The Funding of Subsidiaries Equity, “Double Leverage,” and the Risk of Bank Holding Companies (BHCS)
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Double leverage” is the circumstance in which the parent company issues debt and acquires shares in the equity of subsidiaries (Board of Governors of the Federal Reserve System, 2012). The concern of financial authorities is that such practice reduces the group capital, and bring risk to the firm. The paper is an extensive discussion on this regulatory issue, and provides quantitative evidence on the impact from double leverage on the risk undertaken by Bank Holding Companies (BHCs). For a large sample of United States BHCs we observe that firms exhibit a huge appetite for risk while they raise in the so-called “double leverage ratio.” Several tests do suggest the existence of causality. Our view is that, by double leveraging BHCs can exploit a shortfall in the consolidated capital, and are tempted to risk more. Based on our findings we give suggestions for a more effective monitoring of banking groups.