Brandon Lee
Section 19 of the Banking Regulation Act outlines the restrictions on the nature of subsidiary companies of banking companies. It states that a banking company cannot form a subsidiary company except for specific purposes, such as undertaking permissible businesses or with the permission of the Reserve Bank to operate outside of India. This section also addresses bank reserves, defining terms like bank, transaction account, and nonpersonal time deposits. Amendments to Section 19 have focused on reserve requirements for depository institutions, including foreign branches and subsidiaries, to ensure a stable financial system. The Federal Reserve Bank of New York works to maintain a sound banking system by supervising banks and regulating financial institutions.
| Characteristics | Values |
|---|---|
| Section | 19 |
| Title | Bank Reserves |
| Definition of "bank" | Any insured or non-insured bank, as defined in section 3 of the Federal Deposit Insurance Act, excluding mutual savings banks and savings banks. |
| Definition of "transaction account" | A deposit or account from which the depositor or account holder can make withdrawals by negotiable or transferable instrument, payment orders of withdrawal, telephone transfers, or other similar methods for making payments or transfers to third persons or others. |
| Definition of "nonpersonal time deposits" | A transferable time deposit or account or a time deposit or account representing funds deposited to the credit of, or in which any beneficial interest is held by, a depositor who is not a natural person. |
| Amendments | Amendments to subsection 19(b) were to be effective on October 1, 2011, but section 128 of the act of October 3, 2008, accelerated the effective date to October 1, 2008. |
| Reserve Requirements | Depository institutions must maintain required reserve balances at a Federal Reserve bank, in a Federal Home Loan Bank, or in the National Credit Union Administration Central Liquidity Facility. |
| Foreign Branches, Subsidiaries, and International Banking Facilities | Shall maintain reserves to the same extent required by the Board of foreign branches, subsidiaries, and international banking facilities of member banks. |
| Bank Holding Company Act Amendments | Enacted on December 31, 1970, with references in Section 19. |
| Section 20 Subsidiaries | Prohibits a member bank from being affiliated with any company "engaged principally" in underwriting and dealing in securities that the bank itself may not underwrite or deal in. |
| New York Fed Mission | To make the U.S. economy stronger and the financial system more stable, executing monetary policy, providing financial services, supervising banks, and conducting research. |
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What You'll Learn
Bank reserves
The cash reserve minimum was cut to zero percent by the Federal Reserve in March 2020 as the global pandemic set in. Bank reserves are termed either required reserves or excess reserves. The required reserve is the minimum cash the bank can keep on hand, while the excess reserve is any cash over the required minimum that the bank holds in its vault rather than lending out to businesses and consumers. Banks have little incentive to maintain excess reserves because cash earns no return and may even lose value over time due to inflation. Thus, banks normally minimize their excess reserves, lending the money to clients rather than holding it in their vaults.
In most countries, the central bank may set minimum reserve requirements that mandate commercial banks to hold cash or deposits at the central bank equivalent to at least a prescribed percentage of their liabilities, such as customer deposits. Such sums are usually termed required reserves, and any funds above the required amount are called excess reserves. These reserves are prescribed to ensure that, in normal circumstances, there is sufficient liquidity in the banking system to provide funds to bank customers wishing to withdraw cash.
Foreign branches, subsidiaries, and international banking facilities of nonmember depository institutions shall maintain reserves to the same extent required by the Board of foreign branches, subsidiaries, and international banking facilities of member banks.
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Foreign subsidiaries
The regulatory landscape for foreign subsidiaries is shaped by the interplay between the host country's regulations and the home country's supervisory role. The host country, as the lead supervisor for locally incorporated subsidiaries, has the authority to impose regulations that protect depositors within its jurisdiction. On the other hand, the home-country supervisor is responsible for effective consolidated supervision, ensuring access to all necessary information and practicing global consolidated supervision over their internationally active banking organizations.
In the context of Section 19, which pertains to bank reserves, foreign branches, subsidiaries, and international banking facilities of nonmember depository institutions are subject to maintaining reserves. This requirement aligns with the mandates for member banks' foreign branches, subsidiaries, and international banking facilities. Additionally, Section 19 outlines the conditions under which a member bank can withdraw its required balance from a Federal Reserve bank to meet existing liabilities.
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Holding companies
A holding company is a specific type of business entity that owns and controls other companies' outstanding stock and oversees their operations. Holding companies are often referred to as parent companies or umbrella companies, reflecting their role in overseeing and controlling their subsidiary businesses. The creation of a holding company structure can serve various strategic purposes, including risk management, operational efficiency, and financial benefits. By establishing a holding company, an organization can gain flexibility and streamline management across multiple businesses.
One of the primary advantages of a holding company structure is risk management and limited liability. A holding company is typically set up so that the parent entity owns the necessary assets and conducts minimal operational activities. The subsidiaries, or operating companies, carry out the day-to-day business operations and enter into contracts, employ individuals, and engage with customers and suppliers. This structure ensures that any liabilities incurred by the subsidiaries are contained within those entities, protecting the holding company and its assets. This way, if one subsidiary encounters financial difficulties or legal issues, the others can continue operating without direct impact, and the holding company's assets remain shielded.
