Affiliates in Banking, Finance, and Commerce: Development and Regulatory Background
CRS Report for Congress
Affiliates in Banking, Finance, and
Commerce: Development and
Regulatory Background
William D. Jackson
Specialist in Financial Institutions
Government and Finance Division
Summary
The proliferation of corporate affiliates in banking, finance, and commerce has
figured in discussion of several policy issues, including how to protect against (1) losses
incurred by affiliated companies; (2) anticompetitive “tying” of bank and nonbank
financial services; and (3) misuse of financial data of consumers. The Gramm-Leach-
Bliley Act in 1999 greatly increased affiliations. Sharing of consumer financial
information among affiliates, one issue in reauthorization of the Fair Credit Reporting
Act, requires considerable attention to affiliations. Proposed Community Reinvestment
Act regulations involve affiliates of banks. Comptroller of the Currency efforts to bring
subsidiaries of national banks under federal banking law, preempting than state laws,
also involve affiliations. This report outlines the nature and evolution of affiliates,
primarily from a regulatory perspective. It provides background for discussing financial
issues involving corporate affiliates and will be updated as events warrant.
Background and Analysis
Conducting “nonbanking” activities directly within a bank has generally been viewed
as a threat to the integrity of the bank. Periodically in American financial history, and in
other nations today, bank diversification into nonbanking financial and commercial
business has emerged.1 Safety problems often followed because of a tendency for
entrepreneurs to combine captive sources of (bank) funds with their own (commercial)
uses of funds, without regard for normal due diligence. By forcing nonbanking activities
into a separately capitalized, separately run company associated with a bank,
policymakers sought to lessen the risks that self-funding may pose to banks, to deposit
1 Joseph G. Haubrich and Joao A. C. Santos, “Alternative Forms of Mixing Banking with
Commerce: Evidence from American History,” Financial Markets, Institutions & Instruments,
vol. 12, no. 2, pp. 121-164.
Congressional Research Service ˜ The Library of Congress
insurance funds, and to other governmental policies. Overall, financial policy has
periodically limited commercial/banking affiliations since the 1830s.
The term “affiliate” refers to “any company that controls, is controlled by, or is
under common control with another company.”2 Companies with ownership interests of
25% or more in common are usually always affiliates. Sometimes, a common ownership
interest as low as 5% is sufficient if it involves director selection, policy direction, and
similar control matters. Affiliations are often valued for their potential of cross-
marketing, involving sharing of consumer financial information; thus becoming one focus
of the Fair Credit Reporting Act debate in Congress,3 which resulted in the Fair and
Accurate Credit Transactions Act of 2003, P.L. 108-159. Application of it must address
cross-marketing/information-sharing involving affiliates.4
The simplest affiliation is that of a subsidiary, where a bank owns another financial
business 100%. Examples are a bank owning an insurance agency, small business
investment company, or securities broker. Subsidiaries are regulated by the primary
regulator(s) of the owning banks. A more complicated structure involves a company
controlling banks. This state-chartered business is known as a “bank holding company.”
It “holds” the stock of one or more banks and, often, of other financial businesses. A
bank holding company typically holds all the stock of at least one bank, and a mortgage
company, a securities firm, or a commercial finance business. It may also hold all or part
of joint ventures, foreign alliances, investment companies, and other businesses within
its structure.5 The Federal Reserve (Fed) regulates bank holding companies.
A more complex form of bank holding company is the financial holding company,
authorized by the Gramm-Leach-Bliley Act (GLBA, P.L. 106-102) in 1999. As specially
empowered bank holding companies, these entities may additionally hold full-service
securities and insurance operations, including those making nonfinancial equity
“merchant banking” investments. Similar diversification arrangements allow securities-
based entities to form investment bank holding companies, and savings associations to
come under “thrift” holding companies. GLBA listed activities for such affiliations:
underwriting and dealing in securities, sponsoring and distributing mutual funds, selling
and underwriting insurance, and making insurance company and merchant banking
portfolio investments. Regulators may allow other business affiliations.
The Fed, as the regulator of financial holding companies, oversees them to prevent
affiliations from lowering the soundness of deposit-insured banks. Sections 23A and 23B
of the Federal Reserve Act built financial “firewalls,” which prevent banks from
supporting failing nonfinancial affiliates, or engaging in anticompetitive tying in financial
2 12 U.S.C. 1841.
3 CRS Report RS21576, Fair Credit Reporting Act: Frequently Asked Questions, by Angie
Welborn and Loretta Nott, and CRS Report RS21427, Financial Privacy Laws Affecting Sharing
of Customer Information Among Affiliated Institutions, by Maureen Murphy.
4 Richard Cowden, “FACT Act Affiliate-Sharing Regulations Likely to Be Separate From FCRA
Rules,” Daily Report for Executives, Feb.11, 2004, p. A-32.
