research Conference; seminar participants at the

Federal Reserve Board of Governors, the Federal Deposit Insurance Corporation, George Mason University, the

University of Maryland, Penn State-Harrisburg, and Mitchell Berlin, Cecilia Bustamante, Mark Carey, Michael

Faulkender, Jerry Hoberg, Joel Houston, Laurent Fresard, Rich Matthews, Emily Johnston-Ross, N. Prabhala,

Manju Puri, Bharat Sarath, Rajdeep Sengupta, George Shoukry, Gustavo Suarez, Liu Yang, and Vladimir Yankov

for their useful comments. We thank Matthew Peppe, Michael Pessin, and Kevin Wong for excellent research

assistance. All remaining errors are the authors' alone.

Federal Deposit Insurance Corporation. jpogach@fdic.gov. 550 17th St NW, Washington, DC 20429.

R. H. Smith School of Business, University of Maryland and CFR-FDIC. hunal@rhsmith.umd.edu. Finance

Department, Robert H. Smith School of Business, University of Maryland, College Park, MD 20742.

1
I. Introduction

The extent to which laws and regulations should allow banking organizations to comingle with

nonbanks has been a point of continued historical policy contention and academic debate.

The Glass-Stegall Act of 1933 established boundaries between banks and certain nonbanks

and regulatory policy altered those boundaries over the subsequent generations. Passed on

November 12, 1999, the Gramm-Leach-Bliley Act (GLB) enabled BHCs to operate as nancial

holding companies (FHCs) and engage in previously prohibited nonbank activities, such as

securities underwriting and dealing, insurance underwriting, and merchant banking.1 The

2008 nancial crisis and the Dodd-Frank Act of 2010 rekindled the debate on the scope of

activities that banking organizations should perform. While broad-scope banking potentially

helps customers by giving them single-window access to a broad menu of services, these eects

are not without costs. Regulatory concerns focus on the systemic risk that bank holding

companies (BHCs) create because of their nonbank aliates within the same organization

(BHC).2In this paper, we highlight a dierent and somewhat subtle channel in which liquidity

and capital pressures on the bank subsidiaries from the parent holding company are a function

of the nonbank expansion.

We use the passage of the GLB as a shock to scope economies caused by the elimination

of acquisition restrictions of nonbank rms. Although the restrictions of the Glass-Steagall

Act had been diluted prior to GLB by the establishment of Section 20 subsidiaries, signicant

constraints existed that prevented BHCs to expand their nonbank operations.3In terms of

securities underwriting and dealing, a BHC could not derive more than 25 percent of its gross

1 The stated rationale for GLB, also known as the Financial Services Modernization Act of 1999, was to modernize the industry by taking advantage of economies of scope. As the former President of the Federal Reserve

Bank of Richmond, J. Alfred Broaddus remarked, There are substantial economies to be gained, for example, from

combining credit evaluation for the banking and securities businesses in a single company. . . I think these [GLB created] combinationsprecisely because they are being driven by basic potential economies of scale and scopewill

increase eciency in nancial services markets. . .  (Broaddus (2000)).

2Laeven, Ratnovski, and Tong (2014) nd that systemic risk increases with the complexity of a bank. Meanwhile, De Jonghe (2010) nds that heterogeneity in banks' tail risk is attributable to dierences in the scope of

nontraditional banking activities.

3The name pertains to section 20 of Glass-Steagall Act, which allowed BHCs to engage in securities and dealing

in restricted terms.

2
revenue in underwriting and dealing in corporate debt and equity securities. In addition, a

Section 20 subsidiary of a BHC could not acquire more than 5 percent of voting securities

of a company in a dealer capacity. Similar constraints applied to insurance activities. For

example, BHCs were not allowed to sell insurance as agent in places that had population of

5,000 or more. In terms of merchant banking, the ability of BHCs to provide equity nancing

to nonnancial companies was restricted. BHCs were not allowed to hold more than 5 percent

of the voting securities, or more than 24.9 percent of the total equity of a nonnancial rm.

However, GLB freed BHCs from these constraints and gave them the opportunity to expand

operations in nonbank activities.

The newly acquired investment powers of GLB necessitated that BHCs decide how to

nance the new expansion opportunities. One avenue to expand was through raising equity

at the parent holding company level as predicted by Stein (1997). However, BHCs are averse

to raising external equity since the size of their balance sheets is determined primarily by

the availability of leverage (Adrian and Shin (2010)). Alternatively, parent holding company

could borrow either directly from the capital markets or rely on internal dividends from its

bank subsidiaries. The latter strategy is sensible if the funding costs are less than alternative

funding options in the BHC, either at the parent or nonbank subsidiary levels. In this case,

however, leveraging the bank subsidiary brings costly regulatory scrutiny. The goal of this

paper is to understand the trade-os the BHC faces to nance the nonbank expansion and

how this decision aects the bank subsidiaries of the BHC.

We rst develop a simple model to understand the trade-os of bank versus parent debt

nancing. In the model, either the parent holding company or the bank subsidiary raises

external debt and the latter has a funding cost advantage. In addition, the parent can reallocate capital from the bank subsidiary to the nonbank via internal dividends. A regulatory

capital constraint exists both at the bank subsidiary and the consolidated BHC level, which

limit the ability of the parent to use the bank subsidiary as a source of cheap funding. We

show that strictly positive funding cost advantages at the bank and strictly higher returns on

investments at the nonbank are both necessary conditions for the bank to fund the nonbank

3
via internal dividends, but neither is sucient. Consequently, we predict that in the context

of GLB, BHCs are more likely to use internal dividends from the bank subsidiary to fund

nonbank expansion for lesser regulated investment banks than more highly regulated insurance aliates. We follow a novel approach and use internal dividends information reported

in regulatory lings to test this hypothesis.

Our working assumption in testing the increase in banks' internal dividends is that GLB

created exogeneity in the timing at which bank subsidiaries could begin aliating with certain

nonbanks. Under GLB, BHCs could undertake previously prohibited aliations as early

as March 2000 by becoming nancial holding companies (FHCs). We assume that those

BHCs that opted to become FHCs in March 2000, and particularly those that immediately

established subsidiaries in previously prohibited activities, had been constrained by the GlassSteagall restrictions.4

In our baseline specication, the treated group consists of thirty-two

BHCs that converted to FHCs by December 31, 2000 and had an investment bank subsidiary

by that date. The control group consists of 229 BHCs that converted to FHCs by December

31, 2000, but did not have an investment bank subsidiary by that date. Similarly, the treated

group of FHCs with insurance subsidiaries is 106, with 155 control FHCs. The control groups

allow us to account for other trends in the banking industry surrounding GLB and we assume

that the restrictions on aliation for the control groups had not been binding prior to GLB.

To determine the signicance of the capital withdrawal from the bank subsidiaries, we

undertake a dierence-in-dierences analysis. We show that following the GLB, consistent

with the predictions of the model, bank subsidiaries belonging to the newly formed FHCs that

expanded into investment banking increased their payout ratios signicantly by 16-percentage

points relative to the control group during the 2000 to 2002 period. In contrast, we nd that

banks within FHCs expanding into insurance underwriting did not increase signicantly their

internal dividends. The dierent internal dividends responses of FHCs with insurance and

4On March 13, 2000, the rst day that BHCs were eligible to become FHCs, the Federal Reserve approved 117

applications. In fact, forty of the forty-two US BHCs that operated section 20 subsidiaries became FHCs. The two

remaining BHCs operated their section 20 subsidiaries under the GLB's provisions. Source: Report to the Congress

on Financial Holding Companies under the GLB Act, November 2003. P. 8.

4
investment banking subsidiaries imply that our results cannot be attributed to expansion itself

(e.g., mergers), but rather reects the reaction to the nature of the expansion. We further show

that those FHCs that increased their internal bank dividends following GLB were those that

also had higher subsequent nonbank investments. FHCs expanding into investment banks

also did not increase their external dividends following GLB, suggesting that bank capital

was reallocated internally. Collectively, the investment bank treated FHCs in our sample

increased internal dividends from $64 billion in the three years preceding GLB to $99 billion

in the three years subsequent to GLB. Simultaneously, treated FHCs nonbank investments

rose by $21 billion from the three years preceding GLB to the subsequent three years.5

Our model predicts that for transfers of capital through internal dividends to occur, banks

need to have a funding cost advantage. Thus, we test for dierences between banking organizations and investment banks and insurance rms. In addition, we test for dierences within

the banking organization between the parent holding company and its bank subsidiaries. We

nd that bonds at issuance for parent and their subsidiary banks had spreads over treasury

of about 13 bps lower than bonds at issuance for investment banks and 18 bps less than

bonds at issuance for insurance rms. Within the BHC, issuance at the bank subsidiary is

advantageous relative to the parent holding company. Bonds issued by the bank subsidiaries

have ratings about 0.8 notches higher than bonds with similar characteristics issues by the

parent. Consequently, we nd that within the same BHC, bond issuance costs at the parent

holding company were 41 bps higher than issuance at its subsidiary banks, making the bank

subsidiary a cheaper source of funding for the organization. We note that the funding cost

advantage may be even greater for the bank if we were to also consider the advantage of being

able to raise insured deposits. However, the challenge of measuring the full cost of deposits

(e.g. operation of bank branches) and lack of comparable debt instruments at nonbanks make

bonds the most appropriate basis for comparison.

The other requirement for bank funds to be channeled to a nonbank aliate is that the

nonbank must have higher return investment opportunities than the bank, for example, due

5The data do not allow us to distinguish the specic nonbank to which capital is downstreamed.

5
to dierences in the regulatory oversight of operations. At the time of GLB, investment banks

were regulated by the SEC but subject to weaker capital regulation than banks (two percent of

aggregate debit items, SEA Rule 15c3-1) whereas insurance rms were regulated by states and

were under risk-based capital regulation similar to banks that penalized non-investment grade

securities.6 Given the observed funding advantages at the bank subsidiary, a prot maximizing

BHC can nd it optimal to channel bank capital to investment banking subsidiaries where

capital can be levered at a higher multiple rather than at insurance subsidiaries or banks.

In addition, there existed demand for growth in the investment bank industry relative to

the insurance industry. During the 2000 to 2006 period, the average insurance underwriting

rm in COMPUSTAT grew by 123 percent, while the average investment banking rms grew

by 349 percent (excluding companies that are BHC aliated in both cases). Such a high

relative growth in competitors required extensive nancing needs for the new entrants to

the industry, which placed pressure on the parent company to ease the nancing constraints

and costs on investment banking subsidiaries. In addition to these factors, other regulation

induced incentives could have created the tendency for a BHC to move capital from the bank

subsidiary to a nonbank subsidiary. For example, regulations treat nonbank subsidiary as

bankruptcy remote in a bank failure in a way that the parent entity and other banks within

the BHC are not. Particularly, FDIC can assess the cost of resolving a failed bank against

other banks within the BHC but not against other nonbanks.

