- Robert Effros
- Published Date:
- April 1997
Current Legal Issues Affecting Central Banks
Edited by Robert C. Effros
International Monetary Fund
© 1997 International Monetary Fund
Design and production: IMF Graphics Section
Cataloging-in Publication Data
Current legal issues affecting central banks / edited by Robert C. Effros
Papers from seminars sponsored by the Legal Department of the IMF and IMF Institute.
Includes bibliographical references.
1. Banks and banking. Central—Law and legislation—Congresses. 2. Banking Law—Congresses. I. Effros, Robert C. II. International Monetary Fund. Legal Dept. III. IMF Institute.
K1070.A55 1992 346’.08211—dc20
ISBN 1-55775-142-0 (v.1 1988)
ISBN 1-55775-306-7 (v.2 1990)
ISBN 1-55775-498-5 (v.3 1992)
ISBN 1-55775-503-5 (v.4 1994) 92-16996
Address orders to:
External Relations Department, Publication Services
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DEVELOPMENTS AT INTERNATIONAL FINANCIAL INSTITUTIONS
Jennifer A. Sullivan
William M. Berenson
Russell L. Munk
REGIONAL DEVELOPMENTS AFFECTING CENTRAL BANKS
Cynthia C. Lichtenstein
Rosa Maria Lastra
Sydney J. Key
Kathleen M. O’Day
Marilyn L. Muench
Keith A. Palzer
Ernesto V. Feldman
COUNTRY-SPECIFIC DEVELOPMENTS AFFECTING CENTRAL BANKS
J. Virgil Mattingly, Jr.
Thomas A. Rose, Christine M. Bradley, and Linda L. Stamp
Carolyn J Buck
John S. Baerst
Fé Morales Marks
Melanie L. Fein
Deborah K. Burand
Tobias M.C. Asser
Natalie G. Lichtenstein
TOPICS OF SPECIAL INTEREST AFFECTING CENTRAL BANKS
Thomas C. Baxter, Jr. and Jet Joseph de Saram
James R. Barth and R. Dan Brumbaugh, Jr.
V. Gerard Comizio
Mark J. Welshimer
Sandra M. Rocks
H. Rodgin Cohen
Andrew T. Hook
Simon M. Lome
Charles W. Mooney, Jr.
James V. Houpt
He that will not apply new remedies must expect new evils; for time is the greatest innovator.
In recent years, traditional central banks, with decades or even centuries of experience behind them, have been confronted with entirely new worlds. Some of these worlds are the results of innovations that have grown out of the new technology of the computer. Examples of such innovations that are discussed in this volume include derivatives and products of securitization. Derivatives, lacking intrinsic value of their own, derive value from some external source, for example, a moving index of securities. Securitizations, in hypermodern forms, can give rise to such exotics as stripping interest payments over the life of a security from principal payments and issuing two or more series of securities, perhaps with different maturities, the value of which together may represent the original security from which they were drawn. Other worlds are the results of intraregional consolidation, such as recent developments in the European Community and the creation of the North American Free Trade Agreement (NAFTA).
While certain chapters in this volume focus on some of these new worlds of finance, others hark back to some of the traditional considerations associated with central banks. Can the traditional central bank deal with the explosion of worlds before it? In this introduction, attention is first directed to some basic aspects of the central bank.
The classic literature concerning a central bank deals primarily with its functions, responsibilities, powers, instruments, and effects. Little has been written concerning its intrinsic nature, its position in the general social fabric, and, in particular, its place in the legal framework.
In what follows, the central bank will be viewed as an administrative agency. Its powers will be compared to those of the several branches of government. Finally, its autonomy and ultimately its accountability to these branches and the public will be reviewed. While the institutions examined remain distinct, in the main features of their jurisprudence a convergent evolution seems to be emerging.
The Central Bank: An Administrative Agency
From the aspect of legal analysis, a central bank is an administrative agency. Moreover, it is often a relatively independent administrative agency that is set up in corporate form with collegial decision making occurring through the deliberations of a board of directors. It may be distinguished from a pyramidal government department or an administrative agency with a single administrator responsible for all regulatory policy (even though some rudimentary or anachronistic central banks may take this form). This is because the complex nature of a central bank’s policy-making is believed to benefit by discussion, interaction, and compromise among several persons with different points of view.
If a central bank is an administrative agency, how does it fit within the legal framework of a country?
The Three Branches of Government
In traditional legal analysis, government may be divided into three branches. The French philosopher Montesquieu discerned in government (i) a legislative power, (ii) an executive power, and (iii) a judicial power. He counseled that the three powers should be kept separate from one another in the interest of avoiding tyranny and promoting good government.1 This analysis was incorporated into a number of constituent frameworks, including the Constitution of the United States (where Article I is devoted to the legislature, Article II to the executive authority, and Article III to the judiciary). Initially, some observers argued for a hermetic separation of the three branches of government. If this had been generally accepted, a central bank, like every other administrative agency, would have to be considered a mere appendage of one of the three branches of the government. However, James Madison put forward a broader vision in the Federalist Papers that sought to explain the idea upon which the U.S. Constitution had been based. Madison believed that from the counsels
by which Montesquieu was guided, it may clearly be inferred that in saying “There can be no liberty where the legislative and executive powers are united in the same person, or body of magistrates,” or, “if the power of judging be not separated from the legislative and executive powers,” he did not mean that these departments ought to have no partial agency in, or no control over, the acts of each other.2
In Madison’s view, cases could arise in which a blend of powers among the three branches could be appropriate (since danger arose in his opinion only “where the whole power of one department is exercised by the same hands which possess the whole power of another department”).3 As the doctrine of separation of powers evolved in the United States, Madison’s view gained ascendancy, and it was eventually accepted that it was “left to each [authority] power to exercise, in some respects, functions in their nature executive, legislative and judicial.”4
Administrative Agencies: A Fourth Branch?
If some combination or blend of powers among the three branches of government could be contemplated, was this blend permitted only to each of the three recognized branches of government, or could such a combination be institutionalized in an independent agency outside the parameters of these branches? In the case of a central bank (or, more generally, an administrative agency), would the institution to be created once again be within the bounds of one of the three powers of government (even though possessed of a blend of powers from all three branches) or could it be truly outside them all—a sort of fourth branch or power of government? Whatever the conclusion, the result would require delegation of authority from at least one of the branches that had been entrusted with it at the outset. In the ordinary case, this branch would be expected to be the legislature, which, by enacting a statute or granting a charter, would initially establish the new institution. The English philosopher John Locke argued with force, however, that legislative authority could not validly be delegated. The basis of his argument rests on the familiar legal ground that power entrusted to an agent because of the latter’s special fitness for the task to be performed cannot be transferred by that agent if it would contradict the purposes of the initial transfer:
The Legislative cannot transfer the Power of Making Laws to any other hands. For it being but a delegated Power from the People, they, who have it, cannot pass it over to others. . . . And when the people have said, We will submit to rules, and be govern’d by Laws made by such Men, and in such Forms, no Body else can say other Men shall make Laws for them; nor can the people be bound by any Laws but such as are Enacted by those, whom they have Chosen, and Authorised to make Laws for them. The power of the Legislative being derived from the People by a positive voluntary Grant and Institution, can be no other, than what the positive Grant conveyed, which being only to make Laws, and not to make Legislators, the Legislative can have no power to transfer their Authority of making laws, and place it in other hands.5
Nevertheless, despite the deceptive simplicity of this argument, it soon became obvious that the complexities of modern society and its economy cannot occupy every moment of the legislature (or for that matter, of the executive or judiciary, concerning which the same logic can be applied):
In the modern State the bulk of legislation is so great that Parliament has not sufficient resources of time or personnel to concern itself with all matters of detail.6
In most countries, sooner or later, it is recognized that delegation of authority to specialized administrative agencies is necessary.
The advantages of administrative agencies are by now well-known. Administrative agencies can be created to concentrate technical knowledge and acquire specialized experience in the field to be regulated. They can, moreover, be staffed by objective and nonpolitical experts rather than by politicians. In addition, various kinds of administrative agencies can be created to deal with particular tasks and to perform special roles within society. Different blends of the three powers can then be made according to the task or role to be addressed. Thus, in theory, an administrative agency can be created (i) with executive powers only, (ii) with a mix of executive and judicial powers or executive and legislative powers, or even (iii) with executive, legislative, and judicial powers.7 In practice, in accordance with their constituent charters or statutes, central banks may comprise a blend of elements of (ii) or even (iii).
A Central Bank’s Authority
In the context of an administrative agency, generally, and of a central bank, in particular, executive authority may include powers to interpret and enforce legislation, make inspections, and prosecute violations. In this context, legislative authority may include powers to prescribe rules that have the force of law and to establish licensing criteria. Finally, the judicial authority may extend to conducting hearings, following specialized adjudicative procedures, construing legislation, finding facts, making conclusions of law, arriving at binding determinations concerning one or more parties, and imposing sanctions.8 (However, these functions are only characteristic of, or associated with, the particular authority, and, in any event, they are not necessarily mutually exclusive among the authorities. Thus, a legislature may conduct hearings as well as the judiciary, and the executive authority may, like the judiciary, need to interpret statutes in individual cases. However, the essence of the work of the legislature is not likely to be the conduct of hearings and the essence of the work of the executive is not likely to be its expertise of interpretation.)
All these powers are useful to a central bank, and some of them are indispensable to its functioning. By way of example, the Federal Reserve is empowered to make inspections of member banks9 and bank holding companies and their subsidiaries10 and thus can exercise executive authority. It may prescribe regulations11 that have the force of law on subjects within its jurisdiction and in this way exercise legislative authority. Finally, the Federal Reserve may hold hearings consonant with prescribed, specialized adjudicative procedures,12 make binding determinations of facts and law concerning banks and bank holding companies, issue cease and desist orders,13 remove officers14 and assess civil money penalties15 against banks and other parties, and accordingly exercise judicial authority. However, since the range of responsibilities of central banks may vary from country to country, some central banks may require a fuller or lesser array of powers than others. Thus, some central banks (such as the Federal Reserve) are charged with responsibility for bank supervision, while other central banks may be exempt from this responsibility (the legislators having charged another agency with such authority). In Canada, for example, the Office of the Superintendent of Financial Institutions, which is part of the Department of Finance (reporting to the Minister of Finance), is the bank supervisory authority. In France, while the Bank of France exercises indirect authority over bank supervision, the Banking Commission, the Banking Regulations Committee, and the Credit Institutions Committee all play roles in this area. In Japan, bank supervision is the legal responsibility of the Ministry of Finance, although the Bank of Japan is also involved de facto. In Germany, the primary bank supervisory authority is the Federal Banking Supervisory Office, but it exercises its authority in close coordination with the Deutsche Bundesbank.
