Samson’s Toupeé: Banking Law’s Source-of-Strength Doctrine

The source-of-strength doctrine is a long-standing pillar of bank regulation. It holds that a bank holding company (BHC) is to serve as “a source of financial and managerial strength” for its bank subsidiaries. The doctrine, however, has always been more aspirational than actual. The doctrine has never clearly imposed any liability on BHCs. Thus, it produced no ascertainable recovery for the FDIC against the BHCs of the largest banks to fail in the 2008 financial crisis.  

Despite the doctrine’s post-crisis codification, the situation has not changed because of the failure of the Federal Reserve Board to promulgate implementing regulations. Under current law, absent contractual agreement, when a bank fails, the BHC has no liability for the bank’s obligations. The source-of-strength doctrine is as real a source of strength as Samson’s toupée. 

This Article renews calls made in the wake of the S&L crisis to require BHCs to be formal guarantors of the liabilities of their bank subsidiaries. This targeted curtailment of limited liability subordinates the BHC’s creditors and shareholders to the bank’s creditors. Doing so creates a market mechanism for sorting among positive and negative aspects of bank affiliations with nonbanks through BHCs. A BHC guaranty of the bank would mean that negative, risk-generating affiliations would result in higher capital costs for the BHC, disincentivizing those affiliations. An actualized source-of-strength doctrine would not only facilitate market discipline on risk-taking by banks but would also help protect the FDIC’s deposit insurance fund by forcing losses incurred in bank resolution to be borne by BHC creditors and shareholders. And, perhaps most importantly, BHC guaranties of their subsidiary bank obligations would create a market backstop for and check on fallible regulators.