At rst glance, regulatory constraints might impede our hypothesis that the BHC would

use bank capital to support nonbank operations. Sections 23A and 23B of the Federal Reserve

Act address regulatory concerns relating to a BHC's incentive to use the its bank subsidiaries

as support for other parts of the BHC. These regulations require that transactions across

aliates within the BHC, including credit decisions, asset sales, and leases, be conducted at

arm's length. In addition, these regulations restrict advertising that suggests that the bank

shall in any way be responsible for obligations of its aliates. Thus, regulation recognizes

6See NAIC Model Laws, Regulations, Guidelines and Other Resources, April 2001, https://www.naic.org/

store/free/MDL-283.pdf

6
the incentive to use the bank to support a nonbank aliate and restricts doing so through

these limitations.

Yet, Board of Governors of the Federal Reserve System (2016), the Bank Holding Company

Supervisory Manual (BHCSM) explicitly argues in favor of using bank internal dividends to

support a nonbank aliate. For example, guidance states, because the bank is usually the

largest subsidiary, the holding company may attempt to draw upon the resources of the bank to

aid the nonbank subsidiary. The bank can transfer a substantial portion of its capital through

dividends to the parent company, which may pass these funds on to the troubled nonbank

subsidiary (BHCSM, 2016 Section 4030.0). In other words, internal dividends remain a

mechanism through which the BHC can use the bank to support the rest of the organization.

Our paper relates to several strands of literature. First, the results add to the literature on

economies of scope in general and banking in particular. Cetorelli, Jacobides, and Stern (2017)

demonstrate the expansion of nonbank activities over time and report a negative relationship

between scope expansion and BHC performance. Their results are consistent with both a

narrower literature in banking that nds a similar result (e.g., Stiroh (2004), Stiroh and

Rumble (2006), DeYoung and Torna (2013)) as well as a broader literature on scope-economies

(e.g., Comment and Jarrell (1995), Morck, Shleifer, and Vishny (1990), Matvos, Seru, and

Silva (2018), Villalonga (2004), Schoar (2002)). In contrast, our paper leaves aside the question

of whether scope economies are ecient and focuses instead on the funding decisions through

which BHCs achieve economies of scope. We nd that scope expansion via internal dividends

is generally associated with a diversion of funds from the bank subsidiaries to the nonbank

aliates.

Second, the results presented in the paper t into a large literature on the internal capital

markets at BHCs. This literature focuses on the management of loans using internal capital

markets between banks within a BHC. Houston, James, and Marcus (1997), Houston and

James (1998), and Holod and Peek (2010) nd that multibank holding companies establish

internal markets to smooth loan growth. The literature also shows that internal capital

markets lessen the impact of monetary policy on bank lending and reallocate resources to

7
those banks with the greatest need for capital and that this reallocation occurs through loan

sales and purchases (Campello (2002)). Further, banks raise deposit rates at branches in one

state to help fund loan growth in other states (Ben-David, Palvia, and Spatt (2015)). Another

branch of this literature focuses on lending by multi-market and multinational banks. Cortés

and Strahan (2017) show that multi-market banks reallocate funds toward markets with high

credit demand and away from their traditional markets. De Haas and Van Lelyveld (2010)

nd that the parent's nancial strength is an important determinant of credit supply for

foreign subsidiaries in times of crisis. Cetorelli and Goldberg (2012) show that liquidity is

reallocated using internal capital markets such that those aliates deemed most important

for revenue generation are protected, while traditional funding locations are used as a buer

against shocks to the parent's balance sheet. In contrast to these studies, we study the internal

capital markets at work between bank and nonbank segments within the holding company,

and we examine the internal dividends rather than focusing on investments, particularly on

loan sales and purchases.

Last, we add to the literature on mergers and acquisitions by proposing a new channel

through which the acquirer can relax a target's nancial constraints. Namely, the target

nonbanks in our case need funding for expansion and parent uses one segment of the holding

company, the bank, to provide nonbanks the exibility in terms of nancing needs. In this

regard, our paper complements Erel, Jang, and Weisbach (2015), who focus on the targets

after acquisition by nonnancial rms whereas we focus on the existing subsidiaries of the

acquirer.

The paper is organized as follows. Section II presents a simple modeling framework to

understand BHC funding incentives for nonbank expansion. Section III describes the data.

Section IV discusses the dierence-in-dierences analysis and results and examines the uses

of internal dividends at FHCs. Section V examines funding costs dierences between banks,

other nancials, and parent holding companies. Section VI concludes.

8
II. Model

In this section, we model the funding decision of a parent holding company when it faces an

unexpected and exogenous regulatory change that allows nonbank expansion opportunity into

an investment bank or insurance agency. Before the regulatory change, we consider a simple

structure for the BHC organization, such that it is composed of a parent holding company and

a bank subsidiary. Regulatory change provides new opportunities to expand into investment

bank and insurance underwriting activities. We assume investment banking is less regulated

than insurance agencies and banks, consequently, they have higher returns. To nance the

expansion, the parent holding company can borrow from external sources and downstream

the funding to its nonbank.7 Alternatively, the bank subsidiary can raise debt and can pass

funds to the parent via internal dividends, which then downstreams the funds to the nonbank

subsidiaries. In the model, there is a tradeo between using the funding cost advantage of

the bank subsidiary to fund the higher return nonbank aliate and the regulatory cost of

increasing bank leverage and weakening the bank capital ratio. The following framework

models these nancing options and develops predictions for our empirical tests.

Our modelling exercise relates to the literature of organizational funding and funding

structure of rms, particularly nancial rms. Boot and Ratnovski (2016) argue that banks

may ineciently allocate too much capital to trading activities, exacerbated by risk-shifting

incentives. Other papers in the literature characterize the optimal organization structure

given various institutional environments. Luciano and Nicodano (2014) and Nicodano and

Regis (2019) rationalize organizational structures and intrarm transfers based upon a taxbankruptcy tradeo. The latter nds that it never pays to concentrate leverage in the subsidiary, absent bailouts. Kahn and Winton (2004) suggest that a bipartite structure with

separate subsidiaries tends to be more ecient from a unitary structure in which activities

are combined, mitigating moral hazard in nancial rms. Kolasinski (2009) concludes similarly for nonnancial rms. Meanwhile, Banerjee and Noe (2017) develop a theory in which

7BHCs are averse to equity nancing (Adrian and Shin (2010)). In addition, our sample of banks do not exhibit

signicant equity nancing around the passage of GLB, and no higher than banks outside of our sample.

9
the parent and subsidiary both issue debt to minimize agency frictions associated with imperfectly enforceable debt contracts. In contrast, we do not aim to characterize the optimal

subsidiary structure. Instead, we take as given the requirement of legal separation between

banks and their GLB-enabled nonbank aliates and study how bank funding is used to support investment banking and insurance aliates. Similar to the existing literature (e.g. Boot

and Ratnovski (2016)), we nd that pairing banks with higher return/lesser regulated entities

creates an incentive to transfer capital from the bank subsidiary to the parent via internal

dividends.

A. Model Structure

A.1. Simple Bank Holding Company

Before the regulatory change, the parent holding company solves a simple static prot maximization function to fund itself and its banking subsidiary. The parent has an existing equity

E and chooses to raise debt at the parent and the bank subsidiary levels, Dˆ

P and DˆB, respectively. The parent downstreams its equity to the bank subsidiary as an equity investment.8

However, the parent may choose to retain T0 of its equity at the parent level. This retention

can also be thought as a simultaneous internal dividend payment by the bank subsidiary to

the parent. The parent and its bank subsidiary interest cost of funds are cP and cB = cP −∆c,

respectively, where ∆c ≥ 0. The lower interest cost on bank debt can be the result of access

to deposit markets, including insured deposits, or implicit government guarantees. In addition, the bank's return on investments is rB and the parent's return on its own investments

(i.e., those investments not made at the subsidiary bank) is rP . For a simple bank holding

company, we assume that the return on assets at the bank is at least as high as that of the

parent rB ≥ rP .

Capital regulation exists both at the bank and the consolidated BHC levels. Compliance

costs are inversely proportional to capital ratios; they increase as the bank subsidiary or the

8This is consistent with regulatory treatment. Equity raised at the parent holding company level can be counted

as equity at the bank level if the parent chooses to invest its equity proceeds into its bank subsidiary.

10
BHC increase leverage. Consistent with capital regulation, capital compliance for the parent is

measured on a consolidated basis, netting out intracompany claims, rather than a legal entity

basis. Regulatory compliance-cost of the BHC and the bank subsidiary are scaled by κP and

κB, respectively.9 We allow for the costs of multiple regulators to be arbitrarily small (i.e.,

κP may be arbitrarily close to zero). Compliance costs reect that as leverage increases and

the institution gets closer to the regulatory required capital ratio, costly supervisory scrutiny

increases, such that there is an increasing marginal cost of using debt to fund the organization.

Calculating capital on a consolidated entity basis implies that debt raised by the bank or the

parent holding company counts toward the BHC capital ratio, while debt raised by the parent

does not count toward the bank's capital ratio. In addition, internal dividends of capital from

the bank to the parent aect the bank's capitalization ratio, but not the BHC's. The required

capital ratios for the bank and the BHC are RB and RP , respectively. The parent chooses its

debt, equity, and internal dividends levels (T0) to maximize its prots, such that regulatory

capital requirements are not breached. Specically:

Π0 = max

DˆB≥0,DˆP ,≥0,T0,≥0

rB(DˆB + E − T0) + rP (Dˆ

P + T0) − cBDˆB

−cP Dˆ

P − κB

DˆB + E − T0

eB

− κP

DˆB + Dˆ

P + E

eP

, (1)

The rst term rB(DˆB + E − T0) represents the return on bank-subsidiary assets. The second

term rP (Dˆ

P +T0) represents the return on parent assets. The terms cBDˆB and cP Dˆ

P represent

the total debt interest expense of the bank and the parent, respectively. The last terms

represent the costs of capital regulation, where eB = E − T0 − RB(DˆB + E − T0) and eP =

E − RP (Dˆ

P + DˆB + E) denote the excess capital held at the bank and the consolidated level,

9Separate regulatory costs can emanate from bank subsidiaries and BHCs having dierent regulators. BHCs

are exclusively regulated by the Federal Reserve Board (Fed) in the U.S., while subsidiary banks can be regulated by dierent agencies, such as the state regulators, the FDIC, the Fed and the OCC. As of December

2000, over 80 percent of all commercial banks, including more than 73 percent of those less than $100 million were part of a BHC. See https://www.fedpartnership.gov/bank-life-cycle/grow-shareholder-value/

bank-holding-companies. Meanwhile, only 10 percent of banks had the Fed as their primary federal regulator at

that time.

11
respectively. As the bank or the consolidated BHC exceeds the regulatory capital, the impact

of κi, the parameter reecting the relative compliance costs for entity i, lessens. We assume

that parameters are such that for a simple BHC organization with just a parent and bank

subsidiary,10 we have an interior solution (D ̄B, D ̄

P ).

The rst result is that in the simple BHC, the parent holding company downstreams all

its equity to the bank subsidiary or equivalently, the bank subsidiary does not transfer capital

(pay dividends) to the parent

Proposition 1: The parent BHC downstreams all of its equity to its bank subsidiary. T

∗

0 = 0.

Proof in Appendix B. The result follows from weakly higher returns at the bank and the

fact that capital held at the bank reduces capital compliance costs, without aecting the

parent's capital compliance costs.

