Current Legal Issues Affecting Central Banks, Volume III.


Robert Effros
Published Date:
August 1995
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The traditional U.S. policy is one of national treatment, and the Board of Governors of the Federal Reserve System has said that it strongly supports a policy of national treatment. The Federal Reserve believes that this policy has served the United States very well: the benefits of national treatment outweigh any disadvantage that might accrue to U.S. firms that are trying to enter foreign markets, and the advantages to the U.S. economy as a whole are very great. It has provided the United States with a financial market that is very deep, liquid, flexible, competitive, and innovative. This gives the users of financial services in this market great choice. That is why the Federal Reserve has strongly supported a continuation of the traditional U.S. policy, national treatment.

In connection with the various pieces of legislation that have come forward, the forces arguing against national treatment sometimes do seem to be gathering momentum.1 There is a movement toward a standard of reciprocity. Fair trade, rather than free trade, is emphasized. Naturally, regulators support greater access on a fair basis for U.S. institutions abroad. However, the real benefits that have accrued to the U.S. economy from the policy of national treatment should not be ignored. The Uruguay Round of trade negotiations was very innovative.2 This was the first time that any multilateral binding agreements among nations attempted to cover services and, in particular, financial services.3 The North American Free Trade Agreement has a chapter dealing with financial services that uses the national treatment standard and provides for reasonable measures taken for prudential reasons.4 As regulators, the Federal Reserve, together with the other U.S. banking regulators, has argued strongly that, in any kind of multilateral setting, there must be adequate scope for a regulator to take actions necessary for prudential reasons. For that reason, regulators sometimes view these multilateral agreements with suspicion. Nevertheless, the U.S. regulators assisted the negotiators in the GAIT to ensure that U.S. concerns were addressed and that any binding accord would allow latitude for regulators to take prudential action.5

One of the cornerstones of such a multilateral agreement is an agreement among countries to provide national treatment.6 Although that obligation is contained in the agreement, little effective progress has been made to remove the existing barriers. This is what is holding up any progress in financial services. Although the obligation is there, countries retain the ability, on an unrestricted basis, to protect their current laws. There has not been sufficient movement toward removing the barriers.

There is one other factor that has to be taken into account when considering the U.S. policy of national treatment. That is the experience of U.S. banking in the last decade. Beginning in the early 1980s, there was a movement toward deregulation of financial institutions. In the United States, the thrift industry, which had long been a protected industry and focused on a very narrow segment of the market, was suddenly given broad new powers. Many restrictions on their operations were lifted. As a result, thrifts got into many areas that they were not prepared to cope with properly. New and different practitioners got a hold of these institutions and instituted dubious practices, cutting corners that led to difficult times for the thrifts. Massive S&L failures resulted, and the consequential losses to the insurance fund caused a direct hit to the taxpayer. Although the situation in banking was not as dire, banking suffered as well. With the overheated economy of the 1980s, there was a tremendous amount of overlending, including lending to sectors such as commercial real estate. This led to many bank failures, threatening the Bank Insurance Fund. It was a tremendous shock to learn that there might not have been enough money in the Federal Deposit Insurance Fund to cover all depositors.

This, in turn, led the American public and the U.S. Congress to be suspicious of both the banking industry and those who regulate the banking industry. Consequently, the Federal Deposit Insurance Corporation Improvement Act was adopted.7 This imposed much tougher standards on U.S. banks generally. FDICIA imposed on U.S. banks new reporting requirements, additional restrictions on their activities, and annual on-site examinations. Whereas before, the regulator had discretion as to when to inspect an institution, now banks must be examined on-site every year. In addition, there is now a standard whereby regulators can go into the institution on an earlier basis and intervene—in effect, take over the institution—before the institution is technically insolvent. Higher capital standards are imposed on U.S. institutions as well. The Congress has mandated other statutory requirements designed to reduce risk, whereas before the regulators seemed most interested in reducing the risks to which depository institutions were exposed. However, the Congress took that upon itself and, for example, introduced in the legislation restrictions on the amount of interbank exposure that one institution could have to another. So much attention had been paid to the safe and sound operation of U.S. banks that naturally some of that attention spilled over to foreign banks.

