There seems no end to ways (appropriate or inappropriate) in which banks try to earn more money. Presently, it has come to light that Bank of America Corporation (BAC), through its U.S. banking subsidiary, Bank of America, National Association (“BANA”), had financed contentious trades that helped hedge funds and other clients avoid taxes. The news was first revealed in a Wall Street Journal report.
BofA utilized funds from BANA, which holds federally insured deposits, to finance transactions that involved risky hedging strategies for its European investment-banking arm. Firstly, to use the U.S.-based entity’s funds for financing foreign unit deals is an inappropriate action. And secondly, it was wrong on BofA’s part to use deposits that are federally insured to finance risky investment-banking trades.
The funds from BANA were used for financing a variety of strategies including the dividend-arbitrage strategy. Under this strategy, the company helped hedge funds and other investors avoid or lessen the withholding taxes they pay on stock dividends.
Now the question arises that why did BofA use BANA funds? BANA enjoyed lower cost of funding as it was conservatively regulated to protect depositors. This gave BofA an edge over its competitors, attracting more hedge-fund clients. Further, this funding allowed executives to extend more loans to hedge funds, which in turn, drove more income for BofA.
Notably, as per a BofA spokesman, this practice has since ended. Also, such practices did not lead to losses for the company’s retail banking unit or other affiliates.
Though use of legal methods to lower one’s tax bill is a practice followed by most taxpayers, means which BofA executives used to help clients were incorrect. These activities have drawn disapproval from the federal regulators regarding reputational risks and the need to protect the U.S. deposit-holding subsidiary from risky activities.
We believe that this time, having learnt its lesson the hard way, BofA will not resort to any further wrongdoings in the future, which might jeopardize its financial stability. In 2013, JPMorgan Chase & Co. (JPM) had suffered a huge trading loss owing to such risky derivative transactions, which had put question marks on the company’s ability to handle such trades.
Currently, BofA carries a Zacks rank #4 (Sell). Better-ranked banks include Northern Trust Corporation (NTRS) and SVB Financial Group (SIVB), with a Zacks Rank #2 (Buy).
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