A.2. Gramm Leach Bliley

The Gramm-Leach-Bliley Act enabled BHC nonbank expansion into new types of nonbank

subsidiaries, specically, investment banking and insurance. At the time of the passage of

GLB, we assume that BHCs were positioned to expand into investment banking, insurance

agencies, or not. Consequently, we model the parent holding company's decision of how to

fund the nonbank opportunities, taking as given the desire to expand at the rst opportunity.

Our modelling provides a static comparison of the parent's choice of its debt in this new

environment with that of the simple organization (i.e., without anticipation of future nonbank

expansion opportunities). In this new setting, the parent chooses to optimize its debt, DP

to fund new nonbank investments. The parent can also raise additional debt DB at its bank

subsidiary beyond the D ̄B. The parent can pull these funds from the bank subsidiary via

internal dividends, T, and reallocate the funding to the nonbank subsidiary. The return

on nonbank investments (rN , N ∈ {IN, IB}) exceeds the bank return, rIB > rIN ≥ rB,

where IB denotes the investment banking return and IN denotes the insurance subsidiary

10This assumption excludes corner solutions in which the bank or BHC take on no debt.

12
return. The dierence between the bank and investment bank returns arise because of dierent

regulatory environments. There exist explicit restrictions on bank investments relative to

investment banks, a regulatory regime that imposes costs on investments, or higher linear costs

of debt associated with bank capital regulatory compliance costs. We also allow insurance

subsidiary and bank subsidiary returns to dier, though assume that dierences are smaller

due to similar regulatory restrictions. Thus, ∆c represents the funding costs advantages

of banks relative to its parent, while ∆rN = rN − rB captures any dierences in returns

arising from a less constraining regulatory regime.11 For simplicity, we assume that investment

banks and insurance agencies are not subject to capital requirements. Capital requirements

for nonbank subsidiaries adds complication to the model, without aecting the main model

tradeos. In addition, nonbank investment return is greater than the parent's investment

return (rP ), so that the parent has no incentive to make its own investments.

Assumption 1: We assume that the return on the investment banking subsidiary is high and

the return on the insurance subsidiary is low. In particular, rIB >

κBD ̄B

[(1−RB)E−RBD ̄B]

2 and

rIN <

κBD ̄B

[(1−RB)E−RBD ̄B]

2

The parent's objective is to choose the nancing source of the nonbank expansion such

that prot is maximized. Specically:

Π = max

T ≥0,DB≥0,DP ≥0

rB(DB + D ̄B + E − T) + (rB + ∆rN )(DP + T) − cB(DB + D ̄B)

−cP DP − κB

DB + E − T

eB

− κP

DB + DP + E

eP

, (2)

The rst term represents the returns from the bank, the second term represents the returns

at the nonbank, and the third and fourth terms represent the interest costs of debt at the

bank and parent, respectively. The last two terms represent the cost of capital regulation

at the bank and parent, respectively. Excess bank and parent capital are denoted by eB =

11For simplicity, we use a partial equilibrium analysis and do not allow returns or costs of funds to change with

the addition of nonbank expansion opportunities.

13
(E − T) − RB(DB + D ̄B + E − T) and eP = E − RP (DP + DB + D ̄B + E), respectively.12

Given the model assumptions, our second result is that the parent uses internal dividends

to transfer capital from the bank to an investment banking subsidiary, but not an insurance

subsidiary.

Proposition 2: Bank subsidiary internal dividends are zero when the BHC expands into insurance underwriting . Bank internal dividends are strictly positive when the BHC expands into

investment banking.

Proofs in Appendix B

In addition, we show that internal dividends are weakly increasing in the ∆rIB.

Proposition 3: Internal dividends are strictly positive for a BHC with an investment banking

expansion opportunity, and increasing in the return of the investment bank. That is, internal

dividends T are increasing in the return of the investment bank, ∂T∗/∂∆rIB ≥ 0.

Proof appears in Appendix B.

In sum, our model predicts that internal dividends to fund the parent are zero in a setting

where GLB opportunities do not exist (T

∗

0 = 0) and are higher (T

∗ > 0) in a setting with

GLB opportunities only if the BHC expands into investment bank activities. As a result, the

capital position of the bank subsidiary is weakened, as the parent nds it optimal to use the

bank to fund its lesser regulated investment bank aliate.

III. Data

A. Sources

Data for our analysis come predominantly from Reports of Condition and Income (Call Reports), Consolidated Financial Statements for Holding Companies lings (Y-9C), and the

12SR 00-13 argues that Most of the concepts discussed in [the regulatory framework of FHCs] are already being

applied by the Federal Reserve in the context of the consolidated supervision of BHCs. However, SR 00-13 also

discusses the expanded role of the Federal Reserve under GLB. For simplicity, we assume that κP does not change

with nonbank expansion opportunities.

14
Annual Report of Holding Companies (Y-6) and Report of Changes in Organizational Structure (Y-10). Federal Reserve Board calls the latter two as structure data. In some analysis,

we also rely upon Parent Company Only Financial Statements for Large Holding Companies

(Y-9LP), which are nancial statements of all bank holding companies within the organization

structure for large BHCs, led at the legal entity level (in contrast to a consolidated level).

Using the structure data, we identify BHCs that converted to FHCs as of year-end 2000,

the rst year during which they could do so. To remain consistent across changes to reporting

requirements, we require that consolidated BHC assets are greater than $150 million through

the sample period. We exclude foreign banking organizations. Two reasons exist for this

exclusion. The top Y-9C ler does not correspond to the ultimate parent within the holding

company and measurements of dividends at the Y-9C level are themselves internal distributions to the foreign parent. We also follow Benartzi, Michaely, and Thaler (1997) and use

annual rather than quarterly data. We focus on the six years surrounding the establishment

of FHCs, 1997 through 2002.

Our analysis relies upon the classication of bank and nonbank subsidiaries into two identiable segments of a BHC. Over time, the organizational structures of BHCs have become

extremely complex, and data sources for various subsidiaries and the parent holding company

itself are dispersed across a number of regulatory lings (Avraham, Selvaggi, and Vickrey

(2012)). Typically, a BHC can have three types of subsidiaries: an insured bank, a nonbank,

and a subsidiary BHC. The subsidiary BHC can have a similar types of subsidiaries, resulting in a complex vertical organizational structure. In Appendix A, we explain this complex

structure and various regulatory lings that we use to construct the data and the sample.

From the structure data, we classify nonbank subsidiaries into industry type using their

reported primary NAICS code. For each NAICS code, we use a binary classication for each

BHC-year equal to one if there is a nonbank subsidiary in their organizational structure with

that NAICS code as of December 31 of that year. The number of NAICS digits we use varies

across subsidiaries to retain a meaningful number of observations for various nonbank types.

Although we can identify which nonbanks aliate with which BHC from the structure

15
data, detailed nancial data at the individual nonbank level is not available. Not all nonbank

subsidiaries report nancial data at the legal entity level. We do not observe nancial data by

nonbank activity (i.e. in terms of NAICS codes), such as assets or revenues of the investment

banking or insurance aliates in the BHC. As a result, we use aggregate information on

cash ows and parent investments in nonbank and BHC subsidiaries available in the Y-9LP

lings to construct the nonbank aliate variables. Another complication is that a subsidiary

BHC can also have nonbank subsidiaries. To obtain the nonbank nancial data for the entire

holding company organization, we aggregate income and investments across all BHCs within

the structure. Consequently, each nonbank dollar of income or assets is counted only once,

corresponding to the lowest level of BHC owner. Finally, we subtract any thrift data (available

from Call Reports) from the nonbank segment where appropriate because nonbanks include

thrifts in the Y-9LP denition.

B. Summary Statistics

We begin by documenting the nonbank subsidiaries into which FHCs expanded after the

passage of GLB. Table I reports the proportion of BHC-years in which a BHC owned a

nonbank subsidiary by NAICS code for FHCs and non-FHCs, for pre-GLB (1997-1999) and

post-GLB (2000-2002). We sort the table in descending order by the change in the proportion

of BHC-years after GLB took eect for FHCs and report only those industries for which there

is an increase in the proportion of FHCs with the nonbank type.13 At the top of the list appear

Insurance Agencies (NAICS 5242), followed by Fund, Trusts, and Other Financial Vehicles

(525), and Investment Banking and Securities Dealings (NAICS 52311). FHCs expanded

investment banking and insurance activities by 17.6 and 8.4 percentage points, respectively.

In both cases, the increase in the proportion of FHCs owning these subsidiaries is notably

greater than the increase of non-FHCs owning these subsidiaries. Despite an increase in

the proportion of Funds, Trusts, and Other Financial Vehicles following GLB for FHCs (13

percentage points), non-FHCs experienced an even larger increase (18 percentage point),

13All other nonbank subsidiary aliations are nonnancial and experienced a decline after the passage of GLB.

16
suggesting that the expansion into Fund, Trusts, and Other Financial Vehicles subsidiaries

was independent of BHCs taking advantage of the law's passage. Thus, consistent with the

text of the law, GLB had a meaningful impact on the expansion of insurance and investment

banking activities for FHCs.

We use a dierence-in-dierences analysis to test our hypotheses. Our treated group consists of BHCs that elected to become FHCs with investment banking or insurance subsidiaries.

We view these FHCs to be constrained in their ability to expand their nonbank activities under

Glass-Steagall restrictions and the passage of GLB to have removed those constraints. The

control group consists of BHCs that elected to become FHCs but did not establish insurance

or investment banking subsidiaries.

We construct two treated groups: investment banking FHCs and insurance FHCs. Those

that were FHCs according to the National Information Center (NIC) with an investment

banking subsidiary in 2000 constitute the investment banking treated group. Those FHCs that

had insurance subsidiaries in 2000 constitute the insurance treated group.14 Consistent with

Floyd, Li, and Skinner (2015), we drop observations with negative income because calculation

of payout ratio becomes problematic.15 In addition, we restrict attention to FHCs with data

both before and after the passage of GLB. There are 261 FHC conversions in total by the end

of 2000. Of these, 6 FHCs have only investment banking, 26 have investment banking and

insurance, and 80 have only insurance subsidiaries as of the end of 2000. The remaining 149

FHCs had neither investment banking nor insurance subsidiaries. In the reported regressions,

the investment banking treated group includes 32 FHCs, 26 of which have investment banks

and insurance subsidiaries. The control group constitutes 229 FHCs that have no investment

banking. The insurance treated group has 106 FHC that have an insurance subsidiary and the

control group consists of 155 FHCs that did not have an insurance subsidiary. In unreported

analysis, we nd that our results are robust to alternative denitions of control groups. For

example, in one alternative specication we use a common control group of 149 FHC and use

14Including FHCs that took on both investment bank and insurance agency subsidiaries after 2000 from the

control group does not materially change the results.

15Two FHCs from the control group are dropped as a result of this restriction.

17
32 treated FHCs for investment banking and 106 treated FHCs for insurance.

In Table II, we report summary statistics for our treated groups and the group that had

neither investment banks nor insurance subsidiaries as of 2000 for pre- and post GLB periods.

