Strings Attached: Private Equity Investment in Banks

The lead NY Times editorial last Sunday, had a stern warning against relaxing ownership rules for private equity investing in commercial banks. Let me suggest why this is a misplaced warning.

The current state of play is that ownership of 25% or more of a federally regulated bank subjects the owner to being deemed a “bank holding company.” In fact, ownership of more than 9.9% starts to impose some onerous burdens. At the 25% threshold, it would require that all holdings of the PE firm be subject to the same regulation as the “regulated bank”.

Imagine that a large PE firm who owned a portfolio of manufacturing, consumer products, and business service firms would now need to report these assorted other businesses as part of the “financial services” behemoth called “Blackstone” or “Bain” or “THL” Holdings. It would seem to me common sense to permit these external portfolio investments to be excluded from the regulatory supervision. Further, the “bank” itself even under this higher level of PE ownership would still be very highly regulated under the Bank Holding Company Act.

The Times also does not take into account a rather pesky regulation called Reg W. This regulation constrains transactions amongst affiliates and especially transactions where money moves from the “bank” into an affiliate. It requires extensive reporting and, often, full collateralization of the funds moved from one affiliate to the other. In essence, this regulation alone would go quite far in preventing the self-dealing that the NY Times fears.

We live in extraordinary and challenging times and we need extraordinary capital flows into commercial and investment banks to finally right the system. The Fed has done its job by its liquidity lending programs. Nonetheless, it may not be enough.

Properly done, there is a seat at the table for private equity.

Gail Long is CEO of ACG Boston, a chapter of the Association for Corporate Growth.