To the extent that the responsibility of a central bank is increased, the scope of its powers may need to be augmented. However, to the extent that the responsibility of the central bank is circumscribed, the amplitude of its powers may be reduced. It follows that, if a central bank is not expected to make regulations binding on the banking community but must defer to the Ministry of Finance in this regard, the central bank may not need legislative authority. Similarly, a central bank can dispense with some degree of executive authority if, under its enabling act, it lacks authority to prosecute violations of the law and is expected in such cases only to recommend prosecution to the attorney general.
To sum up, a central bank may be characterized as an administrative agency separate from the traditional three branches of government but possessing a blend of powers from each branch that is appropriate to the tasks appointed for it by the enabling legislation that creates the bank.
Central Bank Accountability
In recent years, a consensus has appeared in favor of central bank independence. The justification for this independence is the belief that, insulated from short-term political pressures, a central bank will be in a position to pursue long-term economic goals more effectively. Independence, however, is not the same as being unaccountable for one’s actions. Thus, an administrative agency may take decisions on its own, but it may have to forecast, explain, and justify its decisions. An administrative agency, then, while prizing its autonomy of decision and action, may nevertheless be accountable to one or more of the three branches of the government—and to the public at large. If it is accountable to no one, the situation may give rise to the risks against which Montesquieu warned when the powers of government are combined. Depending on the importance of the administrative agency, these risks may range from subversion of good government to tyranny within the arena in which the agency exercises its jurisdiction.
One may fairly ask, Why, if a combination of powers creates such risks, should a central bank (or, indeed, any administrative agency) be allowed to exercise them? The answer must lie in the increasing complexity of modern society, which requires the construction of such engines of integrated power to resolve satisfactorily the matters before them. The alternative would seem to be an increasing accumulation of unresolved problems, the primary responsibility for which is denied haphazardly by various government offices. This seems to be the fate of those societies that would enter the modern world without the bureaucratic machinery adequate to its challenges. Max Weber, the eminent German sociologist, wrote that one prerequisite of the modern capitalist-industrial state is a professional bureaucracy. The development of that bureaucracy has thus given rise to the modern administrative state. As a measure of this necessity consider, by way of example, one recent index of administrative growth in the United States:
Here the not-entirely-symbolic measure is the Code of Federal Regulations (CFR). In its first year of publication, significantly 1939, the CFR consisted of sixteen volumes; last year it had expanded to 200 volumes, exceeding 60,000 pages combined. As these numbers suggest, delegation may have come about because the world became too complicated for Congress to handle alone, but it also enabled Congress to address more than it ever otherwise would have on its own.16
It is submitted, therefore, that providing for adequate accountability of administrative agencies, whose inevitability must be acknowledged, is of utmost importance.
In the case of a central bank, which is an administrative agency of unprecedented power, increasingly enjoying unparalleled independence, accountability may be conceived in terms of accountability of the bank to any or all of the three branches of the government, as well as to the public. While the situation may differ from country to country in accordance with the legal traditions and evolution of each, it is of interest to focus on the possible methods of accountability, all of which have their analogues in the world today. It should be noted that, in order to preserve a proper balance between autonomy and accountability, the elements of both may be qualified and conditional. Consider the ways in which a central bank may be made accountable for its actions. That it should be accountable at all follows from the realization that its nature and structure tend to insulate it from effective external control. The trick is to make it accountable to, but not to the extent that it is controlled by, one or more external powers.
Central Bank Accountability to the Legislative Branch
A central bank may be made accountable to the legislative branch. One way of providing for parliamentary accountability is to require regular examination of a central bank’s performance by a select or standing committee of the legislature. In Sweden, this takes the form of having the central bank report to a standing committee of the legislature.17 In the United States, the Federal Reserve must report twice yearly to the banking committees of both the Senate and the House of Representatives on its monetary targets and its objectives and plans for the coming year.18 Not only are reports mandated, but it has also become a tradition for the Chairman of the Board of Governors to appear before the committees to testify. Thereafter, each committee submits to its respective chamber of the legislature a report containing its views and recommendations with respect to the Federal Reserve’s intended policies. In the United Kingdom, the Governor of the Bank of England appears before the House of Commons Treasury and Civil Service Select Committee on a regular basis.19 (However, the Bank, as an incorporated public body, is not directly answerable to the Parliament. Under U.K. constitutional doctrine, parliamentary responsibility lies with a minister.) In France, the Governor of the Bank of France annually addresses a report on the Bank’s activities and on monetary policy to the President of the Republic and Parliament. The Governor may be asked to appear before the finance committees of the two chambers of Parliament. The accounts of the Bank and the report of the statutory auditors are forwarded to the finance committees of the National Assembly and the Senate.
The chief power of the legislature, the power of the purse, is deliberately blunted in the case of most central banks because they almost invariably are invested with an autonomous power to decide on their own budgets without leave from their legislatures. Moreover, the power to decide on their own budgets is not merely theoretical. It is buttressed by the fact that most central banks are highly profitable institutions (even though profit maximizing is not usually among their purposes and should not be regarded as a measure of their efficiency). Accordingly, unlike most other parts of the government, central banks do not have to depend on their parliaments for their finances (although they may have to account for them to the legislative or to the executive branches of their governments). In this respect, most central banks must submit to independent audits in accordance with the terms of their statutes.
Central Bank Accountability to the Executive Branch
A central bank may be accountable to the executive branch. It is the executive branch that appoints the governor of a central bank and its board of directors. (It may do this with the advice and counsel of the legislature in some countries.) It is also the executive that may remove these appointees. Thus, in the United States, the seven members of the Federal Reserve Board are appointed by the President with the advice of the Senate.20 However, the power of the executive branch to dismiss the central bank officials that it has appointed cannot be unfettered. Even as the chief power of the legislature (over the purse) is blunted in the case of a central bank, so the power to relieve the governor and the board members of their offices is also commonly hedged about with qualification. These persons do not serve merely at the pleasure of the appointing authority as might be the case if they were officers of the executive branch. In order to assure them sufficient independence of action, the causes for their dismissal must be limited. By way of illustration, Article 10 of the French central bank act provides that governors of the Bank of France may be relieved from office only if they no longer fulfill the conditions required for the performance of their duties or if they have been guilty of serious misconduct.21 In the United States, the members of the Board of Governors of the Federal Reserve System can be removed from office only for cause,22 a concept that is subject to judicial interpretation.
In addition to the power to appoint and dismiss, in some countries the executive branch may also exercise influence over a central bank through an express power of direction. Thus, the Bank of England Act 1946, which nationalized the Bank of England, provides a general statutory power in the Treasury to issue to the Bank such directions “as, after consultation with the Governor … they think necessary in the public interest.”23 Similar powers of direction may be found in the Canadian and Australian laws.
Central Bank Accountability to the Judicial Branch
A central bank may be accountable to the judicial branch. The jurisprudence of many countries recognizes a general rule that the sovereign cannot be sued without its consent. The basic rationale for this rule is that an unfettered right to bring private claims against the state would hamper the effective functioning of the government. This general rule, however, may be subject to statutory exceptions that are intended to waive immunity for certain purposes. Under English law, since the enactment of the Crown Proceedings Act 1947, the liability of the Crown and other public authorities is recognized in order to grant recovery to a citizen for damages in tort and other enumerated claims.24 Under French law, the principle of administrative liability (responsabilité) is also accepted, pursuant to special rules of administrative law, and extends to all public authorities.25 As stated by one authority in the area:
This principle is expressed in the judgment of the Tribunal des Conflits in Blanco (TC 8 February 1873) as follows:
Considering that the liability which may fall upon the state for damage caused to individuals by the act of persons which it employs in the public service cannot be governed by the principles which are laid down in the Civil Code for relations between one individual and another: that this liability is neither general nor absolute: that it has its own special rules which vary according to the needs of the service and the necessity to reconcile the rights of the state with private rights.26
In other countries, the central bank, generally recognized as a governmental instrumentality, may be subject to suit under its constituent law or under one of the exceptions carved out of the doctrine of sovereign immunity by a general statute regulating suits against the government. However, the liability of the central bank and its officers may be circumscribed. Thus, Section 44H of Trinidad’s Central Bank Act provides that the central bank, its directors, and officers are not subject to liability in respect of acts done or omitted in good faith and without negligence.27 Moreover, the U.K. Banking Act 1987 contains a similar provision, which is discussed subsequently.28
In the United States, Congress enacted the Federal Tort Claims Act, which waives in large measure the tort immunity of the government (subject to significant exceptions). The waiver permits the government to be sued for damages
caused by the negligent or wrongful act or omission of any employee of the Government, while acting within the scope of his office or employment, under circumstances where the United States, if a private person would be liable to the claimant in accordance with the law of the place where the act or omission occurred.29
However, overriding this provision are two exceptions that are particularly noteworthy. The first is “any claim for damages caused by … the regulation of the monetary system,”30 the traditional province of a central bank. The other exception applies to claims based on “the exercise or performance or the failure to exercise or perform a discretionary function or duty on the part of a federal agency or an employee of the Government, whether or not the discretion involved be abused.”31 The latter exception has been held by the U.S. Supreme Court to bar claims against federal bank supervisory agencies for negligent supervision of savings and loan operations.32 In this connection, as is addressed subsequently, the reach of the exception has been particularly effective in defining the duties of the bank supervisors in the context of bank failures.
In appropriate circumstances, banks and other persons who have suffered an invasion of their rights by a central bank or its officials must have the right to sue for relief. However, this right, especially as it involves judicial review of the decisions of a central bank, may need to be qualified. To understand how this judicial review may be qualified, it is instructive to consider the matter generally in the context of the exercise by an administrative agency of its powers. The particulars of three central banks are then examined by way of illustration: the Bank of England, the Bank of France, and the Federal Reserve.
The Right to Sue an Administrative Agency: The Central Bank
The administrative law of countries may be classified into two general categories. One category, typified by the United States, the United Kingdom, and countries whose laws derive therefrom, permits judicial review by the same general court system that presides over litigation generally. In such countries, courts of general jurisdiction consider both private causes of actions and those that involve the state.