The focal variable in Table II is the payout ratio, expressed as the ratio of bank dividends

to bank income. Because the denominator can tend toward zero causing the expression to

go to innity, we winsorize the payout ratio at the 99th percentile. We observe that prior to

GLB, the average bank payout ratio was 52.8% for FHCs that did not expand into investment

banking and insurance activities and remained at that level following GLB. For the bank

subsidiaries of FHCs with investment banks, the average payout ratio rose signicantly from

58.0% pre-GLB to 74.7% post-GLB. This increase is signicantly dierent from FHCs that

did not expand into investment banks or insurance. The dividends to bank assets ratio shows

similar results to the payout ratio. In contrast, bank subsidiaries of FHCs with insurance

subsidiaries show a slight increase in payouts but the increase is not statistically signicant.

The univariate observations provide the initial evidence that FHCs that expand to investment

banking pulled signicant capital from their bank subsidiaries, while this is not the case for

FHCs with insurance subsidiaries.

IV. Analysis

In this section, we rst examine the changes in the internal dividends of bank subsidiaries

following the passage of GLB. Next, we examine how the parent used internal dividends within

the BHC.

A. Bank Funding: Dierence-in-Dierences

We use the passage of GLB in 1999 as the identifying event for the causality of nonbank

expansion on internal dividends of bank subsidiaries. The costs of nonbank acquisition, such

as integration of these new entities into the organization and funding needed to relieve the

target nonbanks' possible nancial constraints, all increased demand for nancing. Our model

18
predicts that BHC would use bank resources if expanding into investment banking activities

and avoid this source if expanding into insurance activities. Thus, evidence of a jump in

the bank internal dividends following the passage of GLB for BHCs with investment banking

subsidiaries but not insurance subsidiaries supports the hypothesis that nonbank expansion

caused the internal dividends of bank subsidiaries to increase.

The dierence-in dierences specication is as follows:

P ayoutjt = γ1T reatedj + γ2P ostt + γ3P ostt ∗ T reatedj + ΓControlsjt + jt, (3)

where j and t denote banking organization and the time, respectively. P ayout is the aggregate

bank subsidiary dividends to earnings ratio.

The variable T reated equals one for the treated sample and zero for the control sample.

P ost is equal to one for post-GLB period and zero for pre-GLB period. The dierence-indierences estimator, γ3, is the coecient on the product of the T reated and P ost variables.

Depending on the specication, the vector Controls contains either BHC xed eects or

nancial variables that are correlated with the internal dividend decisions. Financial variables

include: logarithm of the aggregate bank subsidiaries asset size, protability measured by the

aggregate bank subsidiary return on assets (ROA), and external dividend payouts. Dividend

studies generally nd size to be a determinant of payout policy (e.g., Brown, Liang, and

Weisbenner (2007)). Higher protability makes it easier for the banking organization to

pay higher dividends without attracting regulatory scrutiny. Finally, the external dividend

decision can aect how much cash the holding company extracts from the subsidiaries

Table III presents the regression results for the dierence-in-dierences analysis for the

investment bank treated group. Column 1 reports estimates from the pooled regression approach, treating each BHC-year as a separate observation. The coecient of interest on the

interaction term shows that the bank-subsidiary payout ratios for the treated group rose by

18.1 percentage points in the post-GLB period relative to the control group, signicant at the

1 percent threshold.

19
Bertrand, Duo, and Mullainathan (2003) argue that the standard errors of a pooled

dierence-in-dierences estimator are generally understated. To address this concern, they

recommend aggregating each rm's pre- and post-treatment data into a single pre- and single

post-observation. Using this approach, we construct the three-year payout ratio for each BHC

in the pre- and post-GLB periods.16 We show in Column 2 that the payout ratios for treated

BHCs rose by 15.5 percentage points relative to the control group, signicant at the 5 percent

level.

In Columns 3 and 4, we show that the magnitude and statistical signicance persist after

including control variables and BHC xed eects, respectively. In Columns 5 and 6, we

control for an insurance treatment eect. We nd eects of similar magnitude and statistical

signicance, which shows that an insurance treatment eect does not drive our estimates of

internal dividends of banks with investment banks. An implicit assumption of this specication

is that the eects of investment banks and insurance subsidiaries are separable. In Columns 7

(no BHC xed eects) and 8 (with BHC xed eects) we relax this assumption and allow an

additional treatment eect for FHCs with both investment banking and insurance subsidiaries.

We nd that the investment-banking-only eect drives our results (43 percentage points,

statistically signicant at the 1 percent level), though this is estimate is driven by the six

observations of investment-bank-only FHCs. In Appendix C Table C.1 we report results of

regressions using bank dividends to bank assets as the independent variable, with similar

results.

In Table IV, we undertake the dierences-in-dierence analysis for the investment bank

treated group using the nearest-neighbor propensity score matching with replacement (with a

0.03 caliper match). The pre-GLB matching variables are log assets, bank level capitalization,

return on assets (ROA) and capital ratio, BHC level external dividends and ROA. Panel

A shows the unmatched sample whereas Panel B reports the pre-GLB dierences in the

treated and control groups for the matched samples. The last column reports the dierence16When averaging over years in the collapsed sample, ratios (e.g., P ayout) are calculated as the sum of the

numerator over the sum of the denominator for the pre- and post-periods.

20
in-dierences between the variables. In Panel A, we nd statistically signicant dierence-indierences for all variables except for the bank subsidiary ROA and capital ratio. Consistent

with Table III, Column 2, we observe that the dividend payout of the unmatched treated

banks increased 15.3 percent on average post-GLB.

To eliminate this possibility, In Panel B, we compare the nancial variables for the matched

investment-bank treated and its control group. Matching results in the pre-GLB nancial

variables to show only a weak statistical dierence for only one variable (BHC ROA). Notably,

the dierences in size are eliminated through the matching procedure. For the investmentbank treated group, the bank-subsidiary payout-ratio rose by 18.85 percentage points following

GLB. For the control group, the bank-subsidiary payout-ratio fell by 7.48 percentage points.

The dierence between the dierences of the treated and control groups, 26.3 percentage

points, is statistically signicant at the 5 percent level.17 Despite the small sample size to

match the control group to FHCs with investment banking subsidiaries, this nding suggests

that our results are driven by the measurable pre-GLB dierences of the BHCs that elected

to become FHCs versus those that did not.

In Table V Columns 1 through 4, we report the results of dierence-in-dierences speci-

cations for the insurance treated group. Columns 1-4 show that bank subsidiaries in these

FHCs did not increase their payout ratios. This nding is in stark contrast with the ndings

in Table III where we report signicant increase in internal dividends of FHCs that expand

into investment banking. These ndings support our model predictions.

In Columns 5 through 7 we present the dierence-in-dierence results for the changes in

external dividends post GLB. This is important because the observed increase in investmentbank treated group's internal dividends could be related to the increase in dividends to shareholders. We observe no signicant change in external dividends post GLB in each of the

pooled sample (Column 5), collapsed sample (Column 6) and collapsed sample with BHC

xed eects (Column 7), allowing us to conclude that GLB aected the internal allocation of

17Alternative matching variables and specications generally produce a matched sample estimator larger than

our baseline regression. However, statistical signicance is somewhat sensitive to the specic matched algorithm

given the small sample size.

21
capital within the organization. These results collectively show that the FHCs that expand

into investment banking taxed their banks upon the passage of the GLB.

B. Validity of Dierence-in-Dierences Estimator: Parallel Trends

To examine the validity of the dierence-in-dierences estimator, we provide evidence in favor

of the parallel trends assumption necessary for identication. In the case of our sample rms,

Figure 1 plots the dierence in payout ratios for FHCs with investment banking subsidiaries

(treated) and control BHCs. The estimates and the 95 percent condence intervals are estimated using a regression with year xed eects and yearly interaction terms. In the years prior

to GLB, the dierences between treated and control BHCs remained fairly at. Meanwhile,

in the years following GLB, the payout ratios are consistently higher than in 1999 with the

largest increases in 2000 and 2001 relative to the control group. We note that there is some

lift in in 1999, which may reect the part of the year that fell between the passage of the bill in

November 1999 and the incorporation of the nonbank aliates in the FHC structure in March

of 2000, leading to some anticipatory eects. In addition, we note that in 2002 dierences

in FHC begin to converge to pre-GLB dierences. Both of these observations would be anticipated to dampen the dierence-in-dierences estimator in our baseline regression in Table

III, Column 4. Our estimates of the dierence-in-dierences regression using only 1997-1998

as a pre-GLB period and 2000-2001 as the post-GLB period show that the results from our

baseline specication are robust to the narrower timeframe.

We formally test pre-GLB trend dierences in variables in Table VI, which reports the

dierences in annual variable trends for the three years before GLB on the treated variable,

regressing variable trends against the treated variable (investment banks) and clustering standard errors at the BHC. We do not nd dierences in bank payout trends prior to GLB using

payout ratios (Column 1), dividends to assets (Column 2), log dividends (Column 3). In addition, we do not nd dierences in pre-GLB trends for bank return on assets between treated

and control BHCs.

22
C. Nonbank Investments

Given that the bank subsidiaries that are newly aliated with investment banks increased

their internal dividends and external dividends did not increase, it remains to be shown how

the parents used the funds. In this section, we provide evidence that FHCs with investment

banks used the increases in their banks' internal dividends to support nonbank investments.

We obtain data on parent investments in nonbank subsidiaries from the Y-9LP data, which

segregates bank and nonbank nancial investments and cash ows across all BHCs within

the organization. Unfortunately, the data are not reported granular enough to track parent

investment in specic nonbanks or nonbank types (e.g., investment banking or insurance subsidiaries). Therefore, we assess whether the change in bank subsidiary internal dividends from

investment banking and insurance treated groups are related to changes in their aggregate

nonbank investments. To measure aggregate nonbank investment, we sum across the organization all equity and debt holdings of BHCs in their subsidiary nonbanks each period. We

dene nonbank investment as the change in these holdings less the aggregate nonbank income.

Nonbank income is calculated as the sum of undistributed income of nonbank subsidiaries plus

their internal dividends.18

We estimate the following cross-sectional regression of FHC investments on the change in

average annual dividends in the post-GLB period relative to the pre-GLB period.

NonbankInvi,P ost = β1Dividendi,P ost + Controls + i (4)

where each variable is measured as an average level in the post-GLB period (level regressions).

In an alternative specication, we calculate variables as the dierence between the average preGLB level and the average post-GLB level (dierence regressions). All variables are scaled by

average bank assets in the post-GLB period. These cross-sectional regressions assess whether

18Items BHCP1275 and BHCP3147 on the Y-9LP forms, respectively. We subtract thrift income and equity

from the calculations using Call Report data, where it is applicable. Our results are robust to subtracting only

undistributed income.

23
those FHCs that increased dividends also increased nonbank investment post-GLB.

In Table VII, we report the results of the estimation of Equation 4 for FHCs with insurance

subsidiaries (odd columns) and FHCs with investment banks (even columns). We report

regression results scaling nonbank investments by assets (Columns 1 through 4) and by income

(Columns 5 through 8). Columns 1, 2, 5, and 6 report results of level regressions whereas

Columns 3, 4, 7 and 8 report the results of dierence regressions.

In each specication using the sample of FHCs with insurance subsidiaries, we nd no

relationship between bank subsidiary internal dividends and FHC nonbank investments. That

is, higher internal dividends for FHCs with insurance subsidiaries following GLB are not

associated with higher nonbank investments at those FHCs. In contrast, we nd a strong

correlation between internal dividends and nonbank investments for FHCs with investment

banks. These results show that the FHCs with investment banks did transfer bank capital to

nonbanks, which is consistent with the predictions of our model.

