If anyone doubted that the need to have a BHC is being rethought despite our client report on this last week, Zions puts paid to that.  As I told the Wall Street Journal, moves such as Zions are often called regulatory arbitrage, but they are better understood as astute strategic choices that reflect a natural evolution of banking in the wake not only of Dodd-Frank’s costly standards, but also of the new retail-finance marketplace forged at least as much by innovation as regulation.  Not only should more companies consider following Zions’ example, but the FRB should also step back from its own institutional interests and reevaluate the fundamental rationale for a BHC.  There’s a lot less of one than there used to be. 

Stripping the BHC rationale to its essentials and divorcing consideration from the Fed’s desire to govern BHCs so that Reserve Banks have something to do, it becomes clear why many BHCs should be viewed not as the cumulative total of their subsidiary banks, but rather as shell companies separated from insured depositories except for an express, pre-funded facility to ensure source-of-strength support under stress.  Indeed, the more a BHC is divided into the parts that should be regulated as public trusts – insured depositories – and those that should live or die on their own – pretty much everything else – the better for moral rigor, market discipline, and orderly resolution under either the FDIC or the Bankruptcy Code. 

As Zions CEO Harris Simmons’ statement made clear, what could possibly be the rationale for a Fed examination of a particular activity a week or two after the OCC came in, did that, and left to draw its own conclusions?  One activity, one regulator is a pretty reasonable rule.  One activity and two regulators gets one not only an unnecessary regulatory burden, but also a de facto safety net thrown over the non-bank activities that should be the sole purview of the FRB along with any inter-bank transfers within the BHC that might escape primary supervisors.  Right now, the BHC is essentially a super-bank.  More properly understood, it is the distant parent of an insured depository subject to rules designed only to prevent downstreamed risk or upstreamed conflicts. When looked at in this way, a meaningful answer emerges not only to regulatory burden, but also to TBTF. 

There are three fundamental policy rationales for a parent holding company for insured depositories:  1) as the vehicle for owning more than one bank required before interstate banking; 2) as the vehicle required for engaging in activities not considered part of the business of banking before decades of law and rule redefined banking; and 3) as the source of support for insured depositories, a mandate notably tightened in Dodd-Frank even as all the ties that bind banks to BHCs were otherwise fraying. 

The first rationale – protecting local-based banking – is of course essentially irrelevant in 2017, although some banks prefer separate banking charters for institutional or market reasons.  The second rationale – an effort not only to separate banking from commerce, but also from lots of financial activities – is more compelling, but applicable to individual companies only when they want to engage in non-traditional finance. Ideally, one would have clear U.S. policy defining the barriers between banking and everything else, but any such clarity is long gone given the OCC’s fungible “business of banking” test and even greater flexibility in some states.  Soon to be former Acting Comptroller Noreika asked provocative questions about this issue earlier this month, but it’s more likely that non-banks will redefine banking through fintech and platform capacity than it is that Congress or the banking agencies will redefine the activities permissible within an insured depository. 

Which is why the third BHC rationale – source of strength – is so critical.  Ideally, it should apply to all companies that own an insured depository because of the unique privileges – FDIC insurance and FRB emergency access – that come with a bank charter and that can be all too easily shared with BHC shareholders absent prudential regulation at the parent-company level.  It’s for this reason – not the need to segregate banking from commerce – that I questioned the pending ILC applications from start-up fintechs. If, though, the bank’s shareholders and management are the same as those for all of the activities conducted in association with the bank, then the natural conflict of interest with parent-company shareholders ceases to exist and the need for a parent and its source-of-strength obligations is similarly moot.  When everything that puts an insured depository at risk is conducted within the insured depository subject to primary regulation and aligned incentives, then risk has nowhere to go but back to the bank, its shareholders, and management.

Of course, that two of the three BHC rationales are largely moot does not mean that there aren’t and shouldn’t be BHCs.  Large BHCs, particularly internationally-active ones or U.S. banks that are affiliated with “universal” ones back home cannot be quickly disentangled into true banking and everything else.  Further, many entities in these complex banks must be housed in functionally-regulated entities under the Gramm-Leach-Bliley Act or other applicable requirements.  In these cases, the BHC is far more of a “super-bank” than it is in a case such as Zions and those soon to follow its lead. 

However, even here, far better differentiation of bank from BHC would have sizeable benefits.  There is still no reason to regulate one activity twice in these complex BHCs just to satisfy the Fed that the primary bank regulator got it right. However, there are more reasons to worry about contagion risk to the insured depository if a non-bank affiliate of systemic size gets into trouble and the bank relies on runnable non-core deposits. Even so, better delineation of banking from non-banking in concert with less duplicative FRB regulation should be achieved.  One option was proposed earlier this year by FDIC Vice Chairman Hoenig; another may soon be in the offing sometime from NEC Director Gary Cohn.  Each has significant policy implications, not least due to Mr. Hoenig’s idea for a whopping leverage charge for a parent company of a segregated bank otherwise confined to traditional banking services that pretty much makes the whole idea a non-starter.

A hard look at reconfiguring BHCs and allowing banks to be banks has significant strategic upside not just for traditional institutions such as Zions, but also more broadly across the full swath of even the largest U.S. banks.  A redesigned BHC would reduce internal subsidies derived from insured deposits funding for non-traditional activities, but relief from duplicative regulation and greater scope of fintech and non-traditional activities at the parent level could be meaningful reward.  Reconceive U.S. GSIBs as conglomerate’s instead of BHCs and a new, powerful business model with considerable public-policy benefit takes shape.