Double Leverage

What Is Double Leverage?

Double leverage happens when a bank holding company conducts a debt offering to procure a large equity stake in a subsidiary bank. In a perfect world, dividends earned on the subsidiary company's stock finance the holding company's interest payments. While the strategy is appealing for some bank holding companies, regulators alert that the practice could intensify financial risk and sabotage stability.

Double Leverage Explained

A bank holding company is a corporation that claims a controlling interest in at least one banks yet doesn't itself offer banking services. Holding companies don't run the everyday operations of the banks they own. Nonetheless, they exercise control over management and company policies. They can hire and fire managers, set and assess strategies, and monitor the performance of auxiliaries' businesses.

With double leverage, the holding company infuses capital into a subsidiary bank, which can additionally increase its own borrowings, and in this manner intensifies the original parent's debt. Note that the parent's independent capital doesn't change, through double utilizing the parent in any case turns out to be all the more vigorously presented to the subsidiary.

Since banks have severe capital requirements on the amount of debt they can hold, compared to different types of companies, double leverage can be an indirect workaround to give the bank access to debt-based capital. A few scholastics recommend that the way that banks will utilize double leverage might propose that regulators ought to permit banks to utilize more debt-based financing.

Recent Example of Double Leverage

In April 2018, Reuters reported that certain Business Development Companies (BDCs) had received board endorsement to increase the amount of debt they had the option to borrow. This followed the death of U.S. legislation in March 2018 that permitted them to double leverage on their funds.

A BDC is an organization that puts resources into and assists little and medium-size companies with filling in the beginning phases of development, comparative in certain respects to private equity or venture capital firms. Numerous BDCs are distinct in that they are set up like closed-end investment funds. BDCs are regularly public companies, interestingly, with numerous private equity firms. BDC shares trade on major stock exchanges, like the American Stock Exchange (AMEX), Nasdaq, and others.

Specific BDCs that received endorsement for increased debt levels included Apollo Investment Corp (AINV), FS Investment Corp (FSIC), PennantPark Floating Rate Capital Ltd (PFLT), and Gladstone Capital Corp (GLAD).

Worries Over Double Leverage

A few financial specialists have raised worries about the issue of double leverage for two reasons: first, such intra-firm financing might take into consideration arbitrage of capital; and second, it expects further risk. A 2018 study by Silvia Bressan shows that bank holding companies are more inclined to risk when they increase their double leverage. This specifically happens when the stake of the parent inside auxiliaries is larger than the parent company's capital all by itself.

Bressan recommends that policymakers ought to be more efficient in their regulation of complex financial substances to advance stability. At the point when any entity takes on such a large volume of debt, the ability to repay turns out to be increasingly difficult even on the off chance that the borrower has a strong cash flow history and different revenue streams.

Features

• Financial specialists have much of the time raised worries about the issue of double leverage due to this type of intra‐firm financing.
• Evaluations of a bank's capital adequacy are perplexed by the occurrence of double leverage since it darkens real risk exposure.
• Bank holding companies utilize double leverage when debt is issued by the parent company, and the proceeds are then invested in auxiliaries as equity.