V. Bank-Funding Cost Advantage

Central to our model is that the banks within the BHC have a lower cost of funds than

the alternate funding options within the organization, namely, the nonbank aliate and the

parent. Toward this end, we rst compare the credit spread of new debt issues of investment

banks, insurance companies and BHCs at the consolidated level during pre-GLB. In addition,

we compare the cost structure of within BHCs by comparing credit spreads at issuance for

the parent holding company and their bank subsidiaries during the same period. We use data

from Mergent Fixed Income Security Database on xed-rate nonconvertible bond issues of

banking (NAICS =5221), investment banking and security broker dealers (NAICS = 52311),

and insurance (NAICS = 524).

We use the following credit-spread model that is standard in the literature (Flannery and

Sorescu (1996), Gande, Puri, and Saunders (1999), Penas and Unal (2004)). The model

24
species a bond's credit spread to be determined by bond- and rm-specic factors:

SP READit = c1F I T Y P Eit + c2MATit + c3JNit + c4ISit + c5P UTit + λt + RATit + it (5)

where SP READit is the dierence between the yield of the benchmark treasury issue and the

issue's oering yield expressed in basis points (calculated by Mergent) for issuer i at time t.

F I T Y P Eit is a variable (or vector, depending on the specication) that indicates the type

of nancial institution issuing the debt. When we compare BHCs, investment banks, and

insurance rms we take the issues at the consolidated level as reported in Mergent. However,

when we compare debt issues of parent holding company and its bank subsidiaries, parent

and subsidiary issues need to be hand separated as reported in Mergent. MATit is the time

to maturity. JNit is a binary variable that takes the value one if the issue has junior standing.

P UTit is a binary variable equal to one if the issue is puttable. We add issue size (IS) as a proxy

for dierences in liquidity. Hancock and Kwast (2001) show that issue size positively aects

liquidity. RATit is either a vector of binary variables indicating the bond rating at issuance

or a linearization of bond ratings (i.e. AAA=1, AA+=2,...,B-=17). When using linearization

of ratings, we also include a quadratic term. We include time-quarter xed eects.

In Table VIII, we report summary statistics for our main regression variables. In Panel

A, we report summary statistics for issuances at BHCs, investment banks, and insurance

rms. We observe that bond issuances at BHCs have lower treasury spreads (82 bps) than

insurance rms (121 bps), though comparable spreads to investment banks (90 bps). Average

BHC bond terms at issuance (134 months) are similar to those at investment banks (116

months), though shorter than terms at insurance rms (221 months). In addition, bonds

at BHCs are more likely to be subordinated than at investment banks and insurance rms.

Average BHC issue amounts are also smaller ($280 thousand) than those at investment banks

($494 thousand), but similar to insurance rms ($256 thousand). The dierences in bond

characteristics suggests that it is important to control for the other bond features that might

allow bank costs of funding to be lower. Average ratings of bonds at issuance are worse for

25
BHCs than investment banks by approximately one notch, though similar to those of insurance

rms.

In Panel B, we report sample statistics at organizations with both bank and parent holding

company bond issuances. We identify a subset of rms that have bond issuance data at both

the parent and bank subsidiaries within the organization using the ISSUER NAME eld to

classify parents and banks within the same BHC and verifying those links in the structure

data. In Appendix Table C.2, we list the hand-matched BHC and bank subsidiary names used

in the analysis. We observe that on average, the subsidiary-bank bond issuances have lower

treasury spreads compared to parent bond issuances (48 bps to 94 bps) and are better rated

(lower number) than the parent bond issuances (0.81 notch dierence). Note that Mergent

does not report treasury spreads for all bond issuances, which accounts for the dierences in

the number of observations between variables. Meanwhile, bank bond issuances have shorter

maturities (35 months versus 86 months), and are less likely to be junior (2% versus 6%). Bond

issuance size for subsidiary banks and their parent holding companies are approximately the

same.

In Table IX we report the regression results. For Columns 1 and 2, the focal variables are

IBank and Insurance, which take the value of one if the bond issues are by investment banks

and insurance rms, respectively, and zero otherwise. In Column 1, we compare credit spreads

on BHC debt to investment banks and insurance rms. We nd that BHCs enjoy yields of

13 bps lower than investment banks and 18 bps lower than insurance rms after controlling

for credit ratings and bond characteristics. In Column 2, we nd comparable results using a

quadratic specication of ratings rather than binary variables for each rating category. Results

are similar.

In Columns 3 and 4, we report regression results using the parent holding company and its

bank-subsidiary matched sample. The variable of interest P arent and in both specications

include bond characteristics, BHC xed eects and year xed eects.19 In Column 3, we

show that parent holding company ratings are on average 0.8 notches worse (higher) than

19We do not use quarter xed eects due to the smaller sample size relative to using all BHCs with bond issuances.

26
their bank subsidiary bond issuances. In Column 4, we show that treasury spreads are 41 bps

points lower for bond issuance at the bank subsidiary than for the parent holding company

bond issuance. Together, our results show using bond issuance spreads, the assumption of

our model holds with regard to the funding costs of bank subsidiaries to be lower relative to

the rest of the BHC.

VI. Conclusion

In this paper, we evaluate the funding decisions of BHCs for their nonbank subsidiaries. In

a simple model, we show that BHCs have the incentive to pull funding from banks through

internal dividends and downstream capital to the nonbank aliates. The model predictions

are such that bank funding cost advantages are a necessary but not sucient condition to use

the bank as a source of funds. Capital regulation limits the extent to which the BHC can use

the bank as a source of funding, so the returns on nonbank investments must be suciently

high to warrant the internal transfer of capital. We predict that following the passage of GLB,

BHCs use internal dividends to fund lesser regulated investment bank subsidiaries via bank

internal dividends, but not the more highly regulated insurance aliates. Using a dierence

in dierences framework, we show that the passage of GLB triggers a signicant increase

in bank-subsidiary dividends for BHCs that expanded into investment banks. We nd that

this set of BHCs did not increase its external dividends and instead increased their nonbank

investments, consistent with the model. Our ndings are contrary to the prevailing view in

the banking literature and regulations that the BHC serves as a source of strength for the

subsidiary banks. The underlying principle of this view is the expectation that BHCs should

serve as a source of managerial and nancial strength for their subsidiary banks. However,

our ndings show that the BHC may also rely on its bank as a source of strength to fund

lesser regulated nonbank aliates.

27
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31
Table I: Proportion of BHCs with Nonbank Subsidiaries by Nonbank Subsidiary Type. Nonbank types limited to those

in which the proportion of FHCs increased from 1997-1999 to 2000-2002. The column Dierence shows the dierence indierences in BHC-years with particular nonbank subsidiaries.

BHC-years with at least one nonbank subsidiary, by NAICS

Subsidiary NAICS Code Non-FHCs FHCs

1997-1999 2000-2002 Change 1997-1999 2000-2002 Change Dierence

mean count mean count mean count mean count

Insurance Agencies, Brokerage (5242) 14.7% 2443 19.3% 3652 4.6% 23.8% 651 41.4% 805 17.6% 13%Funds, Trusts, Other Financial Vehicles (525) 6.8% 2443 21.3% 3652 14.5% 17.4% 651 30.6% 805 13.2% -1%Investment Banking and Sec. Dealing (52311) 0.5% 2443 0.5% 3652 0.1% 3.1% 651 11.4% 805 8.4% 8%Other Financial Investment Act. (5239) 9.9% 2443 10.9% 3652 1.0% 22.6% 651 29.1% 805 6.5% 6%Professional, Scientic, and Technical Services (54) 13.3% 2443 13.7% 3652 0.4% 17.8% 651 22.1% 805 4.3% 4%Insurance Carriers (5241) 5.0% 2443 4.9% 3652 -0.1% 18.9% 651 21.6% 805 2.7% 3%Direct Insurance (52412) 0.1% 2443 0.3% 3652 0.2% 2.2% 651 4.0% 805 1.8% 2%Nondepository Cred. Interm. (5222) 19.0% 2443 17.0% 3652 -2.0% 31.5% 651 33.3% 805 1.8% 4%All Other Finance and Insurance (Excl. Banks) 0.0% 2443 0.0% 3652 0.0% 0.3% 651 1.0% 805 0.7% 1%Lessors of Real Estate (5311) 15.3% 2443 14.5% 3652 -0.8% 30.9% 651 31.3% 805 0.4% 1%Real Estate and Rental and Leasing (53) 16.8% 2443 16.1% 3652 -0.7% 33.2% 651 33.4% 805 0.2% 1%Activities Related to Cred. Interm. (5223) 7.6% 2443 4.9% 3652 -2.7% 16.6% 651 14.7% 805 -1.9% 1%

32
Table II: Summary statistics based on collapsed pre- and post-GLB values for each BHC. Panel A shows nancial variables

for BHCs that converted to FHCs, but did not have investment bank or insurance subsidiaries for the pre-GLB (1997-1999)and post-GLB (2000-2002). Panel B shows nancial variables for BHCs that converted to FHCs and also had an investmentbank subsidiary as of yearend 2000. Panel C shows nancial variables for BHCs that converted to FHCs and also had aninsurance subsidiary as of year end 2000. 26 of the 32 FHCs with an investment bank also had an insurance subsidiary. Ineach Panel, Diff represents the mean dierence in pre- and post-GLB values and ∗ denotes that the change is statisticallysignicant at the 5 percent level. In Panels B and C, we denote means that are statistically dierent from means in PanelA at a 5 percent level with

+. In Panels B, we denote means that are statistically dierent from means in Panel C at a 5

percent level with

†

.

