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delivery
Statement by
Manuel H. Johnson, Jr.
Vice Chairman
Board of Governors of the Federal Reserve System
before the
Subcommittee on Financial Institutions, Supervision,
Regulation and Insurance
of the
Committee on Banking, Finance, and Urban Affairs
United States House of Representatives
March 24, 1987
I am pleased to appear before the Committee today to
discuss with you again the topic of
bank-affiliated
export
trading companies.
In its consideration of the export trading
company
legislation in 1982, the Congress determined that U. S. export
performance was inhibited by the inability of U. S. businesses,
especially
small-
foreign markets
expertise
in
and
for
the
medium-sized
their products
mechanics
of
companies,
due
to
to
their
exporting.
The
develop
lack
of
Congress
therefore sought to promote the establishment of companies that
could supply the necessary expertise in order to assist U.S.
companies in increasing exports of their goods and services.
In enacting the Bank Export Services Act ("BESA"), the Congress
decided that one method by which export trading companies could
be developed was by permitting affiliations with banks through
a bank holding conpany structure.
Now
that
we
have
had
some
experience
with
the
operation of bank-affiliated export trading companies under the
legislation, we thought it would be useful to share information
on that experience with you in connection with the Committee's
consideration
of
company concept.
further
refinements
While a beginning
to the export
has
been
made
trading
in
the
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2
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development of export trading companies as promoters of U.S.
exports,
unfavorable economic conditions have not provided an
atmosphere in which export trading companies can flourish.
Since the passage of the legislation in October 1982,
the Federal Reserve has acted upon 43 notifications by bank
holding
companies
to
establish
export
trading
companies.
Sixteen of these have been acted upon by the Reserve Banks
under authority delegated to them by the Board in 1983.
number represents more than 50 percent of the
This
notifications
processed since the delegation rules were adopted.
The
Board
recently
conducted
a
survey
of
nine
bank-affiliated export trading companies, selected to provide
diversity of size and geographic location of the bank holding
company parent.
to
the
survey,
$21 million,
revenues
For those export trading companies responsive
the
assets
size
ranged
from
$210,000
with the average being $8.2 million,
ranged from
thousand to
¡$18
to
and gross
million,
with
the
average also being $8.2 million.
The activities of these export trading companies were
also quite diverse.
Several were engaged almost exclusively in
transactions involving the purchase and sale of goods,
the
others
services.
received
their
income
largely
from
while
fee-based
The services included transportation; marketing and
consulting; acting as an agent for a Foreign Sales Corporation;
and
trade
financing
services.
The
survey
suggests
that
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3
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bank-affiliated export trading companies are able
broad
range
of
services
under
the
current
to offer
statute
a
and
regulations and a number appear to be operating profitably.
While
trading
results
companies
experienced
some
are
suggest
some
operating
bank-affiliated
successfully/
difficulties.
Of
the
no
longer
operational.
In
a
others
have
43 bank-affiliated
export trading companies of which the Board
14 are
export
received notice/
few
instances,
the
cessation of export trading company activity was related to
changes in the ownership of the export trading company, such as
through acquisitions and mergers.
However,
this performance
has been largely related to the difficulties that bank holding
companies
have
experienced
in operating
an
company.
In addition to poor economic conditions
first years of existence, described below,
diminished
have
also
profit
encountered
unfamiliarity
encountered
companies,
potential,
with
are
the
trading
to
which
trading
in their
resulted in
these export trading companies
start-up
peculiar
export
difficulties
business.
the
resulting
Other
activities
of
from
problems
trading
regardless of how long they have been operating:
for example, a customer breaking the terms of its own trade
agreement,
or the inability of an export trading company to
deliver on a major contract, or inadequate controls over the
trading activities.
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4
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To the extent that the performance of bank-affiliated
export trading companies has been disappointing, it should be
noted that there is no evidence that trading companies without
bank affiliation have been any more successful.
While there is
no comprehensive means of tracking the performance of all these
trading companies, the General Accounting Office,
of
preparing
its
February
1986 Report
Implementation of the Export
conducted
a
obtained
survey
of
certificates
Commerce.
Many
of
23
of
those
Trading
trading
review
firms
in the course
to Congress on the
Company Act
of
1982,
that
had
Department
of
organizations
from
the
reported that business was
disappointing, citing economic factors,
particularly the high
value of the dollar, as the reason.
