Current Legal Issues Affecting Central Banks, Volume IV.
Chapter

11 A. Report from the Board of Governors of the Federal Reserve System: Establishing Foreign Bank Offices in the United States

Author(s):
Robert Effros
Published Date:
April 1997
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Author(s)
J. VIRGIL MATTINGLY

Introduction

There is no doubt that financial markets globally are becoming more integrated. One important aspect of that integration from the point of view of the Board of Governors of the Federal Reserve System (the Federal Reserve Board, or the Board) is the entry and expansion of non-U.S. banks in the U.S. market. This chapter briefly addresses the role of the Federal Reserve in the implementation of the Foreign Bank Supervision Enhancement Act of 1991 (FBSEA).1 FBSEA is the most recent major piece of U.S. legislation concerning the offices of foreign banks in the United States.

Growth of U.S. Activities of Foreign Banks

Over the past two decades, the presence of foreign banks in the United States and their importance to the U.S. financial system and economy have grown substantially. From year-end 1973, the first year for which the Federal Reserve collected data, through year-end 1992, the reported assets of branches and agencies of foreign banks located in the United States grew from S25 billion to more than $700 billion. By comparison, over the same period, assets at domestic offices of U.S. banks increased about threefold, to more than S3 trillion. U.S. branches and agencies of foreign banks currently account for about 18 percent of assets of all banking offices in the United States, a considerable increase from the 3 percent at year-end 1973. Moreover, recently collected data show that the assets of branches and agencies of foreign banks operating in the United States, in combination with their branches in offshore banking centers, had about 30 percent as much in total assets as all U.S. banks. With commercial and industrial loans to U.S. borrowers of more than $220 billion, these offices of foreign banks have extended about one-half as much in business loans to U.S. residents as all U.S. chartered banks. This growth, coupled with cases of fraud and other criminal activity by certain banks in the 1980s, convinced the Federal Reserve that U.S. regulators, both state and federal, needed to pay greater coordinated attention to the U.S. offices of foreign banks. In particular, the Federal Reserve came to believe that there should be prior federal review of foreign bank entry and expansion in the U.S. market and that there should also be a federal role in terminating an office of a non-U.S. bank for unsafe and unsound banking practices.

Foreign Bank Supervision Enhancement Act (FBSEA)

FBSEA, which was based on a legislative proposal submitted by the Federal Reserve Board to the committees of the U.S. Congress responsible for banking matters, became law on December 19, 1991.2 The statute was intended to close gaps in the supervision and regulation of foreign banks in the United States and to ensure that foreign and domestic banks were regulated consistently.3 FBSEA established for the first time uniform standards at the U.S. federal government level for the entry and expansion of non-U.S. banks in the U.S. market and substantially increased the role of the Federal Reserve in the ongoing regulation and supervision of their activities.

While FBSEA amended the International Banking Act of 1978, the core statute that regulates the U.S. branches, agencies, and representative offices of foreign banks, FBSEA was not intended to change the basic policy of according national treatment to foreign banks that is embodied in the International Banking Act.4 The principal requirements contained in FBSEA—enhanced supervision and increased examinations by a federal regulator, and a demonstration that the non-U.S. bank is subject to comprehensive supervision on a consolidated basis—are equivalent to the requirements imposed on U.S. banks.5

Implementing FBSEA

Through FBSEA, the U.S. Congress substantially increased the responsibilities of the Federal Reserve by expanding the scope of its regulatory and supervisory duties with respect to non-U.S. banks. Since its enactment, the Federal Reserve has devoted substantial effort and resources to ensure that FBSEA’s mandate of enhanced supervision of non-U.S. banks is fulfilled as expeditiously, yet as carefully and thoroughly, as possible. Similar to any statute constructing a new regulatory and supervisory framework, FBSEA has presented many challenging issues of implementation. For example, in order to assure compliance with a provision of FBSEA requiring annual examinations of foreign branches and agencies,6 the Federal Reserve was required to hire and train large numbers of new examiners in a very short space of time. Moreover, both the Federal Reserve Board and the Federal Reserve Banks have been required to increase their legal staffs significantly. While implementation has come a long way since the date of enactment of FBSEA, this process is a continuing one. The Federal Reserve expects that, over time and with the benefit of experience, it will be able to perform its duties under FBSEA more efficiently and more effectively.

Since the enactment of FBSEA, the Federal Reserve Board has taken the following actions, among Others, to implement its provisions.