The Capital Equivalency Report and the study on whether to require foreign banks to operate in the United States through subsidiaries are important studies.8 In the past, when questioned by the Congress as to what the Federal Reserve thought was the appropriate approach to foreign banks, the Federal Reserve took the view that it was in a position to evaluate the capital of foreign banks, that it believed that the capital requirement should be equivalent, and that foreign banks should be held to the same general standards of strength and financial soundness required of U.S. organizations seeking to do the same activity. With respect to requiring foreign banks to assume the form of a subsidiary, the Federal Reserve strongly opposed that requirement when it was put forth by the Treasury, believing that it is more efficient and better for foreign banks to participate in the U.S. market through branches, thereby relying on their worldwide capital.

The other experience pushing Congress to deal with foreign banks is the series of financial scandals that occurred in the United States over the past few years. First and foremost of these was the collapse of BCCI. Not only were its operators found guilty of money laundering, the entire culture of the organization was believed to be criminal. For a long time, the operators had successfully hidden their control of U.S. banking institutions from U.S. regulators. Prior to that, there was the experience with Banco Nazionale de Lavoro, which ran a set of fraudulent books from one of its U.S. offices. Not only was this in violation of good banking practice but questions have been raised as to whether something more sinister was going on at that institution. The other scandal, which did not get as much publicity, involved a foreign bank, the National Mortgage Bank of Greece, which was soliciting and accepting deposits through representative offices.9 In effect, the bank had set up a branch network around the United States and was raising deposits in the United States in violation of U.S. law.

As a result, because Congress was considering general banking legislation in 1991, the Foreign Bank Supervision Enhancement Act of 1991 (FBSEA), which is Title II of the Federal Deposit Insurance Corporation Improvement Act of 1991, was enacted.10 It sought to respond, in particular, to the BCCI situation. One of the things that the federal regulators did not like about BCCI was that it operated in the United States through a series of offices that were licensed by the various state authorities alone. Prior to FBSEA, a foreign bank could come into the United States without any type of federal review. FBSEA established uniform standards to be applied to every foreign bank that enters the United States, and all foreign banks must now receive the approval of the Federal Reserve before they can establish their offices. Of the standards that are now applied to foreign banks, the most important is consolidated supervision. The key element in the BCCI situation is that regulators did not look at its operations on a consolidated basis. The bank segregated its operations into various jurisdictions and was able to avoid having anyone regulate all of its operations. As a result, FBSEA requires that any foreign bank that wants to enter the United States must be subject to comprehensive supervision or regulation on a consolidated basis by home country authorities. The Federal Reserve issued regulations to give content to that requirement.11 Basically, the Federal Reserve looks at whether the home authorities can obtain enough information on the bank and its relationships with its affiliates to be able to determine whether that bank is in compliance with law and in sound financial condition.

The new law does not seek to impose the U.S. method of regulation on foreign entities. Nevertheless, as a precondition to the approval of entry, the Federal Reserve looks at the extent to which the home country authorities examine the institution, including all of its foreign branches and subsidiaries. Information can be obtained through reporting, outside auditing, or on-site examination. It is intended to be a flexible standard.

The other standards that FBSEA adopted require assessments of the financial condition of the foreign bank and its history of compliance with U.S. law and regulations. These considerations are to be applied uniformly. This uniformity can be facilitated insofar as all entrants now must come to a single regulator, the Federal Reserve, for permission to establish a U.S. office. FBSEA preserves the traditional U.S. policy of national treatment. All of the standards relate to prudential considerations bearing on whether the foreign bank is a fit participant for operations in the United States.


Will national treatment or reciprocity ultimately prevail as the nation’s policy concerning the entry of foreign banks? Certainly, there is a movement toward fair trade that would depart from this unconditional national treatment. A Fair Trade in Financial Services Act has been proposed repeatedly.12 However, the Federal Reserve has stated that national treatment is a policy that has benefited the United States. Furthermore, it supports continuation of that policy.

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