5 The Fed restricts lines of business that may be affiliated through bank holding companies,
including their financial holding company form, in 12 C.F.R. Part 225, “Regulation Y.”
services. Risk of collapse of securities, insurance, and other affiliated businesses evoking
deposit insurance, lender-of-last resort, or outright appropriation to cover bank losses
becomes less likely. Flows of information between banking and nonbanking affiliates,
or as in the Fair Credit Reporting Act, affiliated entities even if no bank is involved, are
limited to preserve competition and privacy concerns. A bank or securities affiliate may
also provide advice to an investment company, even without ownership. Regulators have
warned bank-based organizations against contributing banking resources to advised funds.
Legislative and Regulatory Actions
Beginning in the 1970s, a scramble for funds encouraged businesses ranging from
banks to real estate to manufacturing to affiliate with nontraditional financial firms, taking
market shares from regulated U.S. banks. Regulatory and statutory reactions may have
peaked in 1982.6 Table 1 summarizes the basic developments by which Congress, states,
and regulatory bodies have changed relevant affiliation relationships, increasing or
limiting their extent. Continuing congressional debate involves whether GLBA allows
affiliation of banking with real estate activities.7 Current congressional activity questions
the extent to which affiliates of national banks, such as mortgage company subsidiaries,
are subject to the Comptroller of the Currency’s preemption of state laws.8
Table 1. 100-Year Time Line of Affiliation Environment of Banking
YearsActionAffiliation Change
1906-Many state lawsSeparated life insurance from commercial and
1910-State banking practice, Securities affiliates of state and national banks
1933Banking Act of 1933: fourDefined affiliate and holding company
sections are knownarrangements for Federal Reserve member banks.
collectively as the Glass-Added Section 23A to Federal Reserve Act, limiting
Steagall Act (GSA)member bank transactions with affiliates. Outlawed
ties between commercial and investment banking.
Section 20 prevented Federal Reserve member
banks from affiliating with companies “engaged
principally” in underwriting or dealing in securities.
Section 32 prevented their affiliations with
securities firms via interlocking directorates.
6 CRS Report RL31981, Industrial Loan Companies/Banks and the Separation of Banking and
Commerce: Legislative and Regulatory Perspectives, by William D. Jackson, and CRS Report
RS21188, Enron’s Banking Relationships and Congressional Repeal of the Glass-Steagall Act
Separating Bank Lending from Investment Banking, by William D. Jackson.
7 CRS Report RS21104, Should Banking Powers Expand Into Real Estate Brokerage and
Management?, by William D. Jackson.
8 CRS Report RL32197, Preemption of State Law for National Banks and Their Subsidiaries by
the Office of the Comptroller of the Currency, by M. Maureen Murphy.
YearsActionAffiliation Change
1956Bank Holding CompanyProhibited affiliations of nonbanking entities with
Act of 1956 (BHCA)companies controlling two or more banks. Federal
Reserve could allow affiliations “...closely related
to the business of banking....” Douglas Amendment
prevented multi-bank affiliations; containing
holding company banks inside state lines.
1968Savings and Loan HoldingRestricted affiliations for holding companies
Company Act of 1968owning two savings and loan associations.
Exempted control over one (“unitary”) association.
Insurance Commissioners like BHCA but allowing nonfinancial affiliations.
1970Bank Holding CompanyProhibited nonbanking affiliations for a holding
Act Amendments of 1970company owning one bank. Prohibited banks from
tying services, reciprocity, and exclusive dealing
arrangements with customers generally.
1970New York StockMember broker/dealer firms could sell their own
Exchange Rule Changestock to the public, allowing affiliates directly or via
holding companies in many business lines.
1974-Losses in Bank AffiliatesReal estate investment trusts associated with banks
1975weakened by economic conditions. Banks and their
holding companies took large losses.
1978International Banking ActSubjected foreign bankers in U.S. to BHCA
of 1978affiliation restrictions.
1980sComptroller of thePermitted affiliations of limited-service “discount
Currency and Federalbroker” securities firms with banks.
Reserve Rulings
1982Garn-St GermainAllowed affiliation involving savings and loan
Depository Institutionsassociations, not only real estate but also industry
Act of 1982ownership. Prevented most insurance affiliations
for banks; contained Banking Affiliates Act of
1982Comptroller of theAllowed nationally-chartered “nonbank banks” to
Currency Charteringoffer credit cards and other services, in affiliation
with financial and industrial firms.
1982Bank Export Services ActAllowed bank holding companies to invest in export
trading company affiliates.
1982Federal Deposit InsuranceState-chartered banks not members of Federal
Corporation PolicyReserve could affiliate with full-service securities
Statementcompanies, declared as not covered by GSA.
1986-Federal Reserve RulingsAuthorized bank holding company affiliates to
1987Federal Reserve “SectionAllowed bank holding company subsidiaries to
20 Subsidiaries” Rulingunderwrite municipal revenue bonds, commercial
paper, and asset-backed securities.