Panel A: FHCs, No IBank, No Insurance

1997-1999 2000-2002 Di

mean p50 sd count mean p50 sd count

Bank Dividend/Income 52.8% 44.8% 42.4% 149 52.8% 44.6% 36.6% 149 -0.01%Bank Dividend/Asset 0.7% 0.5% 0.6% 149 0.6% 0.5% 0.6% 149 -0.03%Bank Assets 0.7 0.3 1.3 149 0.9 0.4 1.7 149 0.23

∗

BHC Dividend/Asset 0.31% 0.24% 0.31% 149 0.38% 0.31% 0.40% 149 0.06%Bank Income/Asset 1.3% 1.2% 1.4% 149 1.2% 1.1% 0.7% 149 -0.13%Bank Capital Ratio 9.2% 8.6% 4.9% 149 9.2% 8.6% 3.6% 149 0.06BHC Asset 0.7 0.3 1.3 149 0.9 0.4 1.7 149 0.24

∗

BHC Capital Ratio 9.3% 8.9% 5.3% 149 9.4% 8.7% 5.4% 149 0.09%

``

Panel B: IBank FHCs

1997-1999 2000-2002 Di

mean p50 sd count mean p50 sd count

Bank Dividend/Income 58.0% 64.5% 27.9% 32 74.7%

+† 78.1% 31.6% 32 16.7%∗+†

Bank Dividend/Asset 0.8% 0.8% 0.4% 32 0.9%

+ 0.9% 0.5% 32 0.2%∗+

Bank Assets 80.0

+† 41.5 117.0 32 116.0

+† 66.8 171.0 32 35.9

∗+†

BHC Dividend/Asset 0.5%

+ 0.54% 0.24% 32 0.5%

+ 0.51% 0.23% 32 -0.01%

+

Bank Income/Asset 2.9% 1.3% 9.4% 32 1.3% 1.3% 0.6% 32 -1.6%Bank Capital Ratio 8.4% 8.5% 1.5% 32 8.5%

+ 8.5% 1.3% 32 0.0%

BHC Asset 89.1

+† 42.7 140.0 32 137.0

+† 67.3 234.0 32 47.9

∗+†

BHC Capital Ratio 8.2%

+ 7.7% 1.9% 32 8.4%

+ 8.2% 1.3% 32 0.2%

`

Panel C : Insurance FHCs

1997-1999 2000-2002 Di

mean p50 sd count mean p50 sd count

Bank Dividend/Income 58.7% 60.8% 30.2% 106 63.7%

+ 63.1% 30.0% 106 5.0%

Bank Dividend/Asset 0.8% 0.7% 0.4% 106 0.8%

+ 0.8% 0.5% 106 0.1%

Bank Assets 25.4

+ 0.9 72.9 106 36.9

+ 1.4 106.0 106 11.5

∗+

BHC Dividend/Asset 0.4%

+ 0.4% 0.3% 106 0.4% 0.4% 0.3% 106 0.04%∗

Bank Income/Asset 1.8% 1.2% 5.2% 106 1.3% 1.2% 0.4% 106 -0.5%Bank Capital Ratio 8.4% 8.3% 1.3% 106 8.4%

+ 8.4% 1.2% 106 0.1%

BHC Asset 28.2

+ 1.0 86.1 106 43.3

+ 1.4 141.0 106 15.1

∗+

BHC Capital Ratio 8.6% 8.3% 1.8% 106 8.6% 8.4% 1.7% 106 -0.03%

33
Table III: Dierence in Dierences in Bank Dividends to Income. This table reports results from dierence in dierences

regressions using Equation

3. Treated holding companies are BHCs that convert to FHCs during the rst year of eligibility

(2000) under GLB with an investment banking subsidiary. The control group consists of BHCs that convert during therst year of eligibility (2000), but do not include an investment bank subsidiary. Post is an indicator variable equal to zerobefore 2000 and one after. Column 1 reports results from a pooled regression over the three-year period surrounding GLB,1997-2002. Column 2 collapses each of pre- and post-periods into a single observation for each BHC, taking the cumulativethree-year payout ratios for the pre- and post-periods. Column 3 adds entity nancial variables. Column 4 adds BHCxed eects to the Column 2 specication. Column 5 uses the Column 2 specication, allowing for insurance subsidiarytreatment eects. Column 6 uses the Column 2 specication, allowing for insurance subsidiary treatment eects with BHCxed eects. Column 7 uses the Column 2 specication, allowing for insurance subsidiary treatment eects and a jointinvestment bank-insurance treatment eect. Column 8 uses the Column 2 specication, allowing for insurance subsidiarytreatment eects and joint investment bank-insurance treatment eect with BHC xed eects. Column 9 uses the Column2 specication, dening 1997-1998 as the pre-GLB period and 2000-2001 as the post-GLB period.

(1) (2) (3) (4) (5) (6) (7) (8) (9)

VARIABLES Div Inc Div Inc Div Inc Div Inc Div Inc Div Inc Div Inc Div Inc Div IncPost*IBank 0.181*** 0.155** 0.160** 0.155** 0.155** 0.155** 0.433*** 0.433*** 0.227**

(0.0665) (0.0617) (0.0623) (0.0616) (0.0653) (0.0652) (0.158) (0.157) (0.0985)

IBank 0.0433 0.0337 -0.118* 0.00517 -0.0801 -0.0127

(0.0536) (0.0553) (0.0686) (0.0580) (0.151) (0.0671)

Post*Ins -0.000305 -0.000305 0.0305 0.0305

(0.0478) (0.0477) (0.0490) (0.0489)

Ins 0.0615 0.0521

(0.0475) (0.0499)

IBankIns 0.110

(0.162)

Post*IBankIns -0.360** -0.360**

(0.169) (0.169)

Post 0.0121 -0.0224 0.0121 0.0122 0.0122 0.00141 0.00141 0.0177

(0.0261) (0.0259) (0.0261) (0.0355) (0.0354) (0.0361) (0.0360) (0.0344)

Ln(Asset) 0.0271**

(0.0112)

BHC Div/Asset 41.01***

(7.931)

Bank ROA -1.270***

(0.306)

Observations 1,452 522 522 522 522 522 522 522 474R-squared 0.020 0.017 0.180 0.023 0.023 0.023 0.028 0.038 0.018REG Pool Coll Coll Coll Coll Coll Coll Coll CollYEAR FE YES NO NO NO NO NO NO NO NOBHC FE NO NO NO YES NO YES NO YES NO

Robust standard errors in parentheses

*** p

<0.01, ** p

<0.05, * p

<0.1

34
Table IV: Dierence-in-Dierences of Payout Ratios for Matched Sample. Treated holding companies are BHCs in 1999

that convert to FHCs during the rst year of eligibility (2000) under GLB with an investment banking subsidiary. ControlBHCs are those that do not have an investment banking subsidiary. Treated and control rms are matched on size, bankROA, bank capitalization, BHC ROA and external payout using 1999 data. BHCs are matched using a nearest neighborpropensity score matching with replacement and a tolerance of 0.03.

Control Treated Dierence

Variable Mean Std Dev Obs Mean Std Dev Obs

Panel A: Unmatched

Log Bank Asset 13.13 1.16 228 17.01 2.15 32 3.88***Bank ROA 1.30% 1.15% 228 2.90% 9.37% 32 1.60%Bank Capital 8.70% 4.00% 228 8.38% 1.62% 32 -0.33%BHC Div/BHC Asset 0.36% 0.34% 228 0.46% 0.22% 32 0.10%**BHC ROA 1.17% 0.65% 228 1.34% 0.37% 32 0.17%**∆ Bank Div/Bank Asset -0.01% 0.58% 228 0.19% 0.51% 32 0.21%**∆ Bank Div/Bank Income 1.41% 39.38% 228 16.70% 31.98% 32 15.30%**

Panel B: Matched

Log Bank Asset 16.24 2.18 18 16.17 2.10 18 -0.07Bank ROA 1.09% 0.25% 18 1.17% 0.30% 18 0.08%Bank Capital 7.78% 1.78% 18 8.36% 1.43% 18 0.58%BHC Div/BHC Asset 0.48% 0.31% 18 0.41% 0.24% 18 -0.07%BHC ROA 1.05% 0.30% 18 1.25% 0.37% 18 0.20%*∆ Bank Div/Bank Asset -0.16% 0.50% 18 0.16% 0.40% 18 0.33%**∆ Bank Div/Bank Income -7.48% 37.42% 18 18.85% 35.00% 18 26.33%**

***

p < 0.01, **p < 0.05,

*

p < 0.1

35
Table V: Dierence in Dierences. This table reports results from regressions using Equation

3. In Columns 1 through 4,

the outcome variable is the bank-level payout ratios and treated holding companies are BHCs that convert to FHCs duringthe rst year of eligibility (2000) under GLB with an insurance subsidiary. The control group are BHCs that convertduring the rst year of eligibility (2000), but do not include an insurance subsidiary. In Columns 5 through 8, the outcomevariable is the BHC-level payout ratios and treated holding companies are BHCs that convert to FHCs during the rstyear of eligibility (2000) under GLB with an investment banking subsidiary. The control consists of BHCs that convertduring the rst year of eligibility (2000), but do not include an investment banking subsidiary. Columns 1 and 5 reportresults from a pooled regression over the three-year period surrounding GLB, 1997-2002. Columns 2 and 6 collapse each ofpre- and post-periods into a single observation for each BHC, taking the cumulative three-year payout ratios for the preand post-periods. Column 3 adds entity nancial variables to the previous column's specication. Column 4 and 7 addBHC xed eects to the Column 2 and Column 6 specications, respectively. Errors clustered at the BHC level.

(1) (2) (3) (4) (5) (6) (7)

VARIABLES Div/Inc Div/Inc Div/Inc Div/Inc BHC Div/Inc BHC Div/Inc BHC Div/IncPost*Insurance 0.0489 0.0317 0.0331 0.0317

(0.0429) (0.0455) (0.0463) (0.0455)

Insurance 0.0835** 0.0626 -0.00318

(0.0405) (0.0448) (0.0428)

Post*IBank 0.0331 0.00226 0.00226

(0.0472) (0.0353) (0.0352)

IBank 0.107*** 0.105***

(0.0341) (0.0306)

Post 0.0182 -0.0144 0.0182 0.0572*** 0.0572***

(0.0357) (0.0358) (0.0357) (0.0103) (0.0103)

Ln(Asset) 0.0209***

(0.00730)

BHC Div/Asset 40.76***

(7.891)

Bank ROA -1.386***

(0.278)

Observations 1,448 522 522 522 1,446 522 522R-squared 0.020 0.014 0.175 0.008 0.036 0.041 0.114REG Pool Coll Coll Coll Pool Coll CollYEAR FE YES NO NO NO YES NO NOBHC FE NO NO NO YES NO NO YES

Robust standard errors in parentheses

*** p

<0.01, ** p

<0.05, * p

<0.1

36
Table VI: Parallel Trends. This table reports results from parallel trend regressions for the treated

FHCs relative to non-FHCs. T reated is dened as BHCs that converted to FHCs in the rst year

of eligibility (2000) with an investment bank subsidiary (NAICS 52311), while the control group

are FHCs that converted but did not include an investment bank subsidiary. By denition, this

requires that all FHCs in the sample are in existence at year end 2000. We report trends at

the annual level for ow variables 1996 to 1999 and at a cumulative level for stock variables.

Column 1 reports dierences in trends for treated and control BHCs for payout ratios. Column 2

reports dierences in trends for dividend to asset ratios. Column 3 reports dierences in trends for

nominal dividend growth. Column 4 reports dierences in bank income to asset. Column 5 reports

dierences in cumulative asset growth 1996 to 1999. Column 6 reported dierences in cumulative

capitalization ratios 1996 to 1999.

(1) (2) (3) (4) (5) (6)

VARIABLES ∆ Div/Inc ∆ Div/Asset ∆ Ln(Div+1) ∆ Bank ROA ∆ Ln(Asset) ∆ Eq/Asset

Treated -0.0221 -0.000109 -0.0660 0.00889 -0.123 -0.00733

(0.0283) (0.000404) (0.153) (0.00879) (0.108) (0.00518)

Observations 606 606 606 606 174 174

R-squared 0.002 0.001 0.001 0.013 0.015 0.017

REG OLS OLS OLS OLS OLS OLS

YEAR FE YES YES YES YES YES YES

Robust standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1

37
Table VII: Nonbank Investment and Bank Segment Internal Dividends. Columns 1 through 4

reports results of regressions of nonbank investments as a proportion of bank subsidiary assets in

the post-GLB period (2000-2002). Columns 5 through 8 report results using nonbank investments

as a proportion of bank income in the post-GLB period. Odd columns report results for FHCs with

insurance subsidiaries. Even columns report results for FHCs with investment banking subsidiaries.