Rule Making

In January 1993, the Board issued a final rule implementing the provisions of FBSEA that require prior approval of the Board for the establishment of branches, agencies, commercial lending companies, and representative offices by non-U.S. banks.7 The final rule, which superseded interim rules that the Board had adopted in April 1992,8 contains provisions concerning examinations and lending limits.9 The section of the Board’s final rule implementing the comprehensive consolidated supervision standard of FBSEA sets forth a number of illustrative factors that the Federal Reserve will consider in evaluating whether the standard is met in a particular case.10 These factors were included in the rule in recognition of the fact that different supervisory systems deal with particular supervision issues in different ways. For example, not all systems rely on on-site examinations to the same extent as that of the United States, and financial accounting practices may differ from one jurisdiction to another. As part of the final rule, the Board requested additional public comment on those portions of the final rule that deal with representative offices of foreign banks.11 Comments were sought on the definition of a representative office and on the standards that should govern the activities of a representative office. Following review of the public comments, the Board took further action with respect to representative offices in January 1996.12

Capital Equivalency Study

In June 1992, the Board and the Secretary of the Treasury issued under FBSEA a Capital Equivalency Study,13 which examined the capital standards under which non-U.S. banks operate and also established guidelines to be used in evaluating the capital of non-U.S. banks applying to conduct business in the United States. In broad terms, the study concluded that the minimum capital standards established by the Basle Capita] Accord14 provide a common basis for evaluating the general equivalency of capital among banks from various countries.

Subsidiary Study

In December 1992, the Board and the Secretary of the Treasury issued a Subsidiary Requirement Study,15 which examined the issue of whether, under FBSEA, non-U.S. banks should be required to operate in the United States only through subsidiary banks and not through branches and agencies. The study concluded that non-U.S. banks should not be limited to operating in the United States only through subsidiaries.

Powers of State-Licensed Branches and Agencies

In January 1993, the Board issued for public comment proposed regulations implementing a provision of FBSEA to limit the powers of state-licensed branches and agencies of foreign banks to those powers held by federally licensed branches.16 The Federal Deposit Insurance Corporation (FDIC), which, together with the Board and state banking authorities, supervises state branches and agencies, issued its companion proposed regulation in late March 1993.17 Following review of the public comments and in consultation with the FDIC, the Board issued a final rule with respect to powers of state branches of non-U.S. banks in November 1994.18

Application Procedures

In March 1993, the Board announced new procedures designed to streamline the review of FBSEA applications.19 Most notably, the new procedures establish simultaneous review of applications by staff of the Federal Reserve Bank and the Board and impose deadlines for the preacceptance phase of review.20

Comprehensive Supervision and Regulation on a Consolidated Basis

FBSEA permits the Board to terminate the activities of a non-U.S, bank’s branch, agency, or commercial lending company if the non-U.S. bank is not subject to comprehensive supervision or regulation on a consolidated basis by its home country supervisor.21 In making its decision to terminate, the Board may consider the bank’s relative size and length of operation in its home country, and the effect of termination on the commerce and trade of the community in which the bank’s office is located.22 However, the size of a non-U.S. bank may not be the sole determinative factor in the decision to terminate its offices in the United States.23 Thus, the offices of a non-U.S, bank from a smaller country, particularly a bank that is from a developing country and that is relatively small in terms of assets, will not be at risk solely because of its small size. FBSEA requires the Board, in consultation with the Secretary of the Treasury, to develop and publish criteria to be used in evaluating the operation of any non-U.S. bank in the United States that the Board has determined is not subject to comprehensive supervision or regulation on a consolidated basis,24 The Board developed proposed criteria in consultation with the Department of the Treasury and the Office of the Comptroller of the Currency (OCC).25 The Board is expected to issue a final rule in early 1996. Until such time as the guidelines are issued, it is the policy of the Federal Reserve to take appropriate action against a non-U.S. bank when the most recent examination of the bank’s U.S. office has identified material deficiencies that may be related to home country supervision. Such action could include placing limitations on the foreign bank’s U.S. operations, consulting with the home country supervisor, and, in extreme cases, initiating action to terminate the foreign bank’s U.S. operations. While publication of the criteria required by FBSEA will make the process of evaluating existing foreign bank operations in the United States more transparent, the Board does not anticipate that the criteria will represent a substantial change in this policy.

FBSEA Applications

As of May 1994, the Federal Reserve has accepted 37 applications by foreign banks to establish branches, agencies, and representative offices. The Board has approved 14 of these applications from banks chartered in Chile, France, Hong Kong, South Korea, Spain, Switzerland, Taiwan Province of China, and the United Kingdom. Eight applications have been withdrawn by the applicants.