Although
the experience
of
bank-affiliated
export
trading companies to date has fallen short of expectations,
this
is due primarily
climate
for
exchange
U.S.
rate
for
to
the highly
unfavorable
economic
exports that resulted from, the overvalued
the U.S.
dollar,
the
lack
of adequate
economic growth in foreign industrial countries, and the need
for adjustment in many developing countries.
Therefore,
the
period since 1982 has clearly not been a fair test of the
viability of bank-affiliated export trading companies on which
far-reaching changes in the law should be based.
to the macro-economic
companies,
conditions
faced
by
export
In addition
trading
there are other factors contributing to their slow
development.
It is still a fledgling industry; the oldest of
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the bank-affiliated export trading companies
years old.
is not yet four
Moreover, a review of several articles concerning
bank-affiliated
export
trading
companies
in
recent
years
indicates that the affiliation of two such different corporate
cultures as banking and trading inevitably creates difficulties
in forging a viable and profitable enterprise.
I might add
that the publications generally do not attribute the lack of
success of export trading companies to the Board's regulations,
but rather to the various economic and business factors that I
have mentioned.
In efforts to make
governing
the
operations
of
refinements
to
bank-affiliated
the
legislation
export
trading
companies, which we all see as a desirable effort, it should be
remembered
providing
that
banking
two essential
trading company —
organizations
elements
for
were
a
perceived
successful
as
export
a source of capital and financing and a
network of foreign offices able to evaluate foreign markets and
provide necessary foreign contacts.
The legislation therefore
created a very limited exception to the statutory separation of
banking and commerce in order to achieve the goal of improving
the export sector of the economy.
The BESA was not, as we read
it, intended to let bank holding companies perform every type
of international activity nor to relax to any great extent the
provisions
protecting
Bank-affiliated
assist
other
bank
safety
and
soundness.
export
trading
companies
were
companies
in the
export
their
of
intended
goods
to
and
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6
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services and not to compete with these companies by becoming
themselves producers of services for export.
Moreover, the Act
recognizes that there are activities from which export trading
companies should be explicitly excluded,
activities,
agriculture,
manufacturing.
safeguards
that
dealing
The Act contains
in
such as
securities
commodities,
these
and other
and
important
are intended to maintain the separation of
banking and commerce and
supervisory goals.
to avoid
compromising
significant
These measures were adopted in recognition
that one goal of national
importance —
export promotion —
should not be achieved at the expense of another —
a safe and
sound banking system.
The Board's
designed
to carry
regulations
out
the
implementing
statute's
intent.
the BESA are
Because
the
statute did not focus on promoting trade, but on promoting U.S.
exports through export trading companies, our
regulations are
designed to ensure that such companies engage in trade services
that promote U.S. exports.
As a result, the Board's regulation
requires that 50 percent of a bank-affiliated export trading
company's business must derive from exporting or facilitating
the export of goods and services produced in the United States
by persons other than
subsidiaries.
Under
the export
this
test,
trading
a
company
bank-affiliated
and
its
export
trading company may provide services to any party, foreign or
domestic,
that
is
connected
to
an
international
trade
transaction, as long as the majority of the company's business
is export-related.
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Let me at this point clear up some confusion over one
aspect
of
the
regulations.
50
percent
revenues
A bank-affiliated
test
export
in
the
trading
Board's
company
may
provide services not only to unaffiliated persons,
it can also
help
of
to
promote
the
goods
and
services
of
any
its
affiliates; that activity is considered as facilitating a U.S.
export under the regulation.
For example, an export trading
company could market abroad computer software developed by its
bank
holding
company
parent;
revenues
derived
activity are considered export revenues.
from
that
Thus, contrary to the
perception of some, a bank-affiliated export trading company is
authorized to assist its affiliates in exporting services.
As I have mentioned, one of the fundamental premises
of
the
legislation
is that
bank-affiliated
export
trading
companies will facilitate the export of goods and services of
other U.S. companies and will not engage
activities themselves.
Accordingly,
consistent with the purposes
of
directly
in such
the Board's regulations,
the BESA,
prevent
a bank
holding company, under the guise of an export trading company,
from acting only as a service company for foreigners, that is,
from engaging in a service activity, which might not be even a
trade service, that is provided only to foreign parties.
example
would
sells property
customers.
An
be an insurance company that underwrites and
and casualty
insurance policies
to
foreign
-
This
situation,
in
8
-
which
a bank
holding
company
becomes the producer of the service to be exported,
inconsistent
facilitator
formation
of
of
facilitate
abroad.
with
an
export
exports.
a
The
trading
company's
regulations,
would be
role
however,
as
a
permit
joint venture with an insurance company to
the
sale
of
the
insurance
company's
policies
Therefore, there is a broad scope in the statute and
the regulation for a bank-affiliated export trading company to
provide services in support of exports.
