Current Legal Issues Affecting Central Banks, Volume V

Chapter 5 Cross-Border Electronic Banking: Perspectives on Systemic Risk and Sovereignty

Robert Effros
Published Date:
May 1998
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Two Macrolevel Challenges

The interaction between electronic technology and international banking raises macrolevel challenges that involve a complex mix of finance, law, and policy. This chapter focuses on two broad classes of challenges: systemic risk and sovereignty.2 The first challenge is whether cross-border electronic banking has rendered the international banking system inherently more volatile. Are international banking transactions inherently more risky now than, for example, 20 years ago? In other words, this challenge raises a fundamental systemic public policy concern: To what extent do cross-border electronic banking transactions exacerbate systemic risk?

The second challenge is whether cross-border electronic banking has eroded the sovereign autonomy of central banks to conduct their own banking policies. Are central banks now captive to a technologically driven system? No member of the international banking community doubts that it is the responsibility of each government to safeguard its banking system. Even Adam Smith, in The Wealth of Nations, would appear to accept financial system regulation as a legitimate function of government.3 Of course, Smith could not have anticipated electronic foreign exchange trading, electronic data interchange (EDI), or the Internet. Never before has the difficulty of central banks to keep pace with change been so obvious. This difficulty raises another significant public policy concern, What is the appropriate role of a central bank that finds itself perpetually “behind the curve” of developments?4 Should it, for example, promote market-based self-regulation?

This chapter addresses, in a preliminary fashion, the systemic risk and sovereignty challenges posed by cross-border electronic banking. First, the meaning of “cross-border electronic banking” is explained. Second, cross-border electronic banking and systemic risk are addressed. The chapter argues that electronic technology is both part of the problem and part of the solution. The third part of this paper focuses on the impact of cross-border electronic banking on sovereignty. It maintains that electronic technology has indeed undermined the autonomy of central banks. The last part sets forth conclusions.

Defining the Terms: What Is Cross-Border Electronic Banking?

Bank use of computer and other electronic technologies is a dramatic development in how banks do business. All of the transactional, legal, and policy implications of this use are not yet clear. The following two parts of this chapter address some of the key implications, but to understand them it is first necessary to agree upon a definition of cross-border electronic banking.

Cross Border

The term “cross border” is not problematical. It simply conveys the notion of transcending a geopolitical boundary that divides two or more countries. The challenge is to construct a definition of “electronic banking” that accurately encompasses the dizzying array of contemporary technologies used by banks.

Electronic Banking: Financial and Commercial Purposes

A starting point is to classify the variety of purposes for which banks use electronic technology. Two broad categories exist: financial and commercial. The financial category pertains to the trading, on a principal or agency basis, of financial instruments. For example, banks use electronic technology to trade in the foreign exchange and securities markets. The following two parts of this chapter focus on the financial category. Nonetheless, the commercial category is equally significant. The commercial category pertains to trading goods, that is, physical commodities from mangoes to microprocessor chips. Banks use electronic technology to facilitate their roles in commercial transactions. For instance, they use it to transfer funds by wire and transmit shipping documents, such as bills of lading.5

Three features of electronic technology make it possible for banks to use this technology in financial and commercial transactions. First, the technology offers banks the ability to conduct transactions with great speed. For instance, through an electronic direct dealing system, the terms of a spot or forward foreign exchange trade can be negotiated and agreed in seconds. In part, increased transactional speed results from the elimination of paper. Consider the settlement of a spot or forward foreign exchange transaction. Assume, as is usually the case, that the currencies in a spot or forward foreign exchange transaction are delivered through a real-time gross settlement (RTGS) payments system. In such a case, the appropriate amounts of bank credit denominated in the relevant currencies are transferred in seconds. In other words, neither is physical currency delivered nor are paper-based negotiable instruments exchanged. Rather, bank credit is swapped.6

Second, electronic technology allows banks to store, transmit, reproduce, access, integrate, and manipulate voluminous amounts of information. For example, through an electronic direct dealing system, counterparties to a spot or forward foreign exchange trade can exchange all contractual terms and settlement instructions. Again, the elimination of paper makes it easier to handle large databases.

