Bank Powers:

Insulating Banks From the Potential Risks of Expanded Activities

GGD-87-35: Published: Apr 14, 1987. Publicly Released: Apr 14, 1987.

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GAO reported on a proposed method to permit banks to participate in expanded activities while insulating their insured deposits from risky activities by organizationally separating the new activities from traditional bank operations. Banks generally operate these nontraditional activities under one of their departments, a subsidiary, a holding company subsidiary, or a bank service corporation.

GAO found that: (1) banks engaged in expanded activities insulated their insured deposits by separating their activities legally, economically, and in the market's perception; (2) legal separation insulates a bank's deposits from legal risks because the bank generally is not liable for its affiliate's debts; (3) economic separation from its affiliate restricts the flow of funds from the bank to the affiliate; and (4) if the market perceives a bank and its affiliate as one, even though they are legally and economically separate, the bank may experience problems if the affiliate has financial trouble. GAO also found that: (1) bank departments provide the least amount of insulation because banks are legally liable for them, since they are not separate; (2) although subsidiaries generally provide legal and economic protection to banks' deposits, neither fully protects the bank from market perception risks; and (3) banks may choose not to conduct new activities if the insulation structure is too expensive or inconvenient.

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