Academic journal article Federal Reserve Bulletin

Statements to the Congress

Academic journal article Federal Reserve Bulletin

Statements to the Congress

Article excerpt

Statement by Susan M. Phillips, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Capital Markets, Securities and Government-Sponsored Enterprises of the Committee on Banking and Financial Services, U.S. House of Representatives, April 18, 1996

I am pleased to appear before this subcommittee on behalf of the Federal Reserve Board to provide comments on the Entrepreneurial Investment Act of 1996, a bill proposed by Chairman Baker. At his request, the Board staff provided technical assistance in the drafting of the bill.

This bill would permit smaller bank holding companies to provide limited equity capital to customers of the subsidiary banks. Specifically, bank holding companies of less than $1 billion in assets, all of whose subsidiary banks were well capitalized, could invest in the equity of those of their customers with whom they have had a "significant" debt relationship for at least a year. The individual equity investments in these firms could not exceed 25 percent of the voting shares of the firm; the holding company could not take an active part in the management of the firm in which it held equity; and the subsidiary banks or other depository institution subsidiaries could not hold any of the stock. The aggregate amount of this equity investment could not exceed half of the amount by which the subsidiary banks' capital exceeded the well-capitalized minimum.

The bill prohibits joint marketing of the products of the banking organization and the firms in which the bank holding company invests. For prudential reasons, the Board would have to provide one-time approval for a banking organization to initiate such investments, and the Board could supervise and regulate this activity, as well as require divestiture if it concluded such action was necessary to preserve the safety and soundness of the insured depository subsidiaries. Should the banks' capital decline, the Board could take action to preserve the safety and soundness of the subsidiary insured depository institutions, including requiring divestiture by the parent holding company of shares already held. The bank holding company would be required quarterly to mark the shares to market value, if possible, and if the shares are not traded, to mark them to the lower of their acquisition price by the holding company or their book value as measured by the firm's balance sheet.

Banking organizations already are involved in similar activities under provisions of existing law. For example, under existing statute and regulation, all bank holding companies have for some time been able to acquire passive equity investments in any company of up to 5 percent of the voting shares and up to 24.9 percent of the total equity in a combination of voting and nonvoting stock. There are no limits on the total amount of equity investments that can be made under these provisions. The bill before you also permits 25 percent of the equity of a company to be purchased--although all could be voting--but there are prudential limits on the total amount of equity purchases.

Under existing interpretations of law, national banks may--in addition--take so-called equity kickers as part of loan agreements. That is, the bank may take part or all of its interest on a loan in the form of options or warrants for voting stock or profit sharing. There is no limit on the percentage of the borrowers' shares that may be the subject of these equity kickers. It is our understanding that such equity kickers are increasingly being used, with the options or warrants sold into the market or exercised by a nonbank affiliate. In a number of states, state banks are permitted, under state law and the Federal Deposit Insurance Act, to participate in real estate investments and various types of equity securities through subsidiaries of the bank. Moreover, a national bank itself or any bank holding company already can invest up to 5 percent of its capital in a small business investment company that, in turn, can own up to 49 percent of the voting shares of any small business; the banking organization can also make loans to those businesses. …

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