Third, the technology reduces bank operating costs. Once again, this positive feature results in part from the elimination of paper. Indeed, studies indicate that cost savings range from $5-$50 a document.7

Electronic Banking

Electronic banking involves the dematerialization of banking transactions.8 Data in paperless form are exchanged. Accordingly, electronic banking may be defined as the computer-to-computer exchange of information or value in a predetermined format.9 Actually, this definition applies to a concept even broader than electronic banking, namely, EDI. Electronic banking may be thought of as EDI involving banks.

There are two key parts to the definition. First, the definition suggests a network of two or more computers linked together. Typically, the linkage makes use of telecommunications lines. Interestingly, in 1995 for the first time, data transmitted via the world’s telecommunications lines exceeded voice traffic over such lines.10 In other words, telecommunications systems are now used more for data exchange than telephone calls. As a result of this linkage, the computers “talk” directly to one another, as in the electronic direct dealing example above.

Second, the definition of electronic banking indicates that the data exchanged by the computers appear in a preset format. This format can be recognized by the computers and their bank users. In turn, the format is based on a software program tailor-made for a particular use, such as trading currency spots and forwards.

Of course, in thinking of electronic banking as EDI involving banks, an important caveat should be remembered. As the definition suggests, electronic banking involves the computer-to-computer exchange of information or value. The settling of a foreign exchange trade through an RTGS system illustrates the importance of the latter. In an RTGS system, such as Fedwire, a payment order is not merely information, but is also value. It represents the transfer of bank credit from one account to another by computer. Simply, in an RTGS system, the message is the money,11 and the definition of electronic banking needs to accommodate this fact.

Systemic Risk

Cross-Border Electronic Banking as Part of the Problem

Recent crises create the impression that cross-border electronic banking makes the international banking system inherently riskier than before. More potentially serious problems occurred between 1991-95 than in the previous years of the post-World War II period.

Making Matters Worse?

In 1991, the Bank of Credit and Commerce International (BCCI) collapsed. In 1992-93, the Bank of England was forced to suspend the participation of the pound sterling in the European exchange rate mechanism. In 1994–95, the Mexican peso crisis and the subsequent “tequila effect” occurred. In 1995, Barings collapsed and Daiwa’s treasury loss scandal unfolded. In contrast, between the end of World War II and 1991, there were two key events of such magnitude: the death of the gold standard in 1971 and the Third World debt crisis of the 1970s. To be sure, 1991 is not the year the computer revolution began, and the 1991-95 calamities cannot be blamed solely on cross-border electronic banking. However, computing power and speed have accelerated in the 1990s, and there appears to be a widely held view that such power and speed “make matters worse.”

For example, cross-border electronic banking seems to increase the potential scope of a crisis. Every day, this technology is used to process $2.8 trillion worth of funds transfers in the computers of the Federal Reserve Bank of New York and to support over $1 trillion of turnover in the foreign exchange markets.12 In contrast, a “big” day on the New York Stock Exchange is $14 billion. Also, by way of contrast, the total value of world trade of goods and services in 1995 was approximately $6 trillion.13 Thus, roughly every two days the value of world trade goes through Federal Reserve computers, and about every week that value is transacted electronically in currency markets. In brief, electronic technology facilitates increases in the magnitude and speed of banking transactions. Moreover, electronic technology increases linkages among markets. For instance, dollars transacted in the currency markets are delivered through the New York Clearing House Interbank Payments System (CHIPS) or Fedwire. Hence, the currency markets are integrally linked with the payment system.14

Systemic Risk and Its Components

Is the popular belief that cross-border electronic banking makes matters worse correct? An affirmative answer is in order. Cross-border electronic banking has fundamentally and irreversibly altered perceptions of systemic risk. Systemic risk is conventionally defined as the risk that the failure of one bank will cause failures of that bank’s counterparties, that is, create a domino effect. However, this definition is incomplete in two respects. First, bank failures have implications for the real economy. Systemic risk should be thought of as the risk that a disruption in the financial system, of whatever origin, will cause not only multiple bank failures but also a disruption in the real economy.