Columns 1, 2, 5, and 6 report results using variables measured as the average level in the postGLB period (e.g. Bank Div is the average annual post-GLB bank internal dividend, Bank Asset

is the average year end value of bank assets in the post-GLB period). In Columns 3, 4, 7 and 8,

the numerators of the independent variables are calculated as the dierence between the average

pre-GLB level (1997-1999) and the average post-GLB level of the variable.

Nonbank Inv/Bank Assets Nonbank Inv/Bank Income

Ins IB Ins IB Ins IB Ins IB

(1) (2) (3) (4) (5) (6) (7) (8)

Bank Div/Bank Asset 0.306 0.745*** 17.04 57.16***

(0.197) (0.174) (14.32) (15.24)

Bank Inc/Bank Asset -0.126 -0.371** 16.58 17.57

(0.0797) (0.153) (14.21) (22.15)

Bank Eq/Bank Asset -0.0158 -0.00452 0.290 3.782

(0.0148) (0.0180) (1.779) (2.644)

BHC Div -0.0831 -0.298 -27.53 -88.51*

(0.118) (0.348) (20.26) (50.86)

∆ Bank Div/Bank Asset 0.242 0.708** 11.39 54.61**

(0.188) (0.270) (13.43) (20.35)

∆ Bank Inc/Bank Asset -0.0439 -0.416* 19.57 17.80

(0.0636) (0.205) (12.11) (28.09)

∆ Bank Eq/Bank Asset -0.0150 0.0208 -0.455 3.663

(0.0167) (0.0332) (1.818) (2.921)

∆ BHC Div/Bank Asset -0.138 -0.306 -27.47 -68.06

(0.0968) (0.182) (17.87) (42.55)

Observations 106 32 106 32 106 32 106 32

R-squared 0.172 0.513 0.119 0.376 0.152 0.494 0.125 0.377

Adj R2 0.139 0.441 0.0845 0.283 0.118 0.419 0.0906 0.284

Robust standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1

38
Table VIII: Bond Issuance Statistics of Parent-BHC and Bank Subsidiaries. Data source is Mergent Fixed Income Security

Database. T REASURY SP READ is the dierence between the yield of the benchmark treasury issue and the issue'soering yield expressed in basis points (calculated by Mergent). MAT is the time to maturity. JN is a binary variable

that takes the value one if the issue has junior standing. P UT is a binary variable equal to one if the issue is puttable.

OF F ERING AMT is the oering amount expressed in thousands and IS is the natural log of that amount. RAT is a

linearization of bond ratings (i.e. AAA=1, AA+=2,...,B-=17). In Panel A,

+ and

† indicate a dierence with investment

banking rms and insurance rms, respectively, at the 5% level. In Panel B,

∗ indicates a dierence with the parent at the

5% level.

Panel A: Parent BHC versus Bank Subsiary

Variable BHC Issuance IBank Issuance Insurance Issuance

mean p50 sd count mean p50 sd count mean p50 sd count

TREASURY_SPREAD 82.33

† 74.50 54.76 312 90.31

† 80.50 36.18 72 121.34 102.00 72.15 84

MAT (month) 134.43

† 120.10 119.31 312 116.07

† 84.28 96.01 72 220.99 120.23 208.56 84

MAT 8.02

† 8.20 0.78 312 7.94

† 7.85 0.64 72 8.46 8.20 0.84 84

IS 12.27

+ 12.43 0.81 312 12.87

† 12.77 0.64 72 12.28 12.21 0.59 84

OFFERING_AMT 280.39

+ 250.00 218.23 312 494.10

† 350.00 428.71 72 256.28 200.00 163.68 84

PUT 0.04 0.00 0.19 312 0.03 0.00 0.17 72 0.02 0.00 0.15 84

JN 0.25

+† 0.00 0.44 312 0.01 0.00 0.12 72 0.02 0.00 0.15 84

RATING (linear) 6.12

+ 6.00 2.05 312 5.43

† 6.00 1.53 72 6.37 6.00 2.38 84

Panel B: Parent BHC versus Bank Subsiary

Variable Bank Issuance Parent Issuance

mean p50 sd count mean p50 sd count

TREASURY_SPREAD 47.75* 21.00 43.50 34 94.18 86.50 35.92 42

MAT 6.67* 6.59 0.68 315 7.40 7.37 0.96 320

MAT (month) 35.42* 24.03 48.07 315 85.89 52.31 91.16 320

IS 11.33* 11.51 1.17 315 11.15 10.89 1.21 320

OFFERING_AMT 148.30 100.00 167.25 315 140.66 53.50 189.57 320

PUT 0.00 0.00 0.06 315 0.02 0.00 0.14 320

JN 0.02* 0.00 0.14 315 0.06 0.00 0.24 320

RATING (linear) 4.77* 5.00 1.46 315 5.58 5.00 1.57 320

39
Table IX: Dierences in Cost of Funds for BHC versus Nonbank and Parent versus Bank Subsidiaries. Mergent Fixed Income Security Database is the data source.Panel A, Columns 1 and 2

compare treasury spreads at consolidated BHCs and nonbank institutions (investment banks and

insurance. Column 1 includes 13 binary rating indicator variables (BB- through AAA). Column

2 uses a linearization and quadratic term for credit ratings rather than separate indicators. Panel

B, Columns 3 and 4 compare bond ratings and treasury spreads, respectively, at parent BHCs and

their subsidiary banks.

Panel A Panel B

BHC to Nonbanks Parent to Bank Sub

(1) (2) (3) (4)

VARIABLES Spread Spread Rating-Notch Spread

Parent 0.783*** 40.93***

(0.131) (12.83)

IBank 13.07*** 14.03***

(3.028) (2.986)

Insurance 18.39*** 17.55***

(5.762) (5.823)

MAT 29.32*** 28.44*** 0.232*** 10.48*

(2.452) (2.648) (0.0812) (5.840)

IS 4.541* 4.288* -0.0190 14.71**

(2.480) (2.427) (0.0284) (5.629)

PUT -43.36*** -45.74*** -0.846*** -51.27***

(3.985) (4.501) (0.201) (17.79)

JN -2.091 0.422 0.441** 20.99***

(3.495) (3.710) (0.181) (6.991)

rat_lin -12.40***

(2.782)

rat_lin2 2.020***

(0.225)

Observations 468 468 536 75

R-squared 0.821 0.778 0.767 0.748

Rating FE YES NO NO NO

QTR FE YES YES NO NO

YEAR FE NO NO YES YES

BHC FE NO NO YES YES

Robust standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1

40
Figure 1: Average bank-subsidiary payout ratios for the treated and control groups surrounding the passage of GLB and

the election to become FHCs with an investment bank subsidiary. BHCs could rst elect to become FHCs in March 2000.Treated BHCs are those that elected to become FHCs during that rst year and have a subsidiary with a NAICS code52311. Control BHCs are those that did not elect to become FHCs with an investment banks subsidiary.

41
Appendix A. Bank and nonbank classication,

sample construction, and data sources

Bank and nonbank classication Figure A.1 displays a stylized structure of a bank holding

company (BHC). Four major types of subsidiaries exist in this BHC: bank (and/or savings and

loan), intermediate BHC, intermediate nonbank holding company, and nonbank. Subsidiaries

in each of these categories can further expand vertically by owning other subsidiaries. These

major categories can be divided into domestic and foreign subsidiaries, creating an extremely

complex structure for a BHC, although our analysis focuses only on domestic subsidiaries. In

this structure the parent is often referred to as the top-tier holder or high-holder. All top-tier

holding companies must le annual reports (FR Y-6, FR Y-7) that explain their organizational

structure. In addition, top-tier holding companies must also le a report (FR Y-10) on any

changes in their organizational structures within 30 days of a reportable event.

We use the structure data (FR Y-6, FR Y-7, and FR Y-10) to separate banks from

nonbanks within the organization. In particular, we dene banks to be the legal entity ling a

Call Report, which may include nonbank subsidiaries held within the bank. Each bank within

a BHC is necessarily owned by a holding company (which may be intermediate or top-tier).

We dene nonbanks as those that have a BHC parent and are not thrifts (entities F and

H in Figure A.1). We use this denition because nonbank activity is measureable from the

Y-9LP lings and because we wanted to avoid double counting income and dividends in the

BHC. For example, suppose subsidiary I in Figure A.1 made $1 of income and up-streamed

it to its parent F, who then up-streamed it to the top-tier (A). Both the dollar of income

and the dividend would be recorded on the lings of both I and F. Counting only the

income and dividends from F avoids this problem.

We use this classication to form aggregate bank and nonbank subsidiaries. We aggregate

income and dividend variables of bank and nonbank subsidiaries within each BHC to establish these ow variables for the bank and nonbanks of the BHC. We also sum assets across

subsidiaries and calculate asset-weighted capital ratios for bank and nonbank alates. In

42
the context of Figure A.1, the bank subsidiary variables are created by combining data from

entities C and G, and the nonbank variables are created by combining data from entities

F and H.

Data Sources

Our study requires nancial statement data for banks, nonbanks, and the higher-holder

operations on a stand-alone basis. We use a number of regulatory lings to compile our data.

Looking at Figure A.1, the set of lings in the analysis are those led by the entities with the

thick outlines. This set includes banks (entities C and G), Y-9LP lings of intermediate

BHCs (D), and the high-holder (A).

For the higher-holder operations, we use the Parent Company Only Financial Statement

(FR Y-9LP) that large parents ($150 million or more) must le with the Federal Reserve System (Fed). In addition, we use the Consolidated Financial Statement for Holding Companies

(FR Y-9C) that the holding companies with total consolidated assets of $150 million or more

have to le with the Fed.20 This consolidated report represents on- and o-balance sheet

activities of all subsidiaries in the BHC.

For bank subsidiaries, we use the Consolidated Reports of Condition and Income (FFIEC

031/041 or simply Call Report) that each federally insured depository institution (denoted as

bank) with branches and subsidiaries in the United States must le with the FDIC or the Fed.

This is a detailed report of on- and o-balance sheet items as well as income statements of the

consolidated bank operations. Because a depository institution can have its own subsidiaries,

the reporting is done on a consolidated basis.

20. Before 2006, the reporting threshold was $150 million.

43
D‐ Sub BHC

(Y‐9LP, BHC‐A

Y‐9LP)

F Non‐Bank  HC

(Y‐11, BHC‐A Y‐

9LP)

H‐ Non‐Bank  (Y‐11, BHC‐D

Y‐9LP)

I‐Non‐Bank

(Y‐11)

E‐ Non‐Bank

(BHC‐A Y‐9LP)

B‐ TruPS SPV  

(Y‐11)

J‐Non‐Bank  

C‐ Bank

(Call Report)

G‐ Bank(Call Report)

A‐ Parent BHC  (Y‐9C, Y‐9LP)

K‐Non‐Bank  

Bank Sub

Figure A.1: Stylized Structure of a Bank Holding Company. The bank subsidiary in the paper combines data from BanksC and G. The nonbanks combine data from Nonbanks E, F, and H, measured indirectly from Y-9LP data. Subsidiariesthat can be measured directly have a thick outline. Subsidiaries that can be measured indirectly through their directparent are shaded. The top Parent is A. Subsidary level bank and nonbank income and dividend variables are obtainedby summing over all BHCs within the organization.

