Conflicts of Interest Abound If Banks Cleared to Invest in Corporate Borrowers
Freibert, George, American Banker
Legislation recently introduced by Rep. Richard Baker, R-La., the Entrepreneurial Investment Act, is an unwise piece of legislation for banks and the banking industry.
The bill would allow bank holding companies with assets of less than $1 billion to make equity investments in their corporate borrowers. It proposes allowing holding companies to acquire up to one-quarter of the voting shares of these corporate borrowers.
Politically, such legislation may be of some value, but for financial institutions it is likely to be a mine field.
Permitting holding companies to invest in the equity of their banks' corporate borrowers would create conflicts of interest between the holding company and its bank subsidiary. The interests of creditors and shareholders are in some aspects legitimately different, and this legislation could place financial institutions in a position of playing chess against themselves.
Placing the bank and its holding company in the position of creditor and owner, respectively, of the same corporation could put the holding company in a position of attempting to serve two masters, each with a different interest.
This scenario would be further complicated should a financial institution find it necessary to put one of its board members or officers on the board of the corporation in which the financial institution has an equity investment. In such a situation the bank officer or director may find a direct conflict regarding his fiduciary duty to his own shareholders and those to the shareholders of the borrowing customer.
Occasions would also arise where pressure would build on a bank to increase its lending, or on a holding company to bolster its capital investment in a troubled corporate borrower, in order to strengthen the position of the other party.
One of my last assignments prior to leaving the Federal Deposit Insurance Corp. …