Second, the conventional definition glosses over the components of systemic risk. There are six such components:

  • credit risk, which is the risk of counterparty default (for example, the 1974 failure of the German Bankhaus Herstatt to deliver currency in a foreign exchange transaction);

  • market risk, which is the risk of a substantial decline in the value of a group of assets that forces a bank to absorb a serious loss (for example, in consequence of the 1987 U.S. stock market crash);

  • market liquidity risk, which is the risk that liquidity in a market or group of markets evaporates so that a bank cannot sell its positions without incurring serious losses (for example, the inability of a bank to sell an exotic derivative);

  • payments or settlement risk, which is the risk of a disruption or failure in a payment or settlement transaction (for example, delivering funds or securities or in an entire payment or settlement system, for example, CHIPS or Euroclear);15

  • operational risk, which is the risk that a bank’s computer system will go down (for example, the 1985 failure of the Bank of New York’s computer system for delivering government securities);16 and

  • legal risk, which is the risk that an outstanding transaction does not fit within the law (for example, the English Hammersmith case in which it was held that a U.K. local governmental authority lacked legal authority to enter into swap contracts).17

During an international banking crisis, these six types of risk may coexist and “melt together.” Moreover, they may materialize not only in the Group of Ten countries but also in increasingly important trading centers such as Hong Kong, Singapore, and Kuala Lumpur. There are perhaps 20-30 countries important enough in the international banking system so that a disruption in any one of them could create systemic risk difficulties throughout the world.

Implications for Market Liquidity Risk, Settlement Risk, and Operational Risk

Cross-border electronic banking has especially significant implications for three of the components of systemic risk: market liquidity risk, payments and settlement risk, and operational risk. With respect to each component, electronic technology creates a false sense of comfort based on its ostensible invincibility. Consider market liquidity risk. Electronic technology causes every bank to believe that the bank can be “the first one out the door” to sell assets when necessary. This belief creates the illusion that every market is sufficiently liquid to support rapid sales of large volumes. In fact, liquidity depends on the number of ready, willing, and able buyers, not on the mere technological ability to sell.

Similarly, banks may understate settlement risk because of faith in the power of electronic clearing and settlement systems. Recall the many preparations that CHIPS takes against settlement failures, from posting additional collateral, to guaranteeing receiver finality, to conducting periodic stress and casualty tests. These precautions, which are essential, help create an aura that CHIPS will not fail to settle, that is, that the unwind scenario contemplated in the United Nations Model Law on International Credit Transfers18 and Uniform Commercial Code Article 4A on Funds Transfers19 will not occur.20 Yet, like nuclear war, the consequences of this very low probability event could be devastating. Consider what might have happened if Barings had not fulfilled its obligation to pay roughly $850 million in margin payments to the Singapore Monetary Exchange (SIMEX) or to the Tokyo Stock Exchange (TSE) after its Nikkei stock index futures losses were disclosed. Might SIMEX and the TSE have gone insolvent? The same issue arose with respect to the Options Clearing Corporation after the 1987 U.S. stock market crash.

Operational risks associated with cross-border electronic banking may increase in proportion with the sophistication of that technology. The more moving parts in a mechanism, the more opportunities for a part to break. Likewise, the greater the number of lines in a computer program, the higher the chance of a “bug” or “glitch.” It only took one glitch in 1985 to prevent the Bank of New York’s computers from properly executing government securities transactions. That glitch led to the record $23 billion loan, made at 2:15 a.m. from the discount window of the Federal Reserve Bank of New York.21 Yet, as with market liquidity and settlement risk, there may be an unrealistically low appreciation of operational risk in the international banking system.