The second category recognizes a separate system of administrative jurisdiction and law, so that countries with such a system have, in fact, two systems of courts. France was the leader in establishing a separate jurisdiction of courts presided over by the Conseil d’Etat and guided by a body of judge-made law (the droit administratif).33 Most Western European countries follow the French practice of this parallel jurisdiction,34 as do non-European countries whose laws are derived from or influenced by the French legal system. In all the systems of law examined, the reviewing court is ordinarily reluctant to substitute its judgment for that of the administrative agency whose action is challenged. The judicial review is thus limited in accordance with the relevant jurisprudence that has arisen under the particular system of administrative law.
Under English law, several general grounds for judicial review of administrative actions are recognized.35 The first ground is error of law (“illegality”), where, for example, an agency attempts to exercise authority that it does not possess so that it acts ultra vires, or the agency abuses the power that has been entrusted to it. The second ground is unreasonableness (“irrationality”), where the agency exercises a power in an unreasonable manner so as to bring into play the rules of the Wednesbury case,36 which are concerned with the abuse of discretionary powers. The Wednesbury rules have been summarized as involving four propositions:
(1) an authority must not be affected by immaterial, or ignore material, considerations; (2) it must direct itself properly in law; (3) it must not act in such a way that it can be said of it that no reasonable authority, properly directing itself to what was material, could have concluded that it was entitled so to act; and (4) in reviewing the acts of an authority the court will not substitute its own view of how a discretion should be exercised for that of the authority entrusted by Parliament with the discretion.37
The third ground has sometimes been described as breach of the principles of natural justice, but it appears to involve in practice procedural impropriety, such as failure to follow procedural rules that are expressly prescribed by statute.
The Banking Act 1987 provides a large measure of statutory immunity from liability for the Bank of England. Section 1(4) of that Act states:
(4) Neither the Bank nor any person who is a member of its Court of Directors or who is, or is acting as, an officer or servant of the Bank shall be liable in damages for anything done or omitted in the discharge or purported discharge of the functions of the Bank under this Act unless it is shown that the act or omission was in bad faith.38
Two observations can be made about this provision. First, by its terms, the immunity from liability is not accorded if the act or omission of the Bank was in bad faith. Second, the scope of the immunity extends only to the Bank, its directors, and staff—but not to its agents or to the auditors of the banks.
Section 1(4) of the Banking Act 1987 does not pre-empt the field in its entirety. There is a special procedure for reviewing certain decisions of the Bank of England.39 These decisions deal with the refusal of an application by an institution for authorization, the restriction or revocation of such authorization, or with a direction by the Bank in connection with the revocation or restriction of its authorization. The institution and affected persons may appeal such decisions to a Banking Appeal Tribunal consisting of a barrister, solicitor, or advocate who serves as chairman and two other members having accountancy and banking experience. The tribunal decides whether the decision challenged was unlawful or not justified by the evidence on which it was based. It may confirm or reverse the decision but has only limited power to vary it. The tribunal has concluded that this procedure imposes on it a responsibility for forming its own judgments on whether decisions and findings of the Bank were justified by the evidence on which they were based so that, in effect, the Wednesbury tests of unreasonableness do not apply to circumscribe the scope of its jurisdiction. The institution or other person—or the Bank itself—may appeal to a higher court on any question of law arising from the decision of the appeal by the tribunal. If the court considers that the decision was erroneous in point of law, it will remit the matter to the tribunal for rehearing and determination.
Some persons have sought to fasten liability on the banking supervisor by claiming that regulatory activities conducted by it, if improperly performed, may constitute breach of statutory duty, negligence, or the tort of misfeasance in public office. The latter would allow the conclusion that the Bank or its officer was acting in bad faith and, hence, was no longer within the statutory immunity of Section 1(4) of the Banking Act 1987. Two cases are relevant. In Yuen Kun-yeu v. Attorney General of Hong Kong40 and Davis v. Radcliffe,41 when a deposit-taking institution in Hong Kong (in the former case) and a bank in the Isle of Man (in the latter case) failed, depositors who stood to lose as a result of the failure brought suit for damages against the respective supervisory agencies. In the Davis case, the theory was that the supervisor’s negligence caused damage to the plaintiffs. In the Yuen case, the alleged failure of the banking supervisor to exercise reasonable care was supplemented by the assertion of plaintiffs that by continuing to confer a registered status on the failing institution the supervisor had in fact misrepresented its financial condition as creditworthy. In both cases, the Privy Council held for the bank supervisor on the ground that the supervisor owed neither a statutory42 nor a common law duty to depositors or potential depositors to take reasonable care in the exercise of its powers and duties. These cases were favorably cited by the court in litigation against the Bank of England based on the theory of misfeasance in public office in the aftermath of the failure of the Bank of Credit and Commerce International.43
In France, as in England, under general principles of law an administrative court will not substitute its discretion for that of the administrative agency. Moreover, the administrative agency is protected from interference by ordinary courts under the doctrine of separation of powers. A complainant who seeks the annulment of an administrative act may file an application for annulment based on four grounds: (i) incompetence (incompétence), (ii) defect in form (vice de forme), (iii) violation of law (violation de la loi), and (iv) abuse of power (détournement de pouvoir).44 The first of these grounds signifies that the administrative agency lacks the jurisdiction to take the decision in question. The second ground encompasses a procedural irregularity of consequence. In this connection, it is important to note that the Law of 11 July 1979 requires that reasons for administrative decisions be stated in writing and with precision. The third ground arises if the administrative agency violates a provision of a law, regulation, decree, or the general principles of law. The fourth ground involves a consideration of whether the motives that inspired the action of the administrative agency were those that were in the contemplation of the legislature. One authority, comparing English and French law, has characterized the situation as follows:
It seems that in France the administrative courts will review an administrative act where there has been any of the following forms of misuse of an administrative power:
(a) obstruction to the course of justice;
(b) fraud on the law;
(c) some act inspired by a partisan rather than the public interest;
(d) an act done in the interests of a third party;
(e) an act inspired by political passion;
(f) an act inspired by a public interest other than that which caused the creation of the power (“wrong motive”).
English law, in spite of sweeping dicta which can be found in some of the cases, does not yet go as far as this.45
Cases have given rise to important interpretative doctrines.46
Unlike the Bank of England, the Bank of France does not enjoy statutory immunity from suits. Article 22 of the Law No. 93-980 of August 4, 1993 provides that suits in respect of the internal administration of the Bank or between the Bank and members of the Monetary Policy Council, members of the General Council, or its agents are within the administrative jurisdiction (administrative courts, administrative courts of appeal, and the Conseil d’Etat). Other suits, depending on their nature, may be brought in civil, commercial, or administrative courts. While the Bank of France plays a role, banking regulation and supervision functions are exercised by authorities distinct from the Bank. Notable among these is the Banking Commission. Since the latter lacks legal personality, it is the State’s responsibility that would be engaged in the event of liability. The Conseil d’Etat has recognized, in principle, the liability of the State for a deficient exercise of supervision by the Banking Commission but establishing such liability would require the proof of faute lourde on the part of the Banking Commission.
Under U.S. jurisprudence, when an administrative agency exercises adjudicatory powers, it performs three tasks. First, it interprets the law that it is charged to implement. Second, it finds facts concerning the situation to which it will apply to law. Third, it exercises discretion in applying the law to the facts. It may be expected that a U.S. court that reviews the adjudicatory action of an administrative agency, like its counterparts in the United Kingdom and France, will tend to treat such action with some degree of deference to its expertise. However, the degree of deference may vary according to the task reviewed. Generally, the U.S. court will be inclined to give less deference to the legal conclusions of the agency than to its findings of fact or the scope of discretion. This is because the court may consider itself as competent as the administrative agency in interpreting law. A court may not enjoy this status in respect to complex fact-finding or technical issues of discretion.47
In the United States, specific legislation was enacted in the form of the Administrative Procedure Act of 1946, which sets out the essentials of administrative justice that are binding on all federal administrative agencies and subject to federal court review.48 The act provides a number of limited grounds on which a court can reverse a decision of an administrative agency.49 Two clauses deal with questions of law: whether the Constitution has been violated50 or the agency has exceeded its statutory authority.51 Two clauses deal with facts: whether the agency’s action, findings, or conclusions are unsupported by substantial evidence52 or (exceptionally, where there is a de novo trial) whether these are unwarranted by the facts.53 One clause concerns law, facts, or discretionary matters found to be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.54 Another clause deals with procedural error.55 In actions against federal administrative agencies that seek relief other than for money damages, the defense of sovereign immunity is waived by express provision of the Administrative Procedure Act.56 Thus, that defense is not available if the plaintiff seeks to compel the agency to act or to set aside one of its actions.
While tort claims57 against a federal administrative agency may be brought under the Federal Tort Claims Act,58 important exceptions to this act bar recovery under its provisions, including where government officials exercise a discretionary function,59 even if they abuse their discretion. In one case, the federal regulator of a savings and loan institution removed from its management the chairman of the board, who was also its largest shareholder. Thereafter, the regulator became continuously involved in the institution’s business operations. When the deposed chairman sued, charging that the incompetent actions of the regulator had destroyed the institution, the U.S. Supreme Court held that the regulator was protected under the exception from the Federal Tort Claims Act in favor of discretionary acts. The Supreme Court held that this exception encompasses not only acts on a policy or planning level but also day-to-day management at an operational level.60 It has also been held that the Federal Tort Claims Act modified the sue-and-be-sued doctrines contained in the statutes of particular federal administrative agencies (such as the Federal Deposit Insurance Corporation (FDIC))61 by making the suit under that act the exclusive remedy for torts, whether covered by the act or excepted from it.62
Turning to litigation that has been brought against the Federal Reserve, it is instructive to consider two U.S. cases that dealt with the monetary powers of the central bank. In both cases, the courts protected the monetary powers of the central banks from suit by private parties claiming damage from their exercise. In Home v. Federal Reserve Bank of Minneapolis,63 the court affirmed the judgment of the lower court that dismissed an action brought to restrain the Federal Reserve Banks from issuing currency on the contention that such issue constitutes coining money in violation of the U.S. Constitution, which leaves this function to Congress. The court affirmed the dismissal on the ground that the plaintiffs had no standing to sue. It stated:
[C]ases are unanimous which point out that an injury to be justiciable must be peculiar to the particular plaintiff, and not one suffered by all similarly situated persons in common. Absent personal injury or damage, the plaintiffs here do not have the requisite standing to question the constitutionality of the above-referred-to statutes, or any other statutes, in the courts of the United States.64
Reference may also be made to Raichle v. Federal Reserve Bank of New York,65 involving the dismissal of a bill in equity to restrain the Federal Reserve Bank from engaging in open market operations and fixing a rediscount rate. The Court of Appeals stated:
It would be an unthinkable burden upon any banking system if its open market sales and discount rates were to be subject to judicial review. Indeed, the correction of discount rates by judicial decree seems almost grotesque, when we remember that conditions in the money market often change from hour to hour, and the disease would ordinarily be over long before a judicial diagnosis could be made.66
Moreover, Bryan v. Federal Open Market Committee67 involved dismissal for lack of standing of an action challenging the powers of the Federal Open Market Committee.