YearsActionAffiliation Change
1987Competitive EqualityForestalled affiliations of nonbank banks with
Banking Act of 1987nonfinancial firms. Put moratorium against new
banking affiliations in securities, insurance, and real
estate. Added Section 23B to Federal Reserve Act,
restraining nature of transactions with affiliates.
Exempted industrial banks from BHCA, allowing
commercial affiliations.
1989Federal Reserve “SectionExtended 1987 authority to corporate bonds in
1989Financial InstitutionsTightened affiliation/investment qualifications
Reform, Recovery, andaffecting savings and loan associations.
Enforcement Act of 1989
1990Federal Reserve “SectionExtended 1987 authority to equity dealings (for JP
1991Federal Deposit InsuranceGave Federal Deposit Insurance Corporation veto
Corporation Improvementover state-allowed subsidiaries of banks. Prohibited
Act of 1991state bank affiliation with insurers.
Banking and Branchingallowing holding companies’ bank affiliates across
Efficiency Actstate line boundaries.
1996Comptroller of theAllowed subsidiaries of national banks to expand
Currency Regulationactivities, including insurance and securities.
1997Federal Reserve “SectionLessened restrictions on affiliation relationships and
20 Subsidiaries” Rulingtransactions involving member banks and securities
operations. Exempted holding company affiliates
from certain anti-tying rules.
1998Federal Reserve RulingAllowed insurance firm Travelers to acquire
on Citigroup BusinessCiticorp, to become bank holding company
ActivitiesCitigroup. Conditioned on divestiture of then-
impermissible affiliations.
1999Gramm-Leach-Bliley Act,Repealed Sections 20 and 32 of GSA: allowed
Title Iaffiliations of banks, insurance companies such as
Travelers, securities businesses, etc. via financial
holding companies or investment bank holding
companies. Merchant banking investments of
financial holding companies allowed nonfinancial
affiliations. Authorized bank subsidiaries in these
businesses, except insurance underwriting, title
insurance, merchant banking, and real estate.
Future expansion of affiliations via rulemaking.
1999Gramm-Leach-Bliley Act,Disallowed affiliations of savings and loan holding
Title IVcompanies for a single institution (“unitary thrift
holding companies”) with nonfinancial businesses.
2002Comptroller of theNational banks could purchase bonds convertible
Currency Rulinginto equity (stock).
YearsActionAffiliation Change
2002-Citigroup BusinessDivested most insurance business lines of Travelers
2003Federal ReserveGave bank holding company affiliates much ability
Regulationto process, store, and transmit nonfinancial data.
2003-Federal Reserve RulingsGave financial holding company affiliates authority
2004Comptroller of thePreempted many state laws governing national
Currency Regulationbanks and their affiliates (subsidiaries).
2005Comptroller of theAllowed national banks to engage in electricity
Currency Rulingderivative activities, beyond oil and gas derivatives.
Source: Congressional Research Service, The Library of Congress.
Community Reinvestment Act Regulation of Affiliates?
Regulators have shown concern over affiliates of banks that may be engaging in
undesirable (“predatory”) lending practices, in proposed regulatory language. Through
evaluations under the Community Reinvestment Act of 1977 (P.L. 95-128, Title VIII),
they report bankers’ socially graded performance, largely in lending. They may penalize
banks whose affiliates engage in “discriminatory, illegal, or abusive credit practices,” by
reducing the bank’s Act ratings . They may require disclosure of bank loans purchased
by affiliates.9
Tying?
Banks and their affiliates cannot require customers to “tie” purchases of banking and
nonbanking (securities, etc.) services together, nor give special treatment to some
customers through affiliate arrangements. Customers may, however, voluntarily request
such bundling of financial services. The Fed grants certain exemptions from its rules that
otherwise limit cross-selling of banks with affiliates. It has sanctioned at least one
holding company for direct tying. A trade group found that banks frequently condition
corporate credit on purchase of other services.10 In the other direction, the Comptroller
of the Currency found that the appearance of “tying” was a permissible, understandable
phenomenon.11 The Government Accountability Office (GAO; formerly named General
Accounting Office) examined whether banks tie credit to securities underwriting services,
but could not prove occurrences. GAO suggested stronger enforcement of laws.12
9 See CRS Report RS20197, Community Reinvestment Act, by William D. Jackson.
10 Association for Financial Professionals, 2004 Credit Access Survey: Linking Corporate Credit
to the Awarding of Other Financial Services, June 2004, 15 p.
11 Office of the Comptroller of the Currency, Today’s Credit Markets, Relationship Banking, and
Tying , Washington: Sept. 2003.
12 U.S. General Accounting Office, Bank Tying: Additional Steps Needed to Ensure Effective
Enforcement of Tying Prohibitions, GAO Report GAO-04-03, Oct. 20, 2003.