Cross-Border Electronic Banking as Part of the Solution

While electronic technology distorts perceptions about market liquidity, settlement, and operational risk, it is also a key to a safer, sounder international banking system. It offers the prospect of more accurate monitoring of market risk and perhaps even reductions of this component of systemic risk. Indeed, any internationally active bank must develop state-of-the-art risk-management systems to measure market risk. It must, for example, monitor all of its transactions in real time and compute financial instrument values each day on a mark-to-market basis. For instruments that have no market, such as exotic derivatives, the bank must have realistic valuation models.

Private Risk-Management Systems

Risk-management systems are made possible by electronic technology. The key question that every bank must answer is, What is the maximum loss that the bank can reasonably expect to incur from its portfolio of financial instruments? The only way to answer this question is through a sophisticated computer model that measures the amount of earnings or capital that a bank stands to lose as a result of each of its transactions, that is, a value-at-risk (VAR) model. J.P. Morgan’s RiskMetrics computer software is an example. J.P. Morgan freely distributes this software on diskette along with a brief summary and detailed technical booklet. A bank can modify the standard VAR model to suit its needs.

Fortunately, the Basle Committee on Banking Supervision (commonly known as the Basle Supervisors Committee) recognizes the importance of risk-management systems devised by financial services firms such as J.P. Morgan. In January 1996, the Basle Supervisors Committee published a market risk capital adequacy amendment to the 1988 Basle Capital Accord.22 This amendment allows banks to calculate the amount of capital that they must maintain to absorb losses arising from market risk by following a standard methodology devised by the Basle Supervisors Committee. Alternatively, banks can adhere to their own risk-management methodology, as long as it meets certain qualitative and quantitative standards devised by the Basle Committee. The qualitative and quantitative standards help to ensure that a bank-designed risk-management methodology is flexible enough to allow a bank to function profitably and rigorous enough to prevent the bank from operating in an unsafe and unsound manner.

For the first time in the history of international banking law, the Basle Supervisors Committee has granted banks the ability to self-regulate: the Committee accepts the validity of computer models designed and implemented by banks for the purpose of calculating regulatory capital. In effect, the Committee has been forced to acknowledge two realities. First, central banks cannot rely on physical books and records to measure market risk. Second, practicing commercial bankers, not bank regulators, are in a better position than regulators to devise computer-driven risk-measurement systems.23

In sum, improved private market risk-management systems may help reduce the perception that cross-border electronic banking “makes matters worse.” Further, such systems might lead to more accurate perceptions of market liquidity, settlement, and operational risk. In other words, electronic technology already is part of the solution with respect to market risk, and soon it could help reduce other components of systemic risk.

Nontechnological Answers

Of course, electronic technology, such as the VAR model, is a necessary but not sufficient answer to problems associated with cross-border electronic banking. As a March 1995 report of the Derivatives Policy Group (DPG) correctly points out, internationally active banks ought to disclose fully to regulators the risks incurred from financial transactions.24 Moreover, the DPG report calls upon banks to develop state-of-the-art management controls.25 For instance, the trading and price verification functions of a bank must be entirely autonomous. Senior bank management must take a hands-on approach to understanding what is happening on all of the bank’s trading floors around the world. It is unacceptable to allow a trader in Singapore to “dance to his own tune.” The lack of disclosure, separate functions, and senior management involvement were contributing factors in the Barings and Daiwa affairs; in both cases, disclosures were not made to regulators, and a “rogue” trader or traders were responsible for pricing financial instruments.

To be sure, it is expensive for a bank to maintain a rigorous regulatory disclosure system, and separate trading and pricing functions. Accordingly, it is possible that in the next five to ten years there will be a substantial decline in the number of commercial banks that are truly global, that is, that have a broad-based presence with a broad-based range of services in a broad number of locations. Perhaps only 15-20 institutions will be able to afford the high cost of being a global bank.