Some of
taken
issue
the
with
legislative
the Board's
proposals
have
implicitly
regulation requiring that 50
percent of an export trading company's business derive from
exports or facilitating exports produced by others.
This is
also the area of current regulation where the most flexibility
is
sought
companies,
by
the
i.e.,
surveyed
in the
bank-affiliated
application
of
the
export
trading
50 percent
of
revenues test.
These legislative proposals would alter the original
intent of the statute in a fundamental way.
The original bill
was intended to promote exports and build an export-oriented
infrastructure
of
trading
companies.
Some of the proposed
legislation would not seem to further those goals.
First, these proposals would permit an export trading
company to count as export revenues any revenues derived from
third country trade.
company
itself
is
The rationale is that the export trading
providing
a
service
and
that
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9
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the third country trade activity does not
hurt
U.S.
balances because it does not involve an import.
trade
Our view is
that such proposals sanction the development of bank-affiliated
trading companies that need not facilitate the export of any
product produced
in the United States at
all.
They
would
permit a trading company to set up foreign companies to provide
a broad range of
services
benefit either to U.S.
to foreign
parties
without
any
jobs or toward developing an export
trading industry that can serve companies that actually produce
goods and services in the United States.
create a movement
export
trade
This approach would
in the opposite direction
services
to
those U.S.
from providing
companies
that
need
assistance in exporting.
Moreover,
it is not readily apparent
claim, third country trade would not harm U.S.
that,
as many
trade.
If a
foreign country is buying computers from Germany, it is not
buying
them
therefore
from
can
the
hurt
United
U.S.
States.
exports,
Third
as
many
country
third
trade
country
transactions are substitutions for U.S. exports.
In addition, by permitting bank holding companies to
invest in any company, regardless of its business, as long as
it offers its services exclusively to foreign customers, the
proposed legislation would put
bank
holding
companies
into
direct competition with other U.S. companies that are intended
to be the primary beneficiaries of the original act,
i.e.,
companies that produce goods and services in the United States
-
which
10
-
with the help of an export trading company could be
exported.
Such a result seems perverse in two ways.
First, it
reduces any incentive on the part of bank-affiliated export
trading
companies
companies.
to market
their
trade
services
to U.S,
Under the proposals, if a bank holding company were
to identify potential projects or markets abroad,
it could
establish a trading company to take on the project or service,
rather than approach U.S. companies either to form a joint
venture to take advantage of the opportunity or to otherwise
assist the U.S. company in exporting its service.
Second,
activities
in
the
which
proposals
a
bank
would
holding
expand
the
company
kinds
may
indirectly through an export trading company.
of
engage
There is already
a statutory and regulatory framework for the expansion of the
operations
outside
of
the
bank
holding
United
States
companies and Edge corporations
that
provides
considerable
flexibility in both activities and investments.
For example,
in some
have
instances,
U.S.
banking
organizations
been
permitted to establish foreign companies that underwrite and
sell
life
insurance.
This
has been done,
however,
under
statutes that allow the Federal Reserve to consider fully the
effect on banks and the banking system,
factors not applicable to the BESA.
taking into account
A radical change in the
authority to conduct activities overseas, such as the proposals
would
provide,
question
of
should be dealt with straightforwardly as a
new
products
and
services
for
banking
11
-
organizations.
-
The Board strongly supports authorization of
some new products and services for bank holding companies but
believes that they should be granted in a direct fashion, and
not through trade legislation, especially where there would be
no benefit to U.S. exports generally.
Although these proposals would shift the emphasis of
the original statute from export promotion to promotion
of
international trade per se by permitting bank holding companies
to engage in general
trading
activities
without
regard
to
promoting U.S. exports, this is of course a matter for Congress
to decide.
exports
The Board's regulations requiring a predominance of
are,
however,
fully consistent
with the intent of
Congress at the time of passage of the BESA.
With respect to the ability of a bank to finance its
affiliated export trading company, the BESA subjects a bank's
extension of credit to an affiliated export trading company to
the provisions
of
section 23A.
As
you
know,
section 23A
requires collateralization for any extension of credit by a
bank to an affiliate, usually in an amount that exceeds the
face amount
of
the extension of credit.
appropriate
in order
to
protect
the
This is entirely
bank.
However,
in
recognition of the need for a bank-affiliated export trading
company to secure funding for its trading in goods, the Board
has provided
a
reasonable
exception
by waiving the excess
collateral requirement for loans by a bank to its affiliated
-
export trading company.
