Related Organizations

Types of Risk Posed by Related Organizations

It is difficult to generalize about the types of risks posed to a bank’s safety and soundness by its related organizations. The amount of risk posed to the bank by any specific risk in a related organization depends on the nature of the organization’s activities and its relationship to the bank. Routine business activities between a bank and its related organizations could subject the bank to any or all of the nine types of risk identified below. An operating subsidiary through which a bank conducts a significant line of business, such as a mortgage subsidiary, will pose much different risks from those of the local retail store that is owned by a community bank’s controlling owner and transacts no business with the bank.

Reputation risk is common to almost all related organizations. When a bank’s name is closely associated with another entity (even if the two do not transact business together), the bank may suffer loss of business or other harm if the related organization experiences financial difficulties or receives adverse publicity.

Strategic risk exists when a bank uses related entities to offer products and services to its customers without implementing appropriate oversight controls, or when those products and services are not compatible with the bank’s strategic goals or customers’ expectations.

Credit risk is posed to the bank when related organizations borrow from the bank, although this risk is limited by the quantitative and qualitative restrictions of sections 23A and 23B. However, credit risk can also arise when an affiliated third party fails to meet the terms of any contract with the bank or otherwise to perform as agreed.

Transaction risk is a function of internal controls, information systems, and operating processes. It is most evident in the case of an affiliated third party that is responsible for the bank’s information and transaction processing or that provides products or services to the bank’s customers.

The numerous laws and regulations that bar or limit extensions of credit to and other transactions with affiliates raise the possibility of substantial compliance risk.

Depending on the circumstances, relationships with affiliated entities may also subject the bank to liquidity, interest rate, price, and foreign currency translation risk.

Previous: Identification of Related Organizations Next: Assessing the Different Types of Related Organizations