Another benefit of holding companies is the potential for operational efficiency and centralized management. The parent company can make decisions and implement strategies that align with the overall vision and goals for the collective enterprises. This unified direction can lead to streamlined processes, consistent standards, and economies of scale across the subsidiaries. The holding company can also provide shared services, such as legal, accounting, human resources, and marketing support, to its subsidiaries, reducing duplication of efforts and costs. This centralized approach can enhance operational synergies and enable the subsidiaries to focus on their core competencies.
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Bank subsidiary definitions
A subsidiary bank is a type of foreign entity that is located and incorporated in a foreign country but is either wholly or majority-owned by a parent corporation in a different nation. This particular banking model helps the parent company avoid unfavourable regulations enforced by the home country. Subsidiary banks only have to operate under the laws and regulations of the host country.
In the context of the US banking industry, a subsidiary bank is a subsidiary of a bank through which the bank chooses to indirectly conduct some part of its banking business or related businesses like insurance. To prevent banks from concealing their true structure or strength from regulators, they are required to give public notice of certain transactions with certain operating subsidiaries.
Subsidiary banks are typically unable to offer a full suite of retail banking services. However, they can underwrite securities, whereas most bank branches focus on retail services. A parent bank can establish a banking presence associated with the buying and selling of securities through a subsidiary bank. For example, a bank in the US looking to expand investment banking and trading operations in the UK might choose to do so through a subsidiary bank.
Subsidiaries should not be confused with foreign bank branches. Foreign bank branches are obligated to follow the regulations of both the home and host countries. They can provide more loans than subsidiary banks because they have access to the capital base of the larger entity.
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Bank subsidiary restrictions
In the United States, most banks are owned by bank holding companies (BHCs). The Federal Reserve supervises all BHCs, regardless of whether the bank subsidiary is a state member, nonmember, or national bank. The BHC Act gives the Federal Reserve the authority to examine and inspect BHCs, much like bank regulators examine banks.
A company that proposes to acquire control of a bank must apply to the Federal Reserve for prior approval to become a BHC. Investments by a BHC in additional banks exceeding 5% of the target bank's outstanding voting shares also require prior approval. Applications are processed under established time frames and must meet certain competitive, financial, and managerial standards to be approved.
The Federal Reserve has developed a rating system for BHCs, referred to as RFI/C. R stands for risk management, F for financial condition, and I for impact. A composite rating, C, is also assigned. The RFI/C components are rated from 1 to 5. Small BHCs, those with consolidated assets of less than $1 billion, are supervised largely off-site and assigned only a composite rating.
The Glass-Steagall Act prohibits member banks from being affiliated with any company "engaged principally" in underwriting and dealing in securities that a member bank may not underwrite or deal in (ineligible securities). To ensure compliance, the revenue a bank holding company subsidiary derives from underwriting and dealing in ineligible securities must not exceed 10% of the total revenue of the company.
According to Section 19 of the Banking Regulation Act, a banking company shall not form any subsidiary company except for one or more of the following purposes:
- Undertaking any business permissible for a banking company under clauses (a) to (o) of sub-section (1) of section 6.
- With prior written permission from the Reserve Bank, carrying on the business of banking exclusively outside India.
- Undertaking other business that the Reserve Bank, with the prior approval of the Central Government, considers conducive to the spread of banking in India or otherwise useful or necessary in the public interest.
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Frequently asked questions
Section 19 of the Banking Regulation Act states that a banking company shall not form any subsidiary company unless it is formed for one or more of the following purposes:
- The undertaking of any business which, under clauses (a) to (o) of sub-section (1) of section 6, is permissible for a banking company to undertake.
- With the previous permission in writing of the Reserve Bank, the carrying on of the business of banking exclusively outside India.
- The undertaking of such other business, which the Reserve Bank may, with the prior approval of the Central Government, consider to be conducive to the spread of banking in India or to be otherwise useful or necessary in the public interest.
The purpose of Section 19 restrictions is to ensure that banking companies do not engage in indirect business activities through subsidiary companies that they are not permitted to undertake directly.
No, a bank subsidiary is not considered a "bank" under Section 19. The term "bank" specifically refers to an insured or non-insured bank as defined in Section 3 of the Federal Deposit Insurance Act, excluding mutual savings banks and savings banks.
No, the restrictions in Section 19 apply specifically to subsidiary companies formed by a banking company. Other types of subsidiaries, such as those owned by a bank holding company, may have different regulations.
Yes, there are other sections and acts that also impact bank subsidiaries. For example, Section 20 of the Glass-Steagall Act prohibits a member bank from being affiliated with any company "engaged principally" in ineligible securities activities. Additionally, Section 1841 of the U.S. Code provides definitions related to bank holding companies and their subsidiaries, including "out-of-state bank" and "home state." These sections work together to regulate and supervise financial institutions, ensuring a stable and competitive banking system.