12
-
The regulations require instead that
the bank take a security interest in goods or the proceeds from
the sale of goods that are subject to a contract of sale.
This
measure enables an export trading company to obtain financing
for the activity for which financing is most needed but the
exception does not subject the bank to undue risk.
This
liberalization
of
section 23A's
collateral
requirements is the type of carefully crafted exception to the
provisions of section 23A that we believe is most appropriate
in this context.
It is tailored to the needs of an export
trading company but ensures that the assets of the bank will
not be jeopardized.
The
Board
also
expects
a
bank-affiliated
export
trading company to be capitalized adequately to support its
operations.
There is no regulatory requirement, however, for a
certain capital level.
Each case is evaluated based on its own
facts.
Some
relate
to
of
section
the proposed
23A
and
to
amendments
capital
substantial supervisory concerns.
to the BESA that
requirements
raise
The proposals would expand
the ability of a bank-affiliated export trading company to take
on the equity risk of foreign subsidiaries, clearly increasing
the risk to which the export trading company is subject.
At
the same time, the proposals would reduce the safeguards for
the affiliated bank,
collateral
by exempting all transactions from the
requirements of section 23A and by permitting an
export trading company to be less than adequately capitalized.
-
These
changes
13
would
-
seem
to
be
especially
inappropriate at this time when there is a consensus that bank
affiliates
should
be
subject
to
market
discipline.
An
affiliate should not be able to use a bank's resources —
the federal guarantee for those resources —
except
and
to the
extent permitted by the provisions of section 23A.
As the
Board has consistently stated,
export
if
a bank-affiliated
trading company is creditworthy, it can obtain credit in the
market even from a non-affiliate.
If an export trading company
is not creditworthy, an affiliated bank should not be placed at
risk by being able to lend without collateral.
total
elimination
directly
contrary
Moreover,
a
of
section 23A collateral requirements is
to
the
legislative proposals,
approach
which would
taken
in
actually
other
recent
strengthen
the
protection available to the bank.
As
I have previously
stated,
the Board
has
been
willing to be flexible in its approach to section 23A as it
applies to loans to bank-affiliated export trading companies
but only where the bank will not be adversely affected.
cannot
support
any
proposal
that would permit
We
a nonbank
affiliate to drain the resources of the bank in pursuit of its
business.
With
respect
to
capitalization,
some
of
the
legislative proposals would permit an export trading company to
operate with a capital to assets ratio of 4 percent.
That
ratio would be low for most trading companies; such ratios are
-
typically
at
least
14
25 percent
affiliated with banks.
-
for
trading
companies
not
The proposed ratio is even lower than
the capital required of a bank.
We see no justification for
reducing the Board's ability to require that a bank holding
company subsidiary be adequately capitalized in relation to its
business.
Having said this, it should be noted that where the
proposed activities of a bank-affiliated export trading company
have risk characteristics similar to those of a bank, the Board
has determined that the export trading company may maintain a
capital ratio equivalent to that required of a bank.
Such a proposal permitting a low capital
to assets
ratio would also be contrary to prudent supervisory policies as
reflected in recent efforts, including those of the Congress in
passing the International Lending Supervision Act of 1983,
increase
capital
international
of
banking
activities.
bank-affiliated
export
organizations
Moreover,
trading
it
companies
involved
would
from
to
in
remove
the
market
restrictions imposed on other companies not affiliated
with
banks,
its
thereby
encouraging
increased
risk-taking
concomitant risk to the banking organization.
with
It should be
kept in mind that a bank can be harmed not only by direct
interaction with an affiliate but also by a weakening of the
bank holding company's ability to serve as a source of strength
to its subsidiary banks.
In addition to the supervisory questions raised by
these
proposals
on
section 23A and
capital
adequacy,
the
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15
-
proposals raise a serious issue of competitive equity.
These
proposals place bank-affiliated export trading companies in a
favored position over all other competitors by removing them
from the effects
of market
discipline.
A bank-affiliated
export trading company would have a ready source of financing,
even if the company is not creditworthy, and could undertake a
higher volume of activities because of its low capitalization.
This situation would be entirely inconsistent with the concept
of a level playing field.
In light of these factors, the Board must oppose any
proposals that would increase the risk to the bank from the
operation of
the affiliated
export
trading
company.
Such
export trading companies should be permitted to operate with
sufficient
appropriate
flexibility
to allow them to succeed but within
constraints
affiliated banks.
on
their
ability
to
harm
their
We