Before the Board staff takes an FBSEA application to the Board for approval, it must be confident that the record will support the findings that the Board is required to make under the statute. Two crucial findings are that the applicant bank and any parent foreign bank are each subject to comprehensive consolidated supervision by a home country regulator and that the applicant bank and any parent have provided adequate assurances that the Board will have access to the information that it deems necessary to determine safety, soundness, and compliance with U.S. law.26 In order for the Board to make these findings, Federal Reserve staff must obtain information on the home country supervision of the applicant and the confidentiality restrictions in the major jurisdictions in which the applicant and its affiliates operate. This information is obtained directly from the applicant, from correspondence and consultation with the home country regulator, and from the Board’s own internal information sources.

The Board makes its comprehensive consolidated supervision determinations on a bank-by-bank basis rather than a country-by-country basis. Nonetheless, once a determination of consolidated comprehensive supervision has been made for a bank from one country, a subsequent applicant from the same country will be required only to indicate the extent to which it is supervised in the same manner as the approved applicant and to discuss any material differences in supervision. For example, such differences arc ones that could have arisen because of the passage of time or because the applicant is a different category of banking institution from the previously approved non-U.S. bank. In 11 of the foreign bank office applications approved by the Board, the Board has made findings regarding the existence of comprehensive consolidated supervision. These approved applications are from banks in Chile, Hong Kong, South Korea, Spain, Switzerland, Taiwan Province of China, and the United Kingdom.

In regard to access to information, the Board requests from applicants information on the impediments to disclosure of information in any jurisdiction in which the bank applicant or its affiliates conduct material operations. In addition, the Board requests from the applicant and its ultimate parent a commitment that each of them will provide information to the Board, to the extent permitted by applicable law, and, if impediments to disclosure of information arise, that each will cooperate with the Board to obtain any relevant waivers or consents that would permit such disclosure. Finally, the Board has conditioned each of its approvals so that the failure by the applicant or its parent to provide necessary information would justify termination by the Board of any of the applicant’s U.S. activities or, in the case of a federally licensed branch or agency, a recommendation of termination to the OCC.

Other key standards that the Board examines in FBSEA applications include the compliance of the applicant with U.S. law and the integrity and competence of management.27 A necessary source of information on these standards is the name checks requested by the Board from other government agencies on the applicant foreign bank, certain shareholders, and key personnel. These checks generally are conducted with the Central Intelligence Agency, the Department of State, the Federal Bureau of Investigation, the Drug Enforcement Agency, the Immigration and Naturalization Service, the Customs Service, the Securities and Exchange Commission, the Federal Reserve Board’s Enforcement Unit, and, as appropriate, the Department of the Treasury and Interpol.

Obtaining and analyzing the requisite information for FBSEA applications has proved more time-consuming than the Board and staff originally expected. In particular, the name checks have caused and continue to cause delay in the processing of FBSEA applications. However, in the wake of the Bank of Credit and Commerce International and Banco Nazionale del Lavoro scandals,28 the Board believes that it is prudent to conduct these checks, and it anticipates that they will continue to delay processing of the applications.

The Board has taken a number of steps designed to expedite the completion of name checks and believes that the time frames for their completion may improve in the future. Other agencies have been cooperative in these efforts.

Supervision and Examinations

Beginning in 1992, the Federal Reserve instituted a monitoring program to ensure that all state- and federally licensed branches and agencies were examined annually, as required by FBSEA.29 In the case of state-licensed foreign bank operations, each Federal Reserve bank annually coordinates with the state licensing authority to ensure that the operation is examined as required. Examinations may be conducted solely by a state banking authority or the Federal Reserve, or they may be conducted jointly by both agencies. The Federal Reserve is working with other regulators, including the Conference of State Bank Supervisors, to develop a comprehensive supervision manual for U.S. branches and agencies of foreign banks. This manual will provide common policy and procedural guidance in the examination and overall supervision of these offices. In conjunction with this project, the examination report of U.S. branches and agencies is being revised to focus more clearly on areas of supervisory concern. When complete, the revised report will be presented for the approval of other U.S. bank regulators.

Additionally, the Federal Reserve is developing a supervisory program for state-licensed representative offices of foreign banks. This program includes a onetime registration of all these offices, the development of examination procedures, which are currently being field-tested, and the implementation of any off-site monitoring procedures.

Conclusion

Non-U.S. banks currently play an important part in the U.S. financial system. Through FBSEA, the U.S. Congress has granted the Federal Reserve an important role in the oversight of the entry and activities of non-U.S. banks. The Federal Reserve takes this responsibility very seriously because, as financial markets become more integrated, foreign banks will have an increasing influence on the economy.

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