The principle involved in the cases that test the monetary powers of a central bank is that petitioners must have a direct personal interest in the administrative action that is challenged. They cannot bring an action on a theoretical ground or one that purports to be grounded in the interest of the community generally. This principle is recognized as well by the French Conseil d’Etat. French petitioners who seek to annul an administrative act must show that they have a personal interest in having the act annulled.68 In the words of one authority:
The Council of State applies the well-known procedural principle: “No interest, no action.” It does not mean to deal with the petitions of persons who, not having any personal interest in the annulment of the challenged act, may have acted out of pure chicanery.69
A central bank may also have bank supervisory authority that may be challenged in the courts. In a number of countries, cases have arisen against the central bank or other bank supervisor in which the plaintiff sought recovery on the ground that it was the negligence of the bank supervisor in failing properly to regulate a bank that caused damage to the plaintiff. Sometimes the plaintiff has argued that the banking supervisor should have warned the plaintiff and others in the plaintiff’s position about the deteriorating condition of a bank or the irregularities of its business. The response of the supervisor has often been that, because its duty is statutory in nature and limited to the particular objectives of the statute, no duty is owed to the plaintiff. In the United States, this argument is bolstered by the discretionary function exception to the waiver of sovereign immunity referred to above. The outcome of such litigation has mainly been in favor of the bank supervisory agency. By way of example, it has been decided in the United States that in the ordinary course of regulation the Federal Deposit Insurance Corporation owes no duty to a bank or its officers and directors. (However, if the FDIC goes beyond its normal regulatory activities and substitutes its decisions for those of the bank officials, there is some authority for the proposition that it may assume liability).70 That agency cannot be held liable for failure to warn bank officers and directors about misfeasance that it discovers during its routine inspection.71 Similarly, it has been held that there is no duty on the bank supervisory agency to warn shareholders72 or depositors.73 The issue has been litigated in Germany, initially with a different result. When the German Federal Court of Justice ruled in 1979 that in certain circumstances the Federal Banking Supervisory Office had a duty to protect depositors if it became aware of particular risks,74 the Banking Act was amended to read75 that “the Federal Banking Supervisory Office performs [its] functions … in the public interest only. “76
Central Bank Accountability to the Public
In addition to formal accountability to one or more of the three branches of government, a central bank may have accountability to the public. This accountability may take the form of providing the public with access to information, records, and meetings.
In the United States, central bank accountability to the public is maintained in several ways. First, information is conveyed to the public in the form of daily Federal Register notices of proposed rule making, public hearings, and final rules. Weekly statements of the financial conditions of the Federal Reserve Banks are published. A monthly publication includes regulations, statements of policy, interpretations, notices, and orders of adjudications. Second, the public has access to minutes of meetings of the Federal Reserve Board, subject to certain exemptions77 and after a certain delay in time.78 In addition, a report on the deliberations of the Federal Open Market Committee is released to the public approximately one month following each meeting.79 Third, meetings of the Federal Reserve Board are open to the public except where the Board determines that disclosure of information may lead, among other things, to speculation on the financial markets, frustration of a proposed action by the Board, or the instability of a financial institution.80 Finally, the Board is audited by a public accounting firm, and the report is published in the Board’s annual report.81
Bank of England
In the United Kingdom, the Bank of England prepares an annual financial report, Report & Accounts. The financial statement of the Banking Department generally complies with the accounting provisions of the Companies Act 1985, which is not formally applicable to the Bank.82 Also, “the statements of account of the Issue Department are drawn up in accordance with provisions agreed between the Bank and HM Treasury to implement the requirements of the Currency and Bank Notes Act 1928 and the National Loans Act 1968.”83 Both the financial statement and the statements of account are reviewed by private auditors.84 Details of monthly meetings between the Chancellor of the Exchequer and the Governor of the Bank are published within about six weeks.
Together with the annual financial report, the Bank of England publishes a weekly accounting, Return, in the London Gazette. Return is also displayed in the lobby of the Bank, and available to the public at the Bank.85 The Bank also publishes a quarterly Inflation Report, which is an account of the factors that may affect inflation and an analysis and projections underlying the Bank’s advice to the Chancellor on monetary policy,86 as well as the Quarterly Bulletin, which is a collection of research papers on monetary analysis.87 In addition, the Bank submits to the Chancellor of the Exchequer and publishes an annual report on its supervisory activities, copies of which are laid by the Chancellor before Parliament.88 Since April 1993, the minutes of the monthly meetings between the Chancellor and the Governor have been published. The initiative for this change came from the Treasury Department, but a report from the Treasury and Civil Service Select Committee on the role of the Bank of England also called for the change.89 However, it is the Chancellor, not the Bank’s Governor, who is responsible for explaining changes in interest rates to the public.90
Bank of France
In France, the Bank of France publishes weekly statements on its financial position in the Journal Officiel, pursuant to the requirement to do so set forth in Article 34 of the central bank act. Furthermore, the public has access to information prepared by the Bank of France and published by the Minister of Economic Affairs and Finance regarding the balance of payments and net external position of the country. The Bank also publishes the Bulletin de la Banque de France and other periodicals.
Evolutionists recognize a principle called evolutionary convergence.91 In accordance with this principle, different families of animals, although genetically distinct, may tend to evolve representatives that resemble one another in function when faced with the same external stimuli. It is submitted that the principle of evolutionary convergence may apply to central banks, as well. Central banks are related to each other in some general ways: they are all administrative agencies separate from the traditional three branches of government but possessed of a blend of powers appropriate to the tasks assigned to them. Although not all these tasks are the same for each institution, they share enough of them to create similarities of organization and function. The execution of common tasks requires them to confront similar external factors. This activity produces recognizable patterns of behavioral response common to central banks. It is submitted that these institutions may then be able to anticipate from the experience of their peers certain patterns that are likely, in time, to become their own.
One important direction in which contemporary central banks are being drawn is toward greater autonomy. However, this movement carries a corollary that can be delayed, if at all, only for a limited period of time. The accepted corollary of autonomy is accountability (and the transparency that this implies).92 The process has affected more than one central bank and, it is submitted, will continue to affect them all. While accountability must inevitably accompany autonomy, it may do so in ways that need not compromise the essentials of either. It may be instructive to consider the views of the U.K. Select Committee on Nationalized Industries some years ago in counseling to the Bank of England a publication of full accounts:
Your Committee regard it as wholly inappropriate that a public body should be accountable to nobody. The Bank’s argument that the Court [board of directors] is responsible for the proper running of the Bank appears to miss the point. It is not enough that “a highly responsible body” such as the Court [board of directors] “each and every member of which is appointed on the recommendation of the Prime Minister” should control what the Bank does. . . . The Governor said that the Court of the Bank was responsible to the country for the proper conduct of the Bank … but up to now the country has been quite unable to judge whether the Bank has been properly conducted. . . .93
Other central banks publish accounts in varying degrees of detail. Other central banks enjoy varying degrees of independence. Your Committee have no reason to believe that the degree of independence enjoyed by central banks is in inverse proportion to the amount of information they publish about their accounts: the two factors are quite unconnected. Your Committee fail to see how the publication of accounts by the Bank of England could in any meaningful way damage the Bank’s independence. Publication in itself would not deprive the Court of the responsibility, given it under the Act, for the organisation of the Bank, its staffing, its methods of working, its investment policy, and its relations with its customers.94
The movement toward accountability can only be accelerated by the plethora of banking innovations and developments that central banks must address as the century draws to a close. It is unlikely that any central bank can guarantee that its approach to each of these developments will be unassailable. Its decisions and their consequences must be perceptible to, and challengeable by, the public, debatable in parliament, and, reviewable if necessary in courts or other appropriate forums of redress. It is with this consideration in mind that this volume explores some of the leading developments, both systemic and particular.
The subjects treated in this volume attempt to place the central bank in the contexts of rapidly changing developments. The contexts, in a decreasing order of magnitude, include developments at the level of the international financial institutions, on the regional level in the European Community and NAFTA, and then at a country-specific focus. An important current theme is explored: bank supervision. It is pursuant to this authority that the central bank is most likely to encounter the rapid innovations that are sweeping the banking industry. Finally, topics reflecting recent innovations of special interest to central banks are explored in the areas of payment systems, securities transfers, foreign exchange trading agreements, derivatives, and securitization.
This volume is the fourth in a collection of revised proceedings of seminars that have been sponsored by the International Monetary Fund’s Legal Department, in conjunction with the IMF Institute, for general counsels of central banks. The volume, which reflects topics originally addressed at the 1994 seminar, contains the collected views of many of the foremost thinkers and actors in the field of banking, having particular reference to the legal aspects of the matters discussed. Following the main papers of the proceedings are the remarks of a number of distinguished commentators. Each of these commentators offers a distinct perspective on a given subject. The views expressed in the various papers and commentaries are those of the authors and should not be interpreted as reflecting the views of the International Monetary Fund or any other institution.
