Loan-funded Loans: Equity-like Liabilities inside Bank Holding Companies

Leveraging regulatory data on fund flows within bank holding companies (BHCs), we characterize internal loans as a critical funding source for commercial banks. Although recorded as bank liabilities, parent-to-bank internal loans function as contingent support that resembles capital. We show that internal-loan funded banks do not hoard liquidity; instead, they originate larger and longer-maturity loans at lower spreads, initiate more relationships with marginal borrowers, and retain larger shares in syndicated deals. Internal-loan-funded lending is followed by higher short-run profits but higher future nonperforming loan ratios. We further show that organizational structure shapes internal lending: in BHCs with both bank and nonbank operations, nonbank affiliates crowd out internal lending to banks and discipline banks’ use of internal funds, and these BHCs exhibit higher overall performance. To identify our tests, we exploit the passage of the Gramm–Leach–Bliley Act and the announcement of the Basel III Accord, using instrumental variables and discontinuity-design approaches. Our findings highlight an equity-like internal debt channel that shapes monetary policy transmission, risk-taking, and the role of organizational structure in banking.