Current Legal Issues Affecting Central Banks, Volume V


Robert Effros
Published Date:
May 1998
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The issue of sharing information between supervisory authorities has some practical implications. This comment examines the topic from the different perspectives of (i) a home country supervisor and (ii) a host country supervisor. In addition, the comment addresses the issue of sharing information across industry lines in cases where a bank is part of a group that has different types of financial services institutions operating within the group.

Home Country Supervisor’s Perspective

Home country supervisors care about sharing information because, in order to supervise an institution effectively, they need to know what business that institution is conducting and how the institution is conducting it. Increasing numbers of banks are expanding their operations across borders. Consequently, supervisors no longer have the same kind of access to the full range of such banks’ books or the information on their operations that they had in a simpler time when banks confined their activities to domestic operations. The principle of consolidated supervision is widely accepted as the appropriate standard by which to supervise banks that operate internationally. Both the home and host jurisdictions are reassured by the fact that some supervisor is looking to see that such institutions are operating both safely and soundly and in conformance with the law. Consolidated supervision depends, to a large extent, on good information about the financial condition and activities of these institutions.

How does the home country supervisor effectively supervise when a bank operates in many countries around the world? There are many different ways. One way is that home country supervisors can ask for and receive information directly from the bank. Home country supervisors can ask for information on the bank’s operations and the operations of its subsidiaries or its affiliates regardless of where they are located. In the United States, supervision is based on on-site examination. U.S. examiners may go to other countries and actually look at the books and records of a branch or a subsidiary operating in that jurisdiction.

There are, however, impediments to getting information either directly from the bank or through on-site visits because local laws may impose restrictions on the bank regarding the transmission of information to the home country supervisor. Some countries do not allow foreign supervisors to enter and examine local entities, even when the local entity is headquartered in another country or owned by a financial institution in another country. Moreover, serious impediments to effective supervision arise from bank secrecy legislation. Some jurisdictions seek to attract business precisely on the basis that they can afford high protection for customer information, and customers may feel very confident about placing their money or investments in those jurisdictions because of the bank secrecy requirements.

U.S. supervisors think that these kinds of local impediments, especially bank secrecy requirements, should not be allowed to interfere with effective, consolidated supervision on a worldwide basis. Such impediments create serious safety and soundness problems if the home country supervisor is not able to obtain information on the foreign operations of its own institutions. They also raise the possibility that certain institutions might use those local secrecy laws not for legitimate reasons of customer confidentiality, but for illegitimate reasons, for example, to hide the criminal activities of customers. Any customer that is acting in a criminal capacity has no legitimate right to expect confidentiality. The U.S. supervisors view these kinds of impediments to the sharing of information as serious issues that should be addressed—whether the impediment is between the institution and the home country supervisor, concerns the home country supervisor’s ability to conduct examinations on-site, or derives from a restriction in the local law preventing the local supervisor from sharing information with the home country supervisor. These impediments are under discussion in the Basle Committee on Banking Supervision. Supervisors are trying to understand and deal with the practical aspects of these problems—how to ensure that they are able to exercise consolidated supervision when local law may give rise to these kinds of restrictions.

Host Country Supervisor’s Perspective

The second aspect of why it is important that supervisors be able to share information among themselves is from the perspective of host country supervisors. In the United States, there are hundreds of foreign banks from over 60 countries. U.S. supervisors do not have the same kind of responsibility with respect to those foreign banks as with U.S. banks. However, U.S. supervisors do have certain expectations about such banks. It is expected that they be supervised properly, adhere to prudential standards, and operate safely and soundly. There should be a home country supervisor looking after each bank to make sure it is adhering to those standards and that it is operating in conformance with the law. The U.S. interest as a supervisor of foreign banks’ branches or subsidiaries located in this country is obvious—they are participants in the U.S. market. Although the U.S. supervisors do not bear responsibility for the consolidated organization, they want to make sure that the participation of such banks in the U.S. market does not affect U.S. customers adversely or have an effect on the U.S. system that might weaken it or create other systemic problems. Consequently, U.S. supervisors have an obvious interest in monitoring their liquidity.

The issues may be different when comparing the entry of a foreign financial institution against its continuing operation in the United States. Once the entity is established, it is especially important for the U.S. supervisors to have good lines of communication with the home country authorities because the U.S. supervisors are only seeing a small part of the entity and could be unaware of larger events that are shaping the destiny of a particular bank. The Barings case is an example of this phenomenon. There were various subsidiaries of Barings operating in different markets, although there did seem to be a true awareness on the part of various local supervisors in Asia that something strange was occurring. The home country authorities in the U.K. apparently were not aware that there was something unusual occurring in the various foreign subsidiaries of Barings. If there had been some kind of agreement, arrangement, or contact, it might have been easier for the authorities in Singapore or Japan to pick up the phone and ask the appropriate authorities in the United Kingdom, “Do you know what is going on? Are you aware of the positions that are being built up in this subsidiary?” Such queries could have caused the U.K. authorities to deal with the head office and determine what was occurring. In these circumstances, the outcome may possibly have been different.1 In summary, there is a need for good lines of communication once an entity is open and operating in one’s market.