Cross-Border Electronic Banking and Runs on Countries

The conventional “nightmare” scenario of a central bank (or, perhaps more accurately, a deposit insurer) is a “run” on a bank. Now, this nightmare scenario is magnified: in part as a result of electronic technology, it is possible for a run on a country—that is, a country’s currency—to occur. The 1994-95 Mexican peso crisis and 1992-93 chaos in European currency markets are cases in point. In both instances, private currency traders exhausted the resources and stamina of central banks. Their victory over the central banks is well documented by Gregory J. Millman in The Vandals’ Crown.26 This victory was made possible by cross-border electronic banking technologies. Traders could sell pesos, pounds, and francs so quickly and in such large volumes that central banks could not possibly control the markets, or even stem or reverse market trends.

Autonomy and Discipline

These cases suggest that the autonomy traditionally enjoyed by central banks is under siege from banks employing sophisticated computer programs to buy and sell vast amounts of financial instruments in short periods of time. Electronic technology available to, and even developed by, banks undermines the ability of central banks to manage trading prices and volumes. Every central bank must worry about a run on its currency. If such a run occurs, then a central bank has two unattractive choices: (i) allow its currency to depreciate significantly, which harms importers and can cause import-driven inflation, or (ii) raise interest rates, which may make its currency more attractive to foreign investors but also damages the domestic economy.

Interestingly, the vulnerability of central banks to currency market forces resulting from cross-border electronic banking may not constitute an entirely unwelcome development. To the contrary, cross-border electronic banking facilitates the ability of markets to impose economic discipline on countries. A central bank can prevent a run on its country’s currency only through sound and transparent monetary and exchange rate policies.27 A central bank that fails to engage in such policies risks swift reaction from traders using computers, telephones, faxes, and other electronic communication networks. In brief, cross-border electronic banking technologies provide markets with the means to penalize rightly a central bank that does a poor job of managing its economy.

Cross-Border Electronic Banking and Traditional Jurisdictional Bases

Cross-border electronic banking has far-reaching implications for the jurisdiction of a central bank to regulate the affairs of banks. In brief, it threatens to erode traditional bases for assertions of jurisdiction. These bases are derived from public international law doctrine.

Jurisdiction as Power

As a threshold matter, the core idea behind jurisdiction is power and, in the banking context, the power of a central bank to regulate transactors and transactions. Jurisdiction is a critical element of the authority of a central bank. There are three categories of jurisdiction: prescriptive, adjudicatory, and enforcement.28 Prescriptive jurisdiction refers to the power to make rules, that is, to legislate. It raises the following questions, What is the scope of application of a central bank rule? On what banks and transactions is the rule binding? Adjudicatory jurisdiction pertains to the power to hear and render decisions in disputes. It raises the following question, Does a central bank have authority to subject a bank to the central bank’s adjudicatory process? Enforcement jurisdiction concerns the power to enforce rules and decisions. It raises the following question, Can a central bank use its resources to induce or compel compliance with its regulations and decisions?

The Territorial, Effects, and Nationality Principles

Public international law doctrine answers these questions through principles or bases that a central bank can invoke to claim prescriptive, adjudicatory, or enforcement jurisdiction. These principles relate to (i) territorial, (ii) effects, and (iii) nationality.29 In order for a central bank to have prescriptive, adjudicatory, or enforcement jurisdiction over a crossborder electronic banking transaction, or the transactors, it would have to be able to invoke successfully one of these bases. In considering each basis, the key question is the impact, if any, of cross-border electronic banking.

This question, and the tension it raises, can be explored by using the following hypothetical case. The case involves a yen-U.S. dollar foreign exchange transaction between Indian and Malaysian banks. The deal is negotiated through an electronic direct-dealing system owned by a U.S. company. The trade is settled over the wire transfer systems in the United States and Japan. Which central bank has jurisdiction over this transaction? Should the Board of Governors of the Federal Reserve (the Federal Reserve) and the Bank of Japan have jurisdiction because the trade involves dollars and yen and because CHIPS, Fedwire, and the Bank of Japan Netting System (BOJNET) are used? Should the Reserve Bank of India and Bank Negara Malaysia have jurisdiction because the counter-parties are from those countries? Should the transaction be segmented in some fashion so that different central banks have jurisdiction over different parts of the deal?

