Discussion Paper

Nonbank Subsidiaries and the Hidden Fragility of Internal Capital Markets Reallocation

Abstract: Banks became safer after Basel III. Whether it made the broader organization safer is less clear. We document that bank subsidiaries accumulated capital, improved asset quality, and reduced risk. But holding companies built that capital largely by drawing on their nonbank affiliates. Did the reallocation reduce risk for the organization as a whole or merely move it to a less visible part of the firm? Our evidence points to the latter: the same internal capital markets that helped banks meet tighter requirements left nonbank affiliates with thinner buffers and riskier business models, and a greater capacity to transmit distress back to the organizations that own them.

JEL Classification: G21; G23; G28; G38;

https://doi.org/10.59576/lse.20260717

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2026-07-17

Number: 20260717

Note: This post concludes a three-part series on how bank regulation interacts with the organizational structure of banking firms. The first post documented the equity-rich nonbank subsidiaries inside bank holding companies (BHCs); the second post showed that BHCs met Basel III by reallocating capital internally, moving equity from nonbank affiliates to bank subsidiaries rather than raising new external capital. Here we ask what that reallocation meant for financial stability. The series draws on the authors’ recent Staff Report, “Regulatory Arbitrage Within the Firm.”