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CASE STUDY 1: EXAMPLE OF DOUBLE GEARING OF CAPITAL

A simple case study of a two-tiered financial conglomerate composed of a non-regulated


financial holding company at the top and three fully owned subsidiaries of which two
regulated entities (bank and insurance company) and one non-regulated entity (leasing
company) is presented.

Financial Holding Company


(non-regulated)

Bank Insurance company Leasing company

(100% participation; (100% participation; (100% participation;


regulated) (regulated) non-regulated)
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Unregulated Financial Holding


Company
Participation in Bank S1 800 Capital 200
Participation in Ins. Comp. S2 100 Other liabilities 800
Participation in Leasing Comp.
S3 100
Total assets 1000 Total liabilities 1000

Subsidiary 1 (Bank, 100% participation)


Loans 900 Capital 800 Capital requirement 200
Other assets 400 Other liabilities 500 Actual capital 800
Total assets 1300 Total liabilities 1300 Capital surplus/deficit 600

Subsidiary 2 (Insurance company, 100% participation)


Investments 7200 Capital 100 Capital requirement 150
General reserves 100 Actual capital 200
Technical
provisions 7000 Capital surplus/deficit 50
Total assets 7200 Total liabilities 7200

Subsidiary 3 (Leasing Company, 100% participation)


Leases 2000 Capital 100 Capital requirement* 200
Other liabilities 1900 Actual capital 100
Total assets 2000 Total liabilities 2000 Capital surplus/deficit -100

Group consolidated
Consolidated group
Bank loans 900 Capital 200 capital 300
Consolidated
Other bank assets 400 General reserves 100 requirements 550
Solvency group
Insurance investments 7200 Other liabilities 3200 surplus/deficit -250
Technical
Leases 2000 provisions 7000
Total assets 10500 Total liabilities 10500
* "Notional" capital proxy.
Based on 1999 Joint Forum
examples.
The example shows that although both regulated entities display, on an individual basis,
excess capital, the financial conglomerate on a group-wide basis is undercapitalized. The
explanation is twofold: there is excessive leverage in the group (as the parent has
downstreamed debt to its subsidiaries) and there is an undercapitalized unregulated entity.
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CASE STUDY 2: EXAMPLE OF LEVERAGING

The following figure illustrates the concept of double leveraging and shows that the capital
adequacy at the group level is much lower in the presence of double leveraging.
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A. No Double Leveraging
Bank Subsidiary
Assests Liabilities
$2,000 M $1,840 M
Consolidated Balance
Equity Sheet of the
$160 M Parent Company

Assets Liabiliites
Parent Company Equity to Assets: 8%
$2,500 M $2,300 M
Assests Equity
$200 M $200 M

Invesement
in Bank
$160 M Equity

Investment
Nonbank Subsidiary $ 200 M

in Nonbank
Assets Liabilities
$40 M
$500 M $460 M

Equity
Equity to Assets: 8%
$40 M

Eliminates intercompany items.


Equity to Assets: 8%
(No invesments in subsidiares.)

B. Double Leveraging

Bank Subsidiary
Assests Liabilities
$2,000 M $1,840 M
Consolidated Balance
Equity Sheet of the
$160 M Parent Company

Assets Liabiliites
Parent Company Equity to Assets: 8%
$2,500 M $2,425 M
Assests Liabilities
$200 M $125 M
(Senior Debt)
Invesement
in Bank Equity
$160 M Equity $ 75 M
$ 75 M Nonbank Subsidiary
Investment
in Nonbank Assets Liabilities
$500 M $460 M

Equity
$40 M Equity to Assets: 3%

Equity to Assets: 8%