It wasn’t too long ago that banks were restricted from conducting business outside their home state. But some institutions found a workaround: Bank holding companies offered a way to operate in multiple states, leading Congress to pass the Bank Holding Company Act of 1956. Regulators also wanted to limit banks’ ability to own nonbank firms like a manufacturing company or retailer, which could have allowed them to influence borrowers to patronize those subsidiaries or use deposits to make loans to those businesses, according to Joe Mahon of the Federal Reserve Bank of Minneapolis.
Interstate banking has been the norm since the 1980s, and the Bank Holding Company Act has been modified several times since its 1956 passage. But generally, the law clarifies the purpose of a bank holding company and gives the Federal Reserve broad powers to supervise these companies.
Recently, with the failure of Silicon Valley Bank, questions have been raised about a holding company’s role as a source of financial strength. The Santa Clara, California-based bank’s holding company, SVB Financial Group, remained in operation as of Sept. 7, 2023.
But even in normal circumstances, a holding company presents distinct governance considerations for boards.
Why Have a Bank Holding Company?
A bank holding company’s primary purpose is to hold stock, or ownership, in a bank.
Banks don’t have to be held by a holding company — notable examples of banks without holding companies include Little Rock, Arkansas-based Bank OZK, with $31 billion in assets, and $87 billion Zions Bancorp., in Salt Lake City, which merged its holding company into its bank in 2018. Zions said at the time that the consolidation would improve efficiency and cut down on duplicative regulatory examinations.
A holding company structure eases an organization’s ability to borrow or raise money, and “inject it down into the bank,” says Andrew Gibbs, a senior vice president at Mercer Capital who leads the advisory firm’s deposit institutions group. Equity plans, including employee stock ownership programs, could be easier to manage via a holding company. For smaller banks below $15 billion in assets, it also changes what counts as regulatory capital.
“One of the benefits of bank holding company status is the ability to count securities like trust preferred securities as regulatory capital,” says Gibbs. Zions and Bank OZK didn’t receive those capital advantages due to their size.
A holding company structure also allows a bank to engage in a broader array of activities. “A bank holding company can invest in any kind of company, so long as it holds less than 5% of voting stock of that company,” says Samantha Kirby, partner and co-chair of the banking and consumer financial services practice at Goodwin Procter. Those investments can include fintechs. In Bank Director’s 2023 Bank M&A Survey, conducted last fall, 9% of bank executives and board members reported that their organization had directly invested in fintech companies in 2021-22.
If a bank holding company wants to offer a broader selection of financial services, such as investment banking or insurance, the board can elect to become a financial holding company, a separate designation created in 1999 via the Gramm–Leach–Bliley Act.
A bank holding company can also serve as a financial source of strength for the bank, referencing a doctrine that was reinforced in Section 616 of the Dodd-Frank Act, which amended the Bank Holding Company Act. Put simply, the holding company should provide financial support to its insured bank subsidiary “in the event of the financial distress” of that institution.
James Stevens, a Georgia-based partner at Troutman Pepper, witnessed a number of bank failures in that state during the 2008 financial crisis. Bank holding companies were expected to ensure their subsidiary bank had enough capital to survive. “If a subsidiary bank needs capital, and the bank holding company has additional capital that could be injected into the bank, it is supposed to push that capital into the bank under the source of strength doctrine,” he says. “If a bank holding company doesn’t do that, its board could be subject to criticism from regulators.”
Investors often prefer that capital be held at the holding company rather than at the bank. Gibbs explains that pulling capital out of the bank generally requires regulatory approval, so large capital activities — like dividends — are best handled at the holding company level. “It’s generally easier to keep [capital] at the holding company, and then you don’t need to deal with [the] regulatory process to extract it from the bank, if the bank has too much capital.”
