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The Supervision of Financial Conglomerates

Description of Financial Conglomerates and their Structures

34. Before turning to some of the specific issues involved in supervising a financial conglomerate, it is useful first to be clear as to what is meant by the term financial conglomerate and what kinds of structures a financial conglomerate may take.

(i) Definition

35. There are differing perceptions as to what exactly constitutes a financial conglomerate. To a large extent, these perceptions are dependent upon custom and practice in different countries, but they are also influenced by the existence, in some countries, of rules or laws governing, not only the ownership of banks, but also the activities in which banks can become involved. In the United States, for example, banks' involvement in securities business is generally limited to acting as principal and agent for government and certain public debt securities, as agent for sales of corporate securities, and for private placements. However, US banks underwrite and deal in securities outside the United States and through interpretations of the Glass­Steagall Act, banks have been allowed to engage in certain securities activities, and selected bank affiliates can engage domestically in corporate debt and equity underwriting and dealing. US law also prohibits banks from underwriting insurance and Federal and New York state laws prevent insurance companies owning commercial banks. There are, however, no prohibitions on the mixing of financial and commercial activities in a securities firm or insurance company conglomerate, and such mixing exists. On the other hand, in Switzerland, Italy, Germany, France, Luxembourg and The Netherlands, securities business is considered to be something of a "natural" banking activity which can be conducted within the legal entity of the bank or by a separate subsidiary within a financial conglomerate.

36. In considering the problems of supervising conglomerates, the Tripartite Group has for the purposes of its discussions drawn a distinction between "financial conglomerates" whose interests are exclusively, or predominantly, in financial activities and "mixed conglomerates" ­ those which are predominantly commercially or industrially oriented, but contain at least one regulated financial entity in some part of their corporate structure. The focus of this report is on the financial conglomerate, defined as "any group of companies under common control whose exclusive or predominant activities consist of providing significant services in at least two different financial sectors (banking, securities, insurance)". Such an entity is likely to combine businesses which are subject to different schemes of supervision and might also include financial activities which, in many countries, are not conducted in an entity which is subject to solo prudential supervision (e.g. leasing, consumer credit, certain financial derivatives).

37. To date, prudential supervision of financial conglomerates has normally been based on separate supervision of each individual type of activity, i.e. by bank, insurance and securities regulators. In view of the increasing importance of financial conglomerates, however, this report discusses whether the traditional organisation, procedures and instruments of prudential supervision enable the objectives of the various supervisory authorities to be met. If they are not met, what new and additional tools should supervisors be given? Because financial conglomerates are often made up of entities coming under various jurisdictions and subject to differing supervisory regimes, cooperation among regulatory authorities both domestically and internationally will clearly be an important pre­requisite of any effort to improve the prudential supervision of financial conglomerates.

38. Although the Tripartite Group has focused its discussions on financial conglomerates, it recognises that mixed conglomerates exist widely and that in some countries outside the G­10 it is quite common for a financial institution to form part of a so­called industrial conglomerate. Moreover, some of the large European "universal" banks hold majority or minority participations in industry, engineering, travel, hotels or other non­financial activities (although, in Italy, the law incorporates a principle which separates banking from commerce). Accordingly, some time has been devoted to consideration of the more complex supervisory issues that inevitably arise in groups which are commercially or industrially oriented, but which also contain regulated financial entities; these issues are discussed in section "xiv" of the next chapter. At the same time, it is fair to say that many of the problems associated with the supervision of financial conglomerates would also arise in the case of mixed conglomerates and that most of the recommendations made in this paper could be applied both to financial conglomerates and to the financial elements of mixed conglomerates.

(ii) Structure

39. Among countries, no single structure of a financial conglomerate dominates. A financial conglomerate may have different structural features depending on national laws and traditions. More specifically, a financial conglomerate may be characterised primarily as a securities, an insurance or a banking structure. The character would be determined by the sector represented at the holding company level and / or by the type of activity that constitutes the major business of the conglomerate. Alternatively, a financial conglomerate may be comprised of businesses such that no one sector dominates the character of the entity.

40. For example, a financial conglomerate involved primarily with banking would typically be one in which the parent company is either itself a banking institution under supervision, or is a financial holding company whose most dominant subsidiary is an authorised credit institution. Smaller less important subsidiaries (of the parent and / or of the dominant subsidiary) would include securities firms and/or insurance companies. A financial conglomerate engaged primarily in insurance would typically be one in which the parent or dominant group entity is an insurance company which has a relatively small banking subsidiary (over which banking supervision can be exercised in the traditional way by the bank supervisor). There are a number of examples of financial conglomerates engaged primarily in securities in the United States, where major securities firms are owned by holding companies which are not subject to regulatory capital standards. Through the holding company and its subsidiaries, the conglomerate conducts regulated and unregulated financial and non­financial activities. The regulatory scheme is focused on the regulated securities firm with capital standards which prevent withdrawal of capital for use by the holding company or its affiliates except under severe constraints. This is bolstered by risk assessment rules (i.e. information on the activities of affiliates of the regulated firm). A financial conglomerate in which no one sector dominates would typically be one formed on the basis of a holding company with subsidiaries in the banking and / or insurance and / or securities fields.


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