In the United States, after the failure of the Bank of Credit and Commerce International (BCCI), the U.S. Congress decided that the real difficulty with BCCI was that no one was looking after the whole organization. Consequently, a statute was adopted that provides that no foreign bank can enter the United States to conduct banking operations unless it is subject to comprehensive consolidated supervision by home country authorities.2 Another provision of that statute is a requirement that before the Board of Governors of the Federal Reserve System can approve an application by a foreign bank to open an office or subsidiary in the United States, the Federal Reserve must obtain adequate assurances from the foreign bank that it will provide whatever information is deemed necessary to be able to determine compliance with U.S. law.3 That provision was put in the law specifically because of the collapse of BCCI.

In implementing this provision, the United States recognizes that there are legitimate home country interests in protecting certain kinds of information. The United States does not want to have an absolute requirement that an organization agree to violate its home country laws before it enters the U.S. market. If, for example, local law prohibits the sharing of information without obtaining the consent of a customer, the Federal Reserve requires the bank to agree to try to obtain the consent of the customer. If there are other kinds of restrictions in local law, the bank is asked to agree to use its best efforts to cooperate in getting those restrictions lifted. Finally, the Federal Reserve usually imposes a condition in its approvals of foreign bank applications that if, in fact, in the future, a foreign bank does not provide it with information that is believed to be necessary for the administration of the law, then the Federal Reserve may terminate the U.S. presence of that foreign bank because it cannot keep its commitment.

When acting on a foreign bank’s application to come into the United States, the Federal Reserve also takes into account whether the home country supervisor is able and willing to share information with it concerning that particular bank. In assessing a foreign bank’s application, U.S. supervisors have found it helpful to be able to look to the home country supervisor and know that, even if there are local laws restricting the bank from sharing information, the home country supervisor is statutorily permitted to share information with host country supervisors. Then, if questions arise as to the nature of a bank’s operations or if in a case such as BCCI there are questions of criminal activity or unsafe practices, the U.S. supervisor can turn to the home country supervisor for information. The host country supervisor is not interested in exercising consolidated supervision over the foreign bank. Rather it is interested in knowing that the home country exercises consolidated supervision and that there are open lines of communication with the home country authorities if information about that applicant is needed.

Cross-Industry Sharing of Information

In today’s increasingly integrated world, there is considerable consolidation among organizations across industry lines. Consequently, there is a need for supervisors to work together when there are various types of financial institutions within a group. Initiatives are under way with the Basle Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO) to facilitate sharing of information between bank supervisors and securities regulators. There is also work under way in the Joint Forum, a group established jointly by the Basle Committee, IOSCO, and the International Association of Insurance Commissioners.

What happens in the international supervisory area when securities and/or insurance activities are combined with banking activities in the same corporate group? The standard of consolidated supervision is only accepted currently in the area of banking. No other financial services industry, such as securities or insurance, has agreed to that principle or has recognized the need for a consolidated home country supervisor, for example, for a securities firm operating cross border or for an insurance company operating cross border. Perhaps that is because the problems associated with those two types of companies are not quite as apparent as the problems that arise when a bank operating cross border fails. Also, in the United States there is still a segmentation of the various financial services industries. Full-service securities organizations have difficulty buying banks, banks have difficulty in affiliating with large investment houses, and banks and their owners—bank holding companies—are generally prohibited from affiliating with insurance companies.

While U.S. supervisors have not confronted this problem, in many countries local laws do not segment the financial services industries at all. It is common for banks to own securities companies or insurance companies, and a holding company may have securities, banking, and insurance subsidiaries. Moreover, because of the changes in the financial services industries, it is increasingly difficult to tell a banking product from a capital markets product or an insurance product. Financial organizations tend to act together to cross market their products in order to offer enhancements in these products. A bank may offer credit enhancement of a capital markets product or on an insurance product, and therefore the fate of a bank in one of these groups could become tied to whether or not the group’s securities or insurance company is prudently supervised. While this has not been a problem domestically for the U.S. bank supervisors, there are U.S. financial groups that operate in foreign countries in all three of these areas. For example, large U.S. investment houses, such as Merrill Lynch or Goldman Sachs, are not regulated as banking organizations in the United States, but they may own bank subsidiaries in other countries.

The issues faced by the regulators of these financial companies are becoming more serious. Multilateral initiatives have been undertaken to try to come up with practical ways that information can be shared across industry lines. This will likely be a greater challenge than it has been in banking. For more than twenty years, bank supervisors have recognized the need to talk with each other. Securities regulators in the past fifteen years through the IOSCO have recognized the need to get together. The International Association of Insurance Commissioners provides a forum for insurance regulators to talk with each other. However, all three of the groups now need to get together and determine how they can help one another. Their common aim is to make sure that the various parts of a financial conglomerate do not create problems for the group as a whole. In this endeavor, policy issues, legal issues, and practical issues will need to be resolved.

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