Know Your Role
Both holding company and bank boards have the same fiduciary duties to shareholders, says Kirby, meaning the directors of both boards have a legal and ethical responsibility to act in the best interests of the company’s owners. That said, bank and holding company boards have distinct responsibilities, and directors should have a “clear understanding of whether they are serving on the bank board or on the holding company board, or both,” she says. It sounds basic, but sometimes that line isn’t clear.
Often, the boards mirror one another, but it’s not uncommon for a member or two to serve on just one of the boards. For example, it’s fairly routine for a private equity investor to only serve on the holding company board where they can focus on the overall direction of the company. And sometimes, the holding company and bank boards could be two entirely different groups.
According to Bank Director’s 2023 Compensation Survey, holding companies and banks tend to have the same number of members, at a median of 10. Bank boards meet a little more frequently, at a median 12 times a year versus 10 meetings for the holding company board.
The bank board should focus on the bank’s activities — put simply, strategies, policies and risks related to the bank’s business of making loans and taking deposits. “Bank regulators will not find it acceptable if the bank holding company is the one that’s managing the risk,” says Stevens. “Same thing with audit and compliance management, and the scope of internal audit. … They want the bank board to be focused on those things.”
Stevens describes the structure as one that’s “bottom up,” as the bank board makes important decisions about the business, and the holding company makes higher level decisions about strategy — capital allocation and deployment, or prospective M&A activity. “What’s the risk management framework? What’s our internal audit going to look like? Who has lending authority?” says Stevens. “That stuff has got to be at the bank.”
The holding company typically can add or remove directors from the bank board. “The process and authority depend on the articles and bylaws of the bank,” says Stevens, “but generally the bank holding company, as the sole shareholder of the bank, has the power to change the composition of the bank board.”
Separate Agendas, Minutes
No matter the makeup of the holding company and bank boards, both Kirby and Stevens say it’s important that deliberations — which board is taking action on what — are clearly documented.
Ideally, the bank board and the holding company board would have two distinct agendas, and two sets of minutes.
Stevens sometimes sees mirrored boards make joint resolutions. But he says it can get complicated when the two boards aren’t composed of the same directors. “You have to be thoughtful, if you have separate groups, that you’ve got the right people in the room to make the decisions that impact those fundamental banking decisions.”
That isn’t to say that members of the holding company board won’t sit in on the bank board meeting, or vice versa, says Kirby. But, when it comes time for formal action, that should be taken by the appropriate board.
Revisit Your Structure
Choosing to adopt a bank or financial holding company structure — or not — should be a decision informed by the bank’s strategy. Kirby recommends that this be part of the board’s annual strategic discussions. Consider whether the bank has the right structure to pursue its strategic goals and facilitate its growth.
While the difference between the two boards, holding company and bank, may appear trivial, getting governance right makes a difference on regulatory examinations. The board’s effectiveness factors into a bank’s CAMELS rating, short for capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk. The board falls under the management pillar.
“You want to have this buttoned up, and [you] don’t want to get criticized for it,” says Stevens. “If you’re being examined, and you’re on the cusp of being a three or a four, you don’t want the corporate governance issue to move you from a three to a four CAMELS rating. … It’s not a place for boards to be creative and make mistakes.”
Bank Director’s 2023 Compensation Survey, sponsored by Chartwell Partners, surveyed 289 independent directors, CEOs, human resources officers and other executives of U.S. banks below $100 billion in assets to understand how they’re addressing talent challenges, succession planning and CEO performance. Compensation data for directors, non-executive chairs and CEOs for fiscal year 2022 was also collected from the proxy statements of 102 public banks. Members of the Bank Services Program have exclusive access to the complete results of the survey, which was conducted in March and April 2023.
Bank Director’s 2023 Bank M&A Survey, sponsored by Crowe LLP, surveyed 250 independent directors, CEOs, chief financial officers and other senior executives of U.S. banks below $100 billion in assets to examine current growth strategies, particularly M&A. Members of the Bank Services Program can access the complete results of the survey, which was conducted in September 2022.