First, consider the territorial principle. It indicates that a state has jurisdiction with respect to conduct that wholly or substantially takes place within its territory or the status of persons and interests present within its territory.30 The difficulty in invoking this jurisdictional basis in the context of electronic banking is the cross-border and intangible nature of such banking. By definition, such banking entails a disregard for artificial boundaries and a dematerialization of documents. Yet, the territorial principle seems rooted in a physical approach to jurisdiction—jurisdiction turns on whether the purported object thereof exists within the given boundaries. The hypothetical case suggests that no one central bank has jurisdiction over the entire transaction. The transaction takes place in the jurisdictions where the banks are located, where settlement occurs, and—because airspace or undersea and land lines are used—wherever electronic signals pertaining to the transaction pass. This case strikes at the heart of the jurisdictional authority of a central bank. After all, the rationale for the territorial principle is that a sovereign ought to have exclusive and absolute control over its territory. However, the cross-border electronic foreign exchange trade ignores territory and creates little (if any) paper trail.

Second, consider the effects principle, which is an aspect of jurisdiction based on territoriality. It has two dimensions. A state has jurisdiction over conduct occurring outside its territory if that conduct only has effects (or is intended to have an effect) within its territory.31 Conversely, a state has jurisdiction over conduct occurring inside its territory even if that conduct only has effects (or is intended to have an effect) outside its territory.32 The two dimensions of the effects principle noted above are formally known as the “objective” and “subjective” territorial principles, respectively.33 With respect to the hypothetical case, both dimensions of the effects principle could justify assertions of jurisdiction by the Federal Reserve, Bank of Japan, Reserve Bank of India, and Bank Negara Malaysia. Each central bank could claim legitimately that an action occurring outside its territory affected its banking system or that an action occurring in its banking system had effects overseas. Thus, the effects principle is not helpful in sorting out who has jurisdiction because it answers “everybody.” In turn, it may be argued that cross-border electronic banking challenges the uniqueness of a central bank’s sovereignty. The effects principle amounts to an extension of the territorial principle. The essential underlying notion is that sovereignty (and central bank authority) are diminished if a sovereign (or its central bank) cannot control activities that impact on, or originate in, its territory. However, if all of the central banks have jurisdiction based on the effects principle, then the claim is hardly unique.

The nationality principle is a third basis for deciding who has jurisdiction in the hypothetical case. This basis is straightforward: a state has jurisdiction over its nationals, which include juridical as well as natural persons, regardless of their location in the world. Accordingly, the Reserve Bank of India and Bank Negara Malaysia have nationality-based jurisdiction over the affairs of the Indian and Malaysian banks, respectively. However, this result may not be completely satisfying because it entails a split of jurisdiction over what may be viewed as a single, integrated transaction. Moreover, depending on the corporate form of organization (that is, branch versus subsidiary) of the counterparties and the location of any parent company (that is, inside or outside India and Malaysia), other central banks also may have jurisdiction.34

Lex Monetae

In addition to the territorial, effects, and nationality principles, a fourth principle, lex monetae, may pose solutions to the jurisdictional issues. This Latin term essentially means “the law of the currency.” This principle has been recognized as a basis for jurisdiction to prescribe in the context of a country’s power to regulate its own currency.35 The idea is that a country or its central bank can claim jurisdiction over a transaction if the transaction is conducted in its currency. Thus, for example, the United States could assert an authority to freeze all dollar-denominated assets, wherever located and regardless of who holds them, because those assets are denominated in U.S. dollars.