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Mr. Gianviti begins by tracing the history of the International Monetary Fund from its roots in the United Nations Monetary and Financial Conference of 1944; in this connection, he mentions the three amendments of the Fund’s Articles of Agreement. The focus of his chapter concerns features that make the Fund different from other organizations. He points out that international organizations gradually tend to expand their activities, and consequently, it becomes increasingly difficult to define an organization’s mandate and to tell what makes it different from others. Some of the distinctions between organizations can be attributed to their charters, while others are the result of practice. He provides two examples that illustrate how the Fund is different: (i) its provision of financial assistance to its members; and (ii) the nature of state succession in the Fund. With respect to the first example, the Fund’s financial assistance to its members is subject to different rules, depending on whether the resources are from the General Resources Account (available to all members), the Special Disbursement Account (available, in fact, only to developing countries with the lowest per capita income), or Administered Accounts (available for the specified purposes for which the account was established). Using the General Resources Account as a model, Mr. Gianviti identifies three themes that illustrate unique aspects of the Fund as a financial institution. First, the purpose of the Fund’s assistance is to help member countries solve their balance of payments problems while avoiding recourse to exchange restrictions on current international transactions that might tempt a member faced with a shortage of foreign exchange. Second, the technique by which the Fund provides assistance in the General Resources Account is not in the form of loans but rather in the form of exchanges between the requesting member’s currency and an equivalent amount of either another member’s currency or Special Drawing Rights. Third, whether the Fund authorizes a purchase or approves a stand-by arrangement, the use of its resources is subject to conditions that are related to the purpose of the assistance, namely, to solve the member’s balance of payments problems without resorting to measures destructive of national or international prosperity. In addition, the conditions are also intended to safeguard the Fund’s resources. Turning to the second example of a specific legal feature of the Fund, Mr. Gianviti notes that in the history of the Fund there have been several cases of changes in the legal status of members when, for example, a member has absorbed a nonmember, a member has merged with a nonmember, or two members have merged. However, he points out that more difficult problems can arise when territories within a member state become independent. This may occur through secession from, or even dissolution of, a member. In the absence of any explicit provision in the Articles of Agreement on state succession, he notes that innovative answers to the questions raised by state succession had to be developed. In this connection, he describes the dissolution process by which successors of the Socialist Federal Republic of Yugoslavia and those of Czechoslovakia were deemed to have continued the membership of their predecessors in the Fund.
Mr. Holder considers the relationship between the International Monetary Fund and the United Nations. He notes that both the UN and the Fund are subjects of international law with explicitly conferred legal personalities. He reviews the negotiating history and analyzes provisions of the Agreement Between the United Nations and the International Monetary Fund, which came into force on November 15, 1947. He points out that, although the Fund is a specialized agency within the meaning of the UN Charter, it is not a specialized “agency” (or agent) of the UN. He emphasizes that influence on the decisions of the Fund by political bodies is not countenanced. He describes how the Fund’s independence was put to a test in the case of its relations with one of its members. Mr. Holder explains that, in its deliberations and communications in this case, the Fund took the position that all organs of the Fund were required to adhere to the Articles of Agreement. Under the Articles, the rights of a member must be respected, including the member’s entitlement to use Fund resources, in accordance with Fund policies on the use of Fund resources and subject to the decision of the Executive Board. He explains why the Fund is not obligated to carry out the decisions of the UN Security Council. He then considers why the Fund is exempt from having the UN review its budget. Mr. Holder also describes how the two organizations cooperate in areas such as reciprocal representation, consultations and recommendations, and exchange of information. In addition, reference is made to a special report that in part discusses the relationship of the Fund and the UN.
Mr. Munzberg focuses on specific issues regarding the Special Drawing Right (SDR). He notes a proposal for an allocation of SDRs and the possibility of targeting increased amounts of SDRs to particular groups of members, specifically new members of the Fund. He describes this renewed interest in the SDR as a positive development. Mr. Munzberg surveys the history of the SDR, noting that the SDR Department was created a quarter of a century ago through the First Amendment of the Articles of Agreement and that the Second Amendment added to the Articles the objective of making the SDR the principal reserve asset. He then considers the proposal for a general allocation and the reasons justifying such an allocation. He notes that the needs of individual members or groups of members do not justify an allocation. Instead, it is the need of the world economy as a whole for supplementation of reserves that forms a basis for an allocation of SDRs. Mr. Munzberg explains why a proposal was made, but not adopted, to cancel all or part of the existing SDRs and then to allocate at least the equivalent amount of SDRs on the basis of current quotas. He notes that the Fund continues to study how to increase the amount of SDRs and make available SDRs to all member countries.
Mr. Rigo considers the Global Environment Facility (GEF), which, without a legal personality of its own, is intended to provide an umbrella for cooperation between existing organizations. This facility promotes the financing of projects that are deemed to benefit the global environment. It was restructured and given a permanent status in 1994. He states that the GEF was initially an experiment of international cooperation to finance activities for enhancing the global environment. He notes that the GEF’s unique features make it an interesting case study of an international organization. The issues that arise include how existing structures are used to achieve new objectives, how they are modified in the process, and how new structures come into being. He describes the pilot phase of the GEF; the roles of the International Bank for Reconstruction and Development, the United Nations Development Program, the United Nations Environment Program, and participating states in the GEF; and the funding of the GEF. He mentions the Montreal Protocol and the establishment of the Interim Multilateral Fund, which was created to assist developing countries in meeting their obligations under the Protocol. He points out that, as early as 1992, the participants of the GEF agreed that its structure should be adjusted to play a permanent role beyond the pilot phase. Mr. Rigo concludes by describing the two-year negotiating process that established the permanent GEF, the instrument negotiated, and the GEF structure, including its Assembly, Council, and Secretariat.
Ms. Sullivan provides an overview of developments at the International Finance Corporation (IFC). The IFC, a member of the World Bank Group, promotes development in its member countries by supporting the private sector. It is the world’s largest source of direct investment for private project development in developing countries, lending money to, and investing its funds in, such projects, as well as helping to mobilize funds from other lenders and investors. Ms. Sullivan notes that the worldwide trend of moving away from government control of the economy and toward greater encouragement of private initiative and the development of a viable private sector has confronted the IFC with a special challenge and a special burden. She discusses the IFC’s role as a project investor and its function as a mobilizer of resources. Ms. Sullivan notes that the IFC provides technical assistance to economies in transition. She provides examples of assistance in privatization projects and financing of basic infrastructure projects. Finally, using a power project as an example, she discusses the risks involved: foreign exchange risk, commercial risks, and political and governmental risks.
Mr. Newburg examines some of the legal issues that have arisen during the early years of the European Bank for Reconstruction and Development’s existence. First, he distinguishes the Bank’s charter from those of other international financial institutions. He notes that the Bank has a unique mandate: to support the transformation of the countries of Central and Eastern Europe into market-oriented democratic societies while promoting in all of its activities environmentally sound and sustainable development. Second, he addresses the issues arising from changes in the countries constituting the Bank’s membership. Issues relating to eligibility for membership and the dissolution of the U.S.S.R., Yugoslavia, and Czechoslovakia are discussed. Third, he examines the private sector focus of the Bank’s charter. In particular, Mr. Newburg points out that the Bank’s charter imposes quantitative constraints on its state sector operations by requiring that not more than 40 percent of the Bank’s resources be committed to the state sector of the recipient countries as a whole during the first two years of the Bank’s operations and during each fiscal year thereafter. Then, he analyzes the Bank’s relationships with other international financial institutions, specifically focusing on the coordination of the Bank’s policies and the World Bank’s negative pledge clause. Mr. Newburg closes by stating that, in order for the European Bank for Reconstruction and Development to serve its object and purpose, it will continue to be necessary to adapt its legal norms to the rapidly changing environment in which it operates.
Ms. Lichtenstein analyzes how the European Monetary Institute (EMI) has been charged to prepare for the third stage of European Monetary Union, which is to occur not later than January 1, 1999, and what authority it may or may not have over the national central banks of the member states of the European Union. She concurs with others who would characterize the role of the EMI as more of a power of influence than a power of decision. Her central thesis is that the European System of Central Banks (ESCB), which will comprise the European Central Bank and the national central banks after the third stage begins, will not be a “system” at all. She argues that it will be a Union central bank, a Community organ, with “lawmaking” powers and access to the Court of Justice of the European Communities to enforce its law. The national central banks retain their competences in the field of monetary power during the second stage. Thereafter, they will, in effect, become its branches. She begins her analysis by discussing the structure of lawmaking and enforcement within the European Community. Next, she explains how the Treaty on the European Union fits the ESCB into this structure as the European Union’s independent central bank for monetary policy. She notes that the ESCB’s control over monetary policy does not extend to prudential supervision. The latter will remain within the jurisdiction of the national central banks or other national authorities. Finally, Ms. Lichtenstein concludes by examining how the Treaty provides for the situation in which the third stage of European Monetary Union may begin for some member states but not others, and the special provisions for Denmark and the United Kingdom.
Mr. Smits begins with some introductory statements on the European Community and its legislative process. He explains that the European Union, as the major organization for European economic and political integration is now called, is the current end result of a process of nation building that started after the Second World War. Then, he reports on the development of the European Economic Area, which is composed of the member states of the European Community and the member states of the European Free Trade Association. The European Economic Area brought the economic integration of the continent closer. Turning to the focus of his paper, he states that the Second Banking Directive is the cornerstone of the internal banking market. Moreover, it sets the tone for similar directives in the area of insurance and securities trading. Mr. Smits analyzes the content of the First and Second Banking Directives and refers to the complementary solvency ratio and Own Funds Directives. He addresses the concepts of home and host state supervision, as well as other aspects of the directive, including the concept of a credit institution, the six conditions for obtaining and maintaining a banking authorization, reciprocity, and the “European passport.” He also addresses the harmonization of supervisory rules regarding minimum capital, the suitability of shareholders, the limitations on banks’ involvement in commercial companies, the need for adequate administration and internal controls, and the establishment of branches and provision of services. In addition, he surveys cooperation among bank supervisors. Finally, Mr. Smits addresses some of the Second Banking Directive’s flaws and proposed remedial amendments to the directive.
Mr. Clarotti provides a detailed analysis of the European Community’s directives on deposit guarantee schemes and money laundering. First, however, he addresses the fundamental principles of banking legislation in the European Community, including the necessity of creating a level playing field for all types of financial institutions. Then he describes the legislative history of the directive on deposit guarantee schemes and the adoption of such schemes by various member countries. He notes that there are two essential justifications for the creation of such schemes: first, the need to protect the depositors, and second, the need to ensure the stability of each bank and the banking system in general. Various specific issues that needed to be resolved during the legislative process are addressed. For example, he mentions the various levels of protection offered by the member states and discusses how a compromise solution was reached. Turning to the directive on money laundering, he begins by pointing out that in 1990 the laundering of drug money did not constitute a crime in any member state other than the United Kingdom. He states that the European Commission was aware of the danger that money laundering presented for the soundness and stability of the European financial system and had started preparatory work during a period when international efforts to combat money laundering were increasing. He restates three objectives of the directive: to prevent criminals from taking advantage of the single internal market to carry out money-laundering operations; to avoid member states adopting restrictive measures inconsistent with the single market; and to contribute, within the limits of its competence, to opposing organized crime in general and drug trafficking in particular. Lastly, Mr. Clarotti analyzes important provisions of the directive, including the definition of money laundering and bank secrecy.
