In a recent in-depth report, we analyzed the Fed’s long-awaited capital proposal for insurance-focused depository institution holding companies (DIHCs).  In 2016, the Fed tried out a consolidated approach that applied bank-like standards across subsidiaries and totaled them up into a BHC-like requirement at the parent level.  Now, the Fed is going far easier, proposing a “building-block approach” (BBA) with significant strategic upside not just for acquisition-minded financial companies, but also for fintechs and other innovative entities.

As with anything the Fed proposes, the BBA isn’t a simple construct; see the detailed analysis of the BBA in our earlier report.  Suffice it now to say that the BBA concept allows a DIHC to assemble its capital requirements by building them up from blocks subject at the subsidiary level to different capital requirements.  In the insurance-focused BBA, the parent company retains its insurance operations within the insurance-capital framework set by its state regulators, the insured depository is under bank standards, and so forth.  The framework applies scaling factors to make the Fed happy and subjects some insurance activities (e.g., credit-risk guarantees) to bank capital.  Even so, the Fed believes that DIHCs with insurance subs will generally not need to post more regulatory capital than they already have under the current, less coherent patchwork of capital standards.

The implications for this on the integration of insurance and banking are considerable.  The 1999 Gramm-Leach-Bliley Act created a framework for diversified financial holding companies, but its spark was Citicorp’s transformation into Citigroup as a result of the ground-breaking acquisition by a bank holding company of a giant insurer.  Although the law blessed the deal, the market didn’t.  The Citi/Travelers transaction was among the worst ever and the curse was on.

Only eight hardy DIHCs now have insurance activities of large enough size to utilize the BBA.  It’s unclear, though, if insurance and banking really don’t mix or if it was the Fed that made it so until it recanted twenty years later.  Given the profit and prudential challenges insurers face finding safe, higher-yielding assets, it’s worth giving bank charters another look.

Even more interesting, the BBA has broader implications for all of the companies contemplating ILCs or other banking inroads.  The Dodd-Frank Act made it clear that parent companies that aren’t also bank holding companies can be held to account as sources of strength for an insured depository.  However, the practical ability of the Fed to do so as a subsidiary insured depository becomes distressed is doubtful, making the Fed and FDIC very wary of ILC or similar innovative charters for fintech companies.  Even those with the best chances of winning an insured-depository charter from the FDIC thus will find the banking subsidiary essentially walled off from the rest of the parent company to the best of the FDIC’s considerable ability.

What, though, if the BBA were applied to the fintech as a whole or at least to those financial activities across the company that are analogous to banking activities for which there is an established regulatory-capital framework?  In a BBA, broader payment-system access or rights to draw on the Fed are surely less problematic to the FDIC and the Fed than in an ILC with nothing more than letter agreements to be good to protect the banking system from any parent-company depredation.  Under the BBA, a full-service insured depository can sit within a holding company with capital rules applicable to each building block according to each building block’s rules up to the point at which scaling and other Fed buffers come into play.

Would the BBA work as well for fintechs or other non-traditional charters as it’s likely to do for insurance DIHCs?  What about innovative affiliations between banks and private-equity or securities firms?  In each case, the parts are not only different from the whole, but also very different from the activities for which there is bank-analogous capital.  The key to strategic thinking is to map out what the Fed might demand of these non-bank parts, how painful it is, and whether the pain is worth the price of admission.