However, this example illustrates the unreasonableness of unduly extending the concept of lex monetae. Could the United States freeze Eurodollar accounts in the Sumitomo Bank branch in London? As the Libyan Arab Foreign Bank36 litigation in the United Kingdom demonstrated, the United States had a difficult enough time freezing a Eurodollar account in the London branch of an American bank. No U.S. dollar asset holder would be safe from the limitless extraterritorial reach of U.S. jurisdiction. Not surprisingly, public international law doctrine does not recognize lex monetae as a legitimate basis for jurisdiction. As Sir Joseph Gold has written:

There is no principle that because a country may regulate its currency, the country has legislative jurisdiction over all payments and transfers made in the currency. There is no more substance to such an alleged principle than there would be to the contention that under private international law the law of a country governs all obligations expressed in the currency of the country as the so-called lex monetae.37

All bases for jurisdiction are subject to a general requirement that they be reasonable.38

Lex monetae may be more readily defensible if it is qualified. For example, suppose the Federal Reserve took the position that dollar funds transfers ultimately are cleared and settled in the United States because such transfers cross the books of the Federal Reserve Bank of New York.39 To be sure, scholars might contest the correctness of this position.40 Nonetheless, a logical inference from the Federal Reserve’s position would be that, in this context, lex monetae is nothing more than the territorial principle. Indeed, apparently it is this inference that the Federal Reserve seeks others to draw from its policy statement on privately operated large-dollar multilateral netting systems.41 The policy statement indicates that it is “directed toward any privately operated, multilateral netting system that settles … U.S. dollar obligations through payments affecting one or more accounts at Federal Reserve Banks, either directly or indirectly.…,”42 Accordingly, an offshore dollar clearing and settlement system that uses the books of a non-U.S. bank with no link to Fedwire or CHIPS would appear to be outside of the scope of the policy statement.

The Consent Principle

The failure of the territorial, effects, and nationality principles to resolve with certainty and predictability the jurisdictional problem in the hypothetical case, and the controversy surrounding the assertion of lex monetae, highlights the need to place renewed emphasis on a different approach to jurisdiction, namely, the consent principle. This principle is an accepted part of public international law doctrine and a suitable basis for jurisdiction in the cross-border electronic banking context.

The consent principle provides that a state has jurisdiction to prescribe and enforce a rule of law in the territory of another state to the extent provided by international agreement with the other state. It seems unwise to recharacterize the hypothetical foreign exchange transaction as a series of elementary steps simply to support multiple jurisdictional claims. In fact, the transaction is a single, integrated one: the terms of the deal, such as the exchange rate and amount, events of default, collateral or other security arrangements, and settlement instructions, are integrally related to one another. The more prudent route appears to be an a priori multilateral jurisdictional agreement among central banks, that is, jurisdiction based on consent.

Such an agreement (which could be negotiated under the auspices of the International Monetary Fund) might consist of three basic parts. First, the agreement could specify the types of cross-border electronic banking transactions to which it applies. It could define these transactions in terms of the financial and commercial categories addressed previously in this chapter. Second, the agreement could articulate tests to establish which central bank would have jurisdiction over a given type of transaction. These tests would resolve the difficulties identified above with the traditional territorial, effects, and nationality principles. They would, moreover, ensure that at least one central bank has a bird’s eye view of a transaction at issue. Third, the agreement would commit central banks to share information with one another in order to facilitate the exercise of jurisdiction by a single central bank in a particular case. This commitment could resemble the information-sharing guidelines that the Basle Supervisors Committee published in the wake of the BCCI affair.43 The agreement need not necessarily intrude on the nascent self-regulatory initiatives of the Basle Supervisors Committee. The agreement simply would spell out which central bank has primary regulatory jurisdiction in the event that it becomes necessary to exercise such jurisdiction.


Cross-border electronic banking connotes dematerialization, that is, the computer-to-computer exchange of data in preset formats. Banks use electronic technology to facilitate their roles as intermediaries and participants in trading financial instruments and foreign exchange. This technology may exacerbate certain components of systemic risk, namely, market liquidity, settlement, and operational risk. However, the technology also offers banks the ability to better monitor and perhaps even reduce market risk. Electronic technology facilitates runs on countries and challenges traditional concepts of jurisdiction. Nevertheless, it also highlights the need for central banks to redouble their efforts to reach agreement on supervising cross-border electronic banking transactions.

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