Ms. O’Day addresses the General Agreement in Trade in Services (GATS) and how it may affect banking services. First, she explains why the Board of Governors of the Federal Reserve System, together with other U.S. regulators, thought it important to be involved in the actual negotiations on the agreement relating to trade in services. She notes that the Uruguay Round of General Agreement on Tariffs and Trade (GATT) negotiations represents the first time that trade in services was to be brought within a multilateral agreement. She states that the purpose of the exercise was to achieve greater liberalization in the service sectors. Ms. O’Day identifies three major areas of concern: (i) the need to take account of a country’s right to take necessary actions to protect its banks, its depositors, and the financial system generally; (ii) the enforcement mechanism in the GATS provisions; and (iii) the traditional GATT practice of allowing for retaliation for violations of the agreement. Next, she describes the main features of the GATS as they relate to financial services, including the most-favored-nation concept, the dispute settlement process, the financial services annex, and the understanding on financial services. Ms. O’Day concludes by addressing the implications of the GATS for banking services and for regulators and central banks.
Mr. Palzer analyzes the legal issues arising for central banks under Chapter Fourteen of the North American Free Trade Agreement (NAFTA). First, he considers how the NAFTA legal regime governs banking services and banking regulations. He distinguishes between the two types of activities in financial services covered by NAFTA: investment in financial services, and cross-border trade in financial services. Then he reviews NAFTA’s five basic rules that govern financial services: (i) national treatment; (ii) cross-border trade in services; (iii) most-favored-nation treatment; (iv) new financial services and data processing; and (v) senior management and boards of directors. Following a discussion of supplementary rules that apply to financial services, he examines how NAFTA might promote integration in the financial sectors of the NAFTA countries. Thereafter, he considers provisions of NAFTA bearing on dispute settlement between states and between states and investors. In conclusion, Mr. Palzer observes that the first and most important lesson that central banks can draw from Chapter Fourteen of NAFTA is that of policy emphasis: the U.S. Government has placed financial services on the trade policy agenda and may be expected to press for the achievement of open markets in the sector.
Mr. Guardia surveys recent developments in banking law and practice in Latin America. First, he provides a historical background against which the significance of the developments can be recognized. Next, he examines key developments in central banking law, including the redefinition of the role of the central bank, the rediscovery of central bank independence, the need for accountability, and the key functions of a central bank. Mr. Guardia then reviews developments in bank supervision that have been prompted by the liberalization of the financial system, growing technological advances, and the integration of world financial markets. He closes by stating that the most interesting legal development in Latin America is the philosophical change that is taking place: the new approach toward central banking legislation is market oriented and favorable to the development of a free, competitive, and efficient financial system that may assist in the integration of that system with the larger partners in the world economy.
Mr. Mattingly describes the role of the Board of Governors of the Federal Reserve System in implementing the Foreign Bank Supervision Enhancement Act of 1991 (FBSEA). He states that the statute was intended to create uniform federal standards for the supervision and regulation of foreign banks in the United States and ensure that foreign and domestic banks were regulated consistently. He notes that the principal requirements contained in the FBSEA (enhanced supervision and increased examinations by a federal regulator, and a demonstration that non-U.S. banks are subject to comprehensive supervision on a consolidated basis) are equivalent to requirements imposed on U.S. banks. He points out that the FBSEA permits the Federal Reserve 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. He discusses the FBSEA’s application process and the program for supervising and examining foreign banks. Mr. Mattingly concludes by noting that the Federal Reserve is attentive to its responsibilities under FBSEA because, as financial markets become more integrated, foreign banks will have an increasing influence on the U.S. economy.
Mr. Rose, in the paper presented by him, reports that national deposit insurance has worked to promote banking stability. After a brief explanation of the structure of the U.S. bank regulatory system, he relates the history of the Federal Deposit Insurance Corporation (FDIC) from its creation in 1933 to the present. He notes that the history of the FDIC cannot be considered apart from changes in economic and banking conditions. He reviews the conditions that caused bank failures during specific periods. For example, he notes that conservative banking practices and favorable economic conditions resulted in few bank failures during the late 1940s and 1950s. However, he points out that as the 1980s began several factors undermined the traditional approaches to profitability for the banking industry, resulting in an increase in bank failures. He discusses the problems that the banking legislation adopted by the U.S. Congress during the 1980s and 1990s sought to remedy. Mr. Rose surmises that, although no one can predict what specific role the FDIC will play in the years to come, the FDIC will continue to adapt to the changing economic conditions and shifts in the banking environment in order to protect insured deposits with minimal disruption to the U.S. economy and financial markets.
Ms. Bettauer discusses how the Office of the Comptroller of the Currency (OCC), which has been supervising banks for 130 years, is engaged in changing bank supervision. She points out that, as society and the economy evolve, banking and banking supervision must also evolve. She discusses this evolution and focuses on the OCC’s approach to bank supervision. In conclusion, Ms. Bettauer asks, “What does the future hold for banking?” Her response is that the OCC wants to ensure that the future promises a system of bank supervision that addresses the growing complexity and technical sophistication of the industry.
Ms. Buck elaborates on several current legal issues concerning the regulation of the U.S. savings and loan industry. She explains the recent evolution of the thrift industry from one in which many savings associations were insolvent to the current state of general profitability. During this transition, the industry became smaller. She describes the new enforcement policy of the Office of Thrift Supervision (OTS) in regulating a sounder and smaller thrift industry, which was adopted in response to the changes. This policy puts greater emphasis on recovery by way of restitution from persons responsible for thrift failures, on the prohibition of unsuitable persons from participating in the thrift industry, and on cease and desist orders to correct practices. Next, Ms. Buck provides an overview of five key changes that were made to the OTS’s regulation of mutual savings associations that wish to convert to the stock form of ownership. Again, she notes that these changes in regulation were prompted by the changed condition of the industry, in which profitable mutual associations are seeking to convert into stock associations in order to raise capital for expansion or for stock benefit plans for management and employees. Finally, Ms. Buck reviews the OTS’s regulation of the sale by savings associations of uninsured products, such as mutual funds and annuities, and the need for proper disclosure to customers.
Ms. Morales Marks discusses certain initiatives taken by the U.S. Treasury Department with respect to the provision of financial services. She begins with an analysis of proposed legislation to provide for fair trade in financial services. Proposals for such legislation relate to the Uruguay Round negotiations and bilateral discussions on financial services between the United States and other countries. One such bill provides the Secretary of the Treasury with the power to withhold future expansion and benefits to financial firms based in nations with restrictive barriers to trade in financial services. Next, she addresses the rationale for the enactment of interstate banking and branching legislation, which generally removes the geographic restrictions that had traditionally been imposed on banks in the United States. She then turns to a proposal to consolidate the four U.S. federal banking agencies, considering the structure and possible benefits of such a consolidated agency. Finally, she mentions work in progress to address risks posed by over-the-counter (OTC) derivatives. Ms. Morales Marks concludes by stating that the U.S. Treasury Department has a careful approach calculated to remove obstacles to the flow of credit and make the U.S. system operate efficiently. Furthermore, the Department will seek achievable goals to prepare the U.S. banking system for the challenges of the next century.
Mr. Blair reviews some of the more important recent developments in the banking law of the United Kingdom. He points out that in the last decade the most pronounced development in U.K. banking law has been the growth in the formal body of regulatory law. In particular, he focuses on changes in the structure of regulation, including the role of the Bank of England, the regulation of investment business under the Financial Services Act 1986, and the implementation of European Community banking directives. In addition, specific issues regarding the duties of auditors, derivatives, setoff, money laundering, and environmental liability are addressed. He examines how the courts have increasingly emphasized basic consumer rights. He addresses the protection of guarantors, legislation against unfair contract terms, and the Code of Banking Practice. Lastly, Mr. Blair studies three issues concerning banking contracts in the United Kingdom: jurisdiction, governing law, and the effect of governmental sanctions.
Mr. David surveys developments in the Canadian financial system. First, he examines the institutional structure of the financial system. He notes that traditionally regulation was based on institutional lines, with functional and investment prohibitions aimed at preserving distinctions between the various financial service providers. However, while the institutional classifications have been preserved for regulatory purposes, the functional restrictions have largely been eliminated. This elimination occurred by allowing financial institutions overlapping core powers and permitting banks to own or control investment dealers, trust companies, and insurance companies. Second, he overviews foreign access to the system in the light of (i) the amendments to the Bank Act that allow foreign financial institutions to incorporate Canadian bank subsidiaries and (ii) NAFTA. Third, he discusses financial-commercial linkages in the system, in particular the holding of bank shares by commercial enterprises and investments in commercial enterprises by banks. Commercial entities are generally constrained from holding more than 10 percent of the shares of a bank while financial institutions are prohibited from having equity investments in excess of 10 percent in the shares of any commercial enterprise. Finally, he addresses solvency, deposit insurance, and consumer protection. Mr. David concludes by noting that die general thrust of recent Canadian legislative and regulatory policy has been to re-examine traditional regulatory approaches and to strengthen internal governance regimes. The latter objective involves provisions in the law intended to avoid conflicts of interest, strengthen die role of the external auditor, adopt a prudent investor standard, and increase the responsibility of directors.
Mr. Shea examines some of the developments in banking laws in die Baltic countries, the Russian Federation, and the other republics of the former Soviet Union. He describes the types and number of banks operating in the region. He also mentions the embryonic securities market and the role of the central bank in bank funding. While the practice has been changing, most bank funding had come from the central bank, which channeled funds through commercial banks to particular state enterprises. He discusses the need to improve specific prudential rules governing banks, including rules governing capital, bank ownership, and risk recognition. In conclusion, Mr. Shea proposes reform measures that could be taken to deal with problems in the banking system. Among his suggestions are better prudential rules; substantial recapitalization; new banking laws; bank closures; good accounting rules and practices; laws on collateral for lending, bankruptcy, and payment systems; and dispute resolution procedures.
Mr. Asser addresses banking law reform in the People’s Republic of China. He first comments on the task of law reform in a society that is in transition from a command economy to a market economy. He points out that for the transition to be successful changes must be made not only in economic thinking but also in legal thinking. Next, he examines the functional differences between the banking law in a command economy and a market economy. He explains that, in order to exercise freedom of economic decision making in China’s new socialist market economy, the banks in China should be independent entities under the law. Both banks and the People’s Bank of China, the bank regulator, should have juridical personality and full operational independence under the law. However, establishing such independence by law is not sufficient. Economic practices must change as well. He addresses the need for policy reforms in China’s banking sector and focuses on policy-based lending. Lasdy, Mr. Asser reviews issues regarding institutional, operational, and related legal reforms in the financial sector.
