The family bank is a practice that provides a means for a family's wealth to be leveraged by making loans available to family members on terms not available commercially. These are loans that would be considered high risk by commercial bankers but are low risk to the family because of their contribution to the family's long-term wealth preservation plan.

Loans from a family bank are usually for two purposes: investment, to increase the family's financial capital, or enhancement, to increase the family's qualitative capital, that is, the family's long-term well-being.

Investment

In the case of loans for investment, the family's purpose is to take advantage of opportunities brought by individual family members for financial gain. The loans give the family opportunities to grow its financial wealth while also enhancing the intellectual growth of individual members. These are frequently investments in businesses founded by individual family members.

Such business loans should follow these basic rules:

1. The borrower prepares a business plan and a loan application equivalent to that required by any commercial lender.
2. The borrower discusses the project's feasibility with the family bank's board and advisors.
3. When a loan is granted, the borrower provides proper business reports on the investment.
4. The borrower ultimately repays the loan.

This process gives the family borrower excellent business training and the highest possible chance of a successful financial outcome. It also allows the family the chance to reap a financial reward from the individual family member's initiative.

Enhancement

With enhancement loans, the family's purpose is to increase its qualitative capital by increasing the independence and growth of individual family members.

As with investment loans, proper lending procedures for enhancement loans are critical to the growth of each borrower's qualitative capital. When seeking an enhancement loan, the borrower should be encouraged to state how such a loan will increase his or her independence and growth, as well as how the loan will add to the family's human, legacy, family relationship, structural, or social capital. When family members explain to their peers and advisors on the family bank board how a loan will be enhancing, they must be certain that their individual qualitative capital will really be enhanced. With enhancement loans, repayment comes in the form of the increased independence of the individual borrower and his or her increased qualitative capital.

Common varieties of enhancement loans include funds for education or for the down payment on a primary residence. Such loans may be made on an interest-free base, or on an interest-only payment plan, with the balance to be forgiven at a future date. As a result, enhancement loans may turn into grants or gifts, which requires careful consultation with competent tax advisors. That said, the goal of enhancement loans is never simply tax mitigation but rather the increase of the individual's independence and the family's qualitative capital.

It may seem like a surprising point, that a loan could increase individual independence. The surprise is natural. Entered unwisely, a loan can create terrible dependence and resentment. It is for this reason that many family members react instinctively against the notion of a family bank: “Never a lender or a borrower be!” Never, indeed—without a clear focus on the enhancement of family members' true well-being.

That is why families striving to preserve their complete family wealth quickly grasp that a family bank is not primarily about financial capital. While having a friendly lender gives an enormous competitive boost, it is the growth of qualitative capital that is the true reason for forming a family bank.

Practical Considerations

Managing a family bank is a delicate business. Here are the beginnings of some guidelines for setting one up:

• The family bank should not be a formal institution. It isn't a bank in the normal corporate sense. It is important that it be informal so that its activities remain private and so that it can evolve a system of governance that meets the unique circumstances of the family that creates it.
• While it is not a formal institution, the family bank must have formal rules for meetings. It should have officers, directors, and, if needed, advisory boards. It should have procedures for receiving and processing loan applications. That said, the rules and procedures will vary considerably, depending on who will fund the loans. For example, parents who create a family bank from their own funds will likely have much more latitude than trustees who seek to use a trust as a family bank, even one with a broad mandate for distributions.
• The family bank must have a mission statement explaining its philosophy and reason for being. The lenders and borrowers must understand the family bank's purpose—to be a high-risk, low-interest lender—and the consequences of that policy. The bank's mission statement should also contain a values section incorporating the overall family mission statement and should explain how the bank will assist in carrying out that mission.
• Because family trusts are potential lenders and borrowers, it is particularly important that trustees understand and agree to participate in the family bank. Even if you don't have a family bank right now, if you believe that your family would someday want to use the family bank concept, it would be wise to include the requisite powers and permissions for future trustees in any trusts or successor trusts you create.
• It is important to have concurrence of all family members, both lenders and borrowers, with the terms of the bank's mission statement.

It is particularly important that all family members who agree to participate in the family bank be given copies of all loan applications. Personal financial data may be withheld for confidentiality, but all members should receive the qualitative capital portions of the applications.

Conclusion

Without being named as such, the family bank concept has formed the core of the creation and growth of family fortunes from the days of the Medici and Rothschilds to the present-day creation of many “tech” fortunes. But beyond its financial power, the family bank offers a way for family members to articulate and practice the skills of communication and decision-making that lie at the heart of individual and family flourishing. If qualitative capital is a family's true wealth, the family bank is a paramount means of preserving and growing that capital for generations to come.

This article has been adapted from Complete Family Wealth, 2nd ed. (Wiley: New York, 2022).

Additional Resources

1. James E. Hughes, Jr., Family Wealth, 2nd. ed. (Wiley: New York, 2004).
2. James E. Hughes, Susan E. Massenzio, and Keith Whitaker, Cycle of the Gift (Wiley: New York, 2012).
3. James E. Hughes, Susan E. Massenzio, and Keith Whitaker, Complete Family Wealth, 2nd. ed. (Wiley: New York, 2022).

Biography

Widely considered the father of the field of family wealth, James “Jay” E. Hughes, Jr., is a retired attorney and author of Family Wealth: Keeping It in the Family and Family—The Compact Among Generations. Jay is co-author of The Cycle of the Gift, The Voice of the Rising Generation, and Family Trusts: A Guide for Beneficiaries, Trustees, Trust Protectors and Trust Creators. Jay was the founder of a law partnership in New York City. He is a member of various philanthropic boards and a member of the editorial boards of various professional journals. Jay is a graduate of the Far Brook School, which teaches through the arts, the Pingry School, Princeton University, and the Columbia School of Law.