44
Appendix B. Proofs

Proof Proposition 1

Proof. First, consider the FOCs:

∂Π0

DB

= rB − cB −

κBE

e ̄

2

B

−

κP E

e ̄

2

P

= 0 (A.1)

∂Π0

DP

= rP − cP −

κP E

e ̄

2

P

= 0 (A.2)

Suppose not, such that T

∗

0 = τ > 0, and consider that the parent downstreams  capital

to the bank. Doing so results in an increase in bank subsidiary returns rB and a decrease

in parent returns rP , for a net return of (rB − rP ) >≥ 0. Note, downstreaming capital

from the parent to the bank has no eect on the parent capital compliance costs. However,

the transfer reduces the bank compliance cost by κB ∗ MC(T0) > 0, where MC is the rst

derivative of the compliance cost function with respect to T0. Thus, the  transfer strictly

increases prots, a contradiction.

Proof Proposition 2

Proof. The rst order conditions for optimal debt and internal dividends (D∗

B

, D∗

P

, T∗) of the

objective function after some simplications are (equality holds for interior solutions):

∂Π

∂T = ∆rN −

κB(D∗

B + D ̄B)

e

2

B

≤ 0 (A.3)

∂Π

∂D∗

B

= rB − cB −

κB(E − T

∗

)

e

2

B

−

κP E

e

2

P

≤ 0 (A.4)

∂Π

∂DP

= rN − cP −

κP E

e

2

P

≤ 0 (A.5)

From the rst order condition on T,

∆rN ≤

κB(D∗

B + D ̄B)

[(1 − RB)(E − T∗) − RB(D∗

B + D ̄B]

2

(A.6)

45
The RHS of the inequality is strictly increasing in D∗

B

as the numerator is increasing in D∗

B

and the denominator is decreasing in D∗

B

. In addition, the RHS of the inequality is increasing

in T

∗

. Consequently, the RHS of the inequality is bounded below by:

κBD ̄B

[(1 − RB)E − RBD ̄B]

2

Therefore, the FOC can only hold with equality if ∆r ≥

κBD ̄B

[(1−RB)E−RBD ̄B]

2

.

Proof Proposition 3

To show this, we rst present a lemma. Assuming that rIB − rB is suciently large such

that A.3 holds with equality.

Lemma 1: Either D∗

B > 0 and D∗

P = 0 or D∗

B = 0 and D∗

P > 0.

Proof Lemma 1

Proof. First, we show that either D∗

B > 0 or D∗P > 0. From rN > rP and Equations A.2 and

A.5, it must be the case that:

κP E

[(1 − RP )E − RP (D∗

B + D ̄ B + D∗P

)]2

≥

κP E

[(1 − RP )E − RP (D ̄

P + D ̄B)]2

(A.7)

Thus, D∗

B + D∗

P ≥ D ̄

P > 0.

Next, we show that either D∗

P = 0 or D∗

B = 0. Suppose not, so that Equations A.4 and

A.5 hold with equality. Taking the dierence between them, and also taking the dierence

between Equations A.2 and A.1 yield:

∆c − (rN − rB) = κB(E − T

∗

)

[(1 − RB)(E − T∗) − RB(D∗

B + D ̄B)]2

(A.8)

∆c − (rP − rB) = κBE

[(1 − RB)E − RBD ̄B]

2

(A.9)

⇒

κB(E − T

∗

)

[(1 − RB)(E − T∗) − RB(D∗

B + D ̄B)]2

<

κBE

[(1 − RB)E − RBD ̄B]

2

(A.10)

46
Dene the LHS of the inequality as Ψ. Note that ∂Ψ/∂D∗

B > 0. In addition:

∂Ψ

∂T∗

=

−κB[(1−RB)(E−T

∗)−RB(D∗

B+D ̄B)]2+2(1−RB)[(1−RB)(E−T

∗)−RB(D∗

B+D ̄B)]κB(E−T

∗)

[(1−RB)(E−T ∗)−RB(D∗

B+D ̄B)]4

(A.11)

=

κB

[(1−RB)E−RBD ̄B]

2 > 0 (A.12)

Together, ∂Ψ/∂T∗ > 0 and ∂Ψ/∂D∗

B > 0 contradict inequality A.10.

Given the proof of Lemma 1, we now prove Proposition 3.

Proof. From Lemma 1 either D∗

P = 0 or D∗B = 0.

Case 1: D∗

B = 0 and D∗P > 0.

From Equation A.3, ∆rN =

κBD ̄B

[(1−RB)(E−T ∗)−RBD ̄B]

2

. The implicit function theorem immediately yields the result.

Case 2: D∗

P = 0 and D∗

B > 0

Suppose there is some ∆r

0 where D∗

B

(∆r

0

) > 0 and some ∆r

00 = ∆r0 + ,  > 0 and

let letting (T

00, D00

B

) denote the optimal allocation under ∆r

00 and similarly for ∆r0

. For each

allocation to be optimal, it must be the case that prots under the optimal funding are greater

than those in the alternative:

Π(T

00, D00

B|∆r

00) ≥ Π(T

0

, D0

B

|∆r

00) (A.13)

Π(T

0

, D0

B|∆r

0

) ≥ Π(T

00, D00

B

|∆r

0

) (A.14)

Summing the LHS and RHS, respectively of the inequalities yields: (T

00−T0

) ≥ 0. Therefore,

if  > 0 it must be that T

00 > T0

.

47
Table C.1: Dierence in Dierences in Bank Dividends to Bank Assets. This table reports results from regressions using

Equation

3. Treated holding companies are BHCs that become FHCs during the rst year of eligibility (2000) under GLB

with a previously restricted activity. In Columns 1 through 4, we dened treated FHCs as those holding an investmentbanking subsidiary (NAICS 52311). In Columns 5 through 8, we dened treated FHCs as those holding an insurancesubsidiary (NAICS 5242). In Columns 9 and 10, we allow for both treatment groups. The control group are BHCs thatconvert during the rst year of eligibility (2000), but do not include a subsidiary of the restricted activity. P ost is anindicator variable equal to zero before 2000 and one after. Column 1 reports results from a pooled regression over thethree-year period surrounding GLB, 1997-2002. Column 2 collapses each of pre- and post-periods into a single observationfor each BHC, taking the cumulative three-year payout ratios for the pre- and post-periods. Column 3 adds entity nancialvariables. Column 4 adds BHC xed eects to the Column 2 specication. Column 5 reports results from a pooledregression over the three-year period surrounding GLB, 1997-2002. Column 6 collapses each of pre- and post-periods intoa single observation for each BHC, taking the cumulative three-year payout ratios for the pre- and post-periods. Column7 adds entity nancial variables. Column 8 adds BHC xed eects to the Column 2 specication. Column 9 reports aregression with collapsed pre- and post-periods. Column 10 adds FHC xed eects to the specication in Column 9.

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

VARIABLES Div/Asset Div/Asset Div/Asset Div/Asset Div/Asset Div/Asset Div/Asset Div/Asset Div/Asset Div/AssetPost*IBank 0.00187** 0.00208** 0.00268*** 0.00208** 0.00189** 0.00197**

(0.000873) (0.000965) (0.000875) (0.000964) (0.000947) (0.000866)

IBank 0.000519 0.000579 -0.00273*** 0.000139

(0.000809) (0.000811) (0.000945) (0.000867)

Post*Ins 0.000763 0.000803 0.000957 0.000803 0.000414 0.000962*

(0.000666) (0.000667) (0.000657) (0.000666) (0.000652) (0.000581)

Insurance 0.00102* 0.000978 -0.000245 0.000949

(0.000616) (0.000625) (0.000557) (0.000670)

Post -0.000171 -0.000810** -0.000171 -0.000242 -0.000807 -0.000242 -0.000315 -0.000548

(0.000386) (0.000382) (0.000386) (0.000538) (0.000559) (0.000538) (0.000542) (0.000496)

Ln(Asset) 0.000477*** 0.000274**

(0.000168) (0.000123)

BHC Div/Asset 0.825*** 0.822***

(0.144) (0.143)

Bank ROA 0.00759 0.00539

(0.0179) (0.0185)

Observations 1,452 522 522 522 1,452 522 522 522 522 522R-squared 0.008 0.014 0.301 0.014 0.013 0.017 0.293 0.005 0.024REG Pool Coll Coll Coll Pool Coll Coll Coll Coll CollYEAR FE YES NO NO NO YES NO NO NO NO NOBHC FE NO NO NO YES NO NO NO YES NO YES

Robust standard errors in parentheses

*** p

<0.01, ** p

<0.05, * p

<0.1

48
Table C.2: Banking Organizations with Bond Issuances at the Parent and Bank Levels 1997-2002. Org is an ID variable

created to group banks and parent BHCs within a single organization. P ROSP ECT USISSUER

N AME is the name of

the issuer as it appears in the Mergent data. BHC is a binary variable taking on the value one if it is issued by the parentand zero if it is issued by the bank. Notes indicates whether the issuer ID appears in the pre- or post-GLB periods.

Org. P ROSP ECT USISSUER

N AME BHC Notes Org. P ROSP ECT USISSUER

N AME BHC Notes

1 BANK AMER CORP 1 10 MBNA AMER BK NATL ASSN 01 BANK AMER N A CHARLOTTE N C 0 10 MBNA CORP 12 BANK ONE CORP 1 11 NATIONSBANK CHARLOTTE N C N A 0 Pre GLB2 BANK ONE N A 0 11 NATIONSBANK CORP 1 Pre GLB3 BANKBOSTON CORP 1 Pre GLB 12 OLD NATL BANCORP IND 13 BANKBOSTON N A 0 Pre GLB 12 OLD NATL BK 04 CAPITAL ONE BK 0 13 PNC BK N A PITTSBURGH PA 04 CAPITAL ONE FINL CORP 1 13 PNC FDG CORP 15 CHASE MANHATTAN BK USA 0 Pre GLB 14 U S BANCORP 15 CHASE MANHATTAN CORP 1 Pre GLB 14 U S BANCORP DE 15 CHASE MANHATTAN CORP NEW 1 Pre GLB 14 U S BANCORP ORE 16 FLEET FINL GROUP INC 1 14 U S BK NATL ASSN 06 FLEET NATL BK 0 14 U S BK NATL ASSN CINCINNATI OHIO 06 FLEET NATL BK PROVIDENCE R I 0 14 U S BK NATL ASSN MINNEAPOLIS 06 FLEETBOSTON FINL CORP 1 14 U S BK NATL ASSN N D FARGO 07 HUNTINGTON BANCSHARES INC 1 15 WACHOVIA BK N C N A 07 HUNTINGTON BANKSHARES INC 1 15 WACHOVIA CORP 17 HUNTINGTON NATL BK 0 15 WACHOVIA CORP NEW 17 HUNTINGTON NATL BK COLUMBUS 0 16 WELLS FARGO & CO 18 J P MORGAN CHASE & CO 1 Post GLB 16 WELLS FARGO & CO NEW 18 J P MORGAN CHASE BK 0 Post GLB 16 WELLS FARGO & COMPANY 19 KEY BK N A 0 16 WELLS FARGO BK NA 09 KEYCORP 1

49