Mr. Promisel examines the general issues associated with the role of the central bank in bank supervision and regulation and why it is important that central banks should be involved in these matters. First, he emphasizes that it is the fundamental responsibility of central banks to ensure (i) monetary stability and (ii) the stability of financial markets, although each central bank may have a somewhat different mandate and objectives. Monetary stability involves the stability of the price level and the value of the currency, while the stability of financial markets relates to the institutions in the financial sector, the players, the structure of the financial markets, the infrastructure, and financial market prices. While the central bank need not invariably have a supervisory role over financial institutions, Mr. Promisel believes that it has been important in the U.S. experience. In addition, he describes other functions of a central bank, including (iii) management of the payment system, (iv) lender of last resort, and (v) crisis management (including its international aspects). Finally, Mr. Promisel mentions how the risks posed by derivatives and hedge funds are being monitored by central banks.
Ms. Roberts addresses central bank involvement in banking supervision, primarily in the Group of Seven (G-7) countries. She provides an overview of a review of supervisory practices in the G-7 countries compiled by the Board of Governors of the Federal Reserve System. While most of these central banks are involved in bank supervision to a greater or lesser extent, the specifics of the involvement vary from country to country. She describes each of the nine specific areas relating to banking supervision and regulation that were addressed: (i) the legal basis for supervision; (ii) the agencies involved in banking supervision; (iii) the chartering responsibilities; (iv) the examination authority; (v) the reliance on external audits; (vi) statistical reporting and surveillance; (vii) corrective measures and sanctions; (viii) the responsibility for rule making; and (ix) deposit insurance. The findings for each of the G–7 countries are summarized by Ms. Roberts.
Mr. Giddy evaluates the merits of a country’s having an independent agency for the supervision of banks, as compared to housing the bank supervisory function in the central bank or the finance ministry. He argues that an independent agency is in the best interests of depositor safety and bank efficiency because it leaves the central bank free to concentrate on its proper function—monetary policy. He divides a government’s interest in the banking system into three public policy objectives: controlling the volume of liquidity, protecting the integrity of the banking system, and ensuring the availability of credit. He describes a division of labor among the central bank, the bank supervisor, and the finance ministry. Mr. Giddy matches the public policy objectives with the functions of these three agencies, explaining that when the functions are confused things tend to go awry. He then examines bank supervision and the central bank as lender of last resort; deposit insurance and the need to counter moral hazard incentives; prudential regulation; the behavior of regulators; and the U.S. debate as to where bank supervisory authority should lie. He notes that the argument in favor of an independent supervisory agency runs along the same lines as the argument for an independent central bank. In conclusion, Mr. Giddy surmises that, in an ideal world, the bank supervisory agency would be separate and independent and have the sole function of administering liability-side prudential regulation.
Mr. Wahlig provides a German perspective on who should be the banking supervisor. He defines the objectives of banking supervision and compares these objectives with the goals of monetary policy and the tasks of the central banks. Then he examines whether central banks may be exposed to conflicts if they are ultimately responsible for banking supervision, as well as serving as lenders of last resort. Next, he describes the system of banking supervision in Germany and explains the interaction between the Federal Banking Supervisory Office, which is responsible under the law for banking supervision, and the Deutsche Bundesbank, which is extensively involved in banking supervision in practice. Lastly, Mr. Wahlig mentions the role of the projected European Central Bank in banking supervision.
Mr. Sparve offers a Swedish perspective on who should be the banking supervisor. He identifies two major models for banking supervision: supervision conducted by the central bank and supervision conducted by an authority separate from the central bank (either in the ministry of finance or a supervisory authority under the government). He surveys which of the models exist in several Organization for Economic Cooperation and Development countries. Mr. Sparve points out that, in all cases where the main responsibility for supervision is outside the central bank, a close exchange of information and cooperation between the responsible authority and the central bank exist. In addition, he notes the tendency to move supervision closer to the central bank. Next, he turns to the advantages and disadvantages of transferring banking supervision from a separate authority to the central bank. Mr. Sparve draws the following conclusions: (i) the choice of banking supervisor is not a crucial issue; (ii) there is no need for a country to reformulate its structure unless there is a specific need; and (iii) if a country were to build a new system, the central bank model should be recommended.
Mr. Milleret provides a French perspective as to who should be the banking supervisor. He begins by examining the legal framework for banking regulation and supervision in France. He describes the establishment, composition, and tasks of the regulatory and supervisory authorities, namely, the National Credit Council, the Banking Regulations Committee, the Credit Institutions Committee, and the Banking Commission. Then, he examines the independence recently granted to the Bank of France. In particular, he describes its two governing bodies: the Monetary Policy Council and the General Council. In addition, he explains changes in the Bank of France’s relations with the regulatory and supervisory authorities. Mr. Milleret closes by stating that the Bank of France plays an essential role in banking regulation and supervision, although these functions are fulfilled by authorities that are distinct from the Bank of France.
Mr. Baxter, in the paper presented by him, examines the lessons that bank supervisors can learn from the failure of the multinational bank known as the Bank of Credit and Commerce International (BCCI). He provides answers to the following five questions: (i) What happened? (ii) How did BCCI occur? (iii) Why are these events important to banking supervisors? (iv) What can be done to prevent a recurrence? and (v) What lessons can be learned from the failure of BCCI? He explains the financial and human costs. He identifies factors in six categories that led to the failure: (i) fractured supervision; (ii) irrational corporate organization; (iii) corporate culture; (iv) authority; (v) representation; and (vi) technology. Mr. Baxter describes international initiatives to improve international cooperation among bank supervisory authorities and domestic legislation concerning foreign bank operations in the United States. Specific actions taken in the course of criminal prosecutions and civil enforcement of banking laws in the United States are reviewed. Mr. Baxter concludes by noting that perhaps the most important lesson from BCCI’s failure is that bank supervisors can no longer limit their supervision and regulation of banking organizations to their own geographic boundaries.
Professor Barth, in the paper presented by him, considers the role of deposit insurance in the United States. He points out that the large number of costly depository institution failures and the changing role of depository institutions in the U.S. financial marketplace have raised many questions: What caused all the failures and the huge resolution costs? Why are depository institutions losing market share? Are depository institutions becoming obsolete? Should the federal government provide financial stability through deposit insurance, given the evolving environment? He describes the turmoil in the U.S. banking system over the past 15 years. Then, he addresses the erosion in market share experienced by U.S. banking institutions over the same period. In addition, he explains why the failures were so numerous and costly and why market shares have evolved as they have. Professor Barth identifies the key aspects of the present U.S. regulatory system and their effect on the evolution of the U.S. banking system. He considers several options for the reform of deposit insurance. Two of these options would eliminate deposit insurance by establishing (i) the narrow bank concept, in which assets would comprise short-term government securities and liabilities would be demand deposits or transaction accounts, and (ii) a variation of the first proposal that would include the establishment of a federal government money market mutual fund. Lastly, he considers the implications of the U.S. banking experience for the evolution of financial and regulatory institutions.
Mr. Atiyas addresses the importance of bankruptcy laws, citing their role in the development of financial markets and industrial restructuring policy. He notes that most bankruptcy laws prescribe variants of two distinct procedures: liquidation, and reorganization of the insolvent debtor. He discusses market imperfections that provide the economic rationale for the existence of bankruptcy and reorganization policies. Then, Mr. Atiyas compares the bankruptcy laws of the United States, the United Kingdom, and France. He believes that (i) the U.S. law may tend to favor the debtor, (ii) the U.K. law may tend to favor creditors (particularly secured creditors), and (iii) the French law grants substantial decision-making authority to the court rather than to debtors or creditors. Thereafter, he offers some thoughts on bankruptcy policies for developing countries, where the law may be outdated. He cautions against giving banks a dominant role in bankruptcy procedures. Mr. Atiyas concludes by noting that reform of the bankruptcy system alone is ineffective unless undertaken as part of a general overhaul of the regulatory environment in which restrictions on the mobility of capital and labor and inadequacies in the social safety net are addressed.
Mr. Whelan analyzes important elements of Chapter 11 of the U.S. Bankruptcy Code. This innovative chapter has as its objective the rehabilitation of the debtor through reorganization rather than the liquidation and distribution to creditors of the debtor’s assets. He notes that the filing of the bankruptcy petition triggers the imposition of an automatic stay of proceedings, which creates a court-imposed moratorium on adverse actions against the debtor and the debtor’s property. He mentions the appointment and role of the unsecured creditors’ committee. He then describes some of the rights of the debtor in possession, including the right to reject or assume executory contracts or unexpired leases; the right to avoid or annul certain prepetition transactions; the right to use, sell, or lease property of the estate; the right to obtain secured or unsecured credit; and the right to secure turnover of property of the estate that was seized by creditor process prior to the Chapter 11 case. The countervailing rights of creditors are also mentioned. Mr. Whelan also addresses the process by which the debtor’s reorganization plan is confirmed, as well as the statutory requirements that the plan must satisfy before the bankruptcy court. He states that the framework of Chapter 11 is based on several important legal principles that, on balance, protect both the debtor and the creditors. Mr. Whelan concludes that the rehabilitative provisions of the bankruptcy law have not only resulted in successful reorganizations but have also saved countless jobs, provided a significant return to creditors, and enabled debtors to preserve the going concern value of their businesses.
Mr. Schifftnan first analyzes aspects of bankruptcy law in Eastern Europe. Providing examples from the bankruptcy laws of the Czech Republic, Hungary, and Poland, he focuses on the following aspects: administrative efficiency, the stay of related proceedings, the degree of finality of proceedings, enterprise rehabilitation, the avoidance of prebankruptcy transfers, and priorities in the distribution of assets. Second, Mr. Schiffman examines bank insolvency law in Eastern Europe. He critiques certain methods of providing for the initiation of insolvency proceedings against a bank. He discusses how one law sets forth two stages. In the first stage, when a marked reduction in capital occurs, the central bank tries to find a buyer for the bank. In the second stage, if the bank declares that it is insolvent or if the central bank so determines, a court takes over the process and initiates bankruptcy proceedings. Mr. Schiffman considers whether a country’s bank insolvency law should be consistent with its general bankruptcy law.
Mr. Emert discusses how the new master netting agreements for foreign exchange can help to reduce systemic risk. Focusing on the International Foreign Exchange Master Agreement (IFEMA), he provides information about the characteristics of the foreign exchange market, the development of the master netting agreements, the variety of possibilities for their use, and a view of how the market is working to solve these problems. A master agreement, he explains, represents not one transaction but a number of transactions that are all subsumed under one contract. The principles underlying the master agreement and associated close-out provisions of foreign exchange agreements are intended to permit a nondefaulting party to close out open positions without the risk of “cherry-picking” by a trustee or other representative of the defaulting party’s estate. He also discusses how regulatory authorities are recognizing the risk-reducing benefits of netting agreements for the purpose of measuring capital adequacy. Mr. Emert notes the importance of legislation upholding netting in cases of default or bankruptcy of a party to such a contract. He addresses issues arising from master agreements involving parties that trade in multiple jurisdictions—the “multibranch question.” He provides an example of banks’ trading in two jurisdictions to show the significance of netting. Mr. Emert concludes by addressing the risks of not knowing the identity of one’s counterparty that can arise in dealing with financial intermediaries.
Ms. Ainslie analyzes the particular provisions of the International Foreign Exchange Master Agreement (IFEMA). She notes that a major issue is the extent to which enforceable global master agreements should protect against systemic risk by allowing the handling of a counterparty failure to be based on a net rather than on a gross valuation of the deals under the agreement. She discusses each of the general sections of IFEMA, explaining their significance and interrelationship. Ms. Ainslie notes that any product-specific master agreements can be combined with other product-specific master agreements by the use of an inclusive “master” master agreement.
Mr. Cunningham describes over-the-counter (OTC) derivatives, their uses, and the credit risk management technique for OTC derivatives known as netting. He explains that, although the label “OTC derivatives” encompasses a wide variety of instruments, an OTC derivative in essence is a nonstandardized financial instrument that does not trade through any particular exchange or clearinghouse. He addresses the benefits and risks of OTC derivatives transactions, including certain concerns of regulators: leverage and credit risk. He focuses on the International Swaps and Derivatives Association (ISDA) Master Agreement. Mr. Cunningham considers why netting works under the ISDA Master Agreement. In this area, he refers to the work of the Group of Thirty, the Basle Committee on Banking Supervision, and various governments. He notes that, in the countries represented on the Basle Committee on Banking Supervision, netting is generally the law. In certain jurisdictions that needed clarification, validating statutes have been enacted. In others, legal opinions provide the basis for their acceptance.
Mr. Raisler focuses on the risks of derivatives. He lists seven risks that are associated with derivatives: legal risk, credit risk, market risk, liquidity risk, operational risk, reputation risk, and systemic risk. He points out that an important finding of a Group of Thirty report on derivatives is that the risks of derivatives are fundamentally no different from the types of risks associated with traditional instruments, including loans, securities, and deposits. He recommends that the senior management of any institution investing in derivatives set the standards by which that entity will engage in derivatives and manage the program that it will implement. Mr. Raisler analyzes each of the risks associated with derivatives. Finally, he addresses an additional risk that he describes as the potential for legislative or regulatory risk overreaction.
Mr. Welshimer considers the general concepts underlying securitizations, the factors that have influenced their growth and development, and the benefits and risks to financial institutions and other parties that participate in the securitization process. He defines this process as taking relatively illiquid assets originated by financial institutions and repackaging them into securities that can be sold to capital market investors. The effect is a form of disintermediation that replaces traditional bank lending funded by deposits with funding of the same assets directly by the capital markets. In part, the motivation for securitization is the desire of banks to reduce assets (and the required capital related thereto), to manage risk and generate fee income. Mr. Welshimer describes various kinds of securitizations. He concludes that securitization has been a great success in the United States and foresees that developments in U.S. securitizations over the next few years will increase the efficiency of the transactions. He notes that markets elsewhere are developing rapidly.
Mr. Giovanoli begins by defining the term “netting” as an agreed off-setting of positions or obligations by trading partners or participants in a system. He notes that interest in netting schemes and arrangements has focused on payment systems and contractual commitments, mainly in connection with derivatives and foreign exchange transactions. He then provides a general overview of the legal issues raised in connection with netting. He describes the origin and scope of netting. Next, he points out the need for central banks to oversee payment systems, with a view to ensuring their smooth and efficient functioning, as well as their integrity and stability. He distinguishes between gross settlement systems and net settlement systems and explains netting of contractual commitments and netting of payments. Mr. Giovanoli considers the risks involved in payment systems and how those risks can be reduced. National legislation and international initiatives, including initiatives of the Basle Committee and the European Union, are reviewed. In conclusion, he emphasizes the need for international harmonization of legislation on netting and payment systems.
Mr. Cohen notes that the principal systemic risk preoccupying central banks is settlement risk in respect of large-value payments. Some observers have proposed that all large-value payments should be made on a real-time gross settlement basis. He discusses the problems associated with this solution, including the costs to the private banking system of collateralizing such a system in accordance with central bank requirements. He surmises that, notwithstanding the flaws of real-time gross settlement, the systemic concerns over settlement risk are so great that they are likely to prompt comprehensive real-time gross settlement unless settlement risk can otherwise be reduced to an acceptable level. Mr. Cohen then turns to the principal means to effect that reduction: legally binding netting on an international basis. He notes that the key question is whether it is possible to construct a netting scheme that is binding in all relevant jurisdictions. He believes that the only way to achieve the necessary level of certainty is a legislative solution on an international level, perhaps involving a model law to be enacted by participating countries by way of a treaty. He states that the U.S. experience illustrates the need for uniform, multijurisdictional legislation. He describes U.S. legislation that was needed to provide legal certainty with respect to netting.
Mr. Cohen addresses several legal issues arising in the context of legislated validation of netting arrangements: the scope of the netting legislation in terms of the institutions covered; bilateral versus multilateral netting; the obligations covered; the use of one or more currencies; obligations of different maturities; the degree of flexibility accorded to the central bank in administering netting legislation; the degree of specificity of the structural requirements for valid netting; conflict of laws; and the question of whether a netting contract should apply just to the local branch of an international bank operating outside its home country or to the entire bank. Finally, Mr. Cohen makes two points. First, if there is legally binding netting, it should be treated as such for purposes of the Basle capital guidelines. Second, in any payment system, there must be legal finality of payment.
Mr. Patrikis examines the concept of delivery against payment with regard to securities transfers. He describes how securities transactions were completed in the past with physical delivery of the certificates and compares the book-entry systems of today. He analyzes several types of delivery against payment systems. Reference is made, among others, to the Fedwire Clearing House Interbank Payments System (CHIPS), the Participants Trust Company, and the Central Gilts Office. Mr. Patrikis refers to the function of the central bank in the payment system, noting the Federal Reserve’s role through Fedwire in extending daylight overdraft credit in the context of a real-time gross settlement system that provides securities against payment for federal government securities.
Ms. Fisher reviews the work of the Group of Ten central banks in the area of securities transfers. She points out that almost all securities transactions occur through intermediaries and that, as each intermediary is added to the process, new legal relationships are created that carry new risks. Another problem is that issuers and investors have no choice about the clearing and settlement mechanisms that are used. In addition, she notes that in a cross-border environment the issues that arise in the systems are compounded by questions of choice and conflict of laws. She explains the difficulties that investors face in trying to protect themselves from risk when they do not know which intermediary is involved, where it is located, and what country may claim jurisdiction over the transaction. She notes that there are two different types of schemes into which book-entry securities may be fitted: the legal regime applicable to physical securities, and special schemes that explicitly recognize electronic securities. Finally, Ms. Fisher refers to the complex issues that can arise from the insolvency of intermediaries on the international scene.
Mr. Lorne provides two illustrations of why securities clearance and settlement are of interest to central banks. First, he describes the decline of security prices on, and consequent temporary closure of, the Hong Kong stock exchange in October 1987 and the “rescue package” that was put together by the authorities, the banks, and the brokers to reopen the exchange by lending to the guarantee corporations. Second, he reviews the circumstances surrounding the bankruptcy of the Drexel Burnham Lambert Group in New York in February 1990, which did not encompass that firm’s broker-dealer or government securities subsidiaries. He explains how these examples illustrate the importance of the legal and practical aspects of securities clearance and settlement. Then, he asks what can be done to reduce the risks involved in the securities clearance and settlement system. He focuses on three approaches: shortening the settlement cycle, demobilizing or dematerializing securities, and creating and improving netting systems. Mr. Lome states in conclusion that securities regulators and central bankers must work together to address the issues involved in improving the clearance and settlement system.
Mr. Houpt examines the emerging international capital standards, particularly standards for market risks arising from the trading activities of banks. He reviews two risk-measurement techniques considered by the Basle Committee on Banking Supervision: one based on a so-called standard approach that applies risk weights to various trading positions, and another based on the results of a bank’s own internal models. He describes the 1988 Basle Capital Accord, which addressed credit risk—the risk that a borrower will default on its obligation and not repay the bank. Mr. Houpt notes that it did not address other important risks that banks face. One important risk is that evolving market conditions, such as changing interest rates or changes in the prices of equity instruments that banks trade, may affect a bank’s financial strength. He describes the work of a subgroup established by the Basle Committee to address these matters. He reviews proposals concerning the supervisory treatment of market risks and the supervisory recognition of netting for capital adequacy purposes. In conclusion, Mr. Houpt offers some general observations on the process of developing such standards.
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I would like to express my gratitude to Pamela Bickford Sak of the Legal Department and Thomas Walter of the Fund’s External Relations Department for expert editorial assistance, and to Jai Oh of the Legal Department and to Jennifer Johnson, research assistant, and Aradhana Kumar and Michael VanHuysen, interns, who lent their efforts importantly to the publication of this volume. Thanks also go to Clare Huang, my assistant, who contributed both to the seminar and to the publication of its proceedings. Several members of the Fund’s Graphics Section also made important contributions: Philip Torsani designed the cover, and Julio R. Prego and Victor Barcelona typeset the text. Additional assistance was provided by Renee LaDue Bergfalk, Miriam Camino-Wolosky, Thet Mon Mya, Michael P. Filippello, and Steven Williams. Finally, I am indebted to Francois Gianviti, General Counsel of the International Monetary Fund, as well as to Ian McDonald of the Fund’s External Relations Department, and to members of the IMF Institute, who, through their guidance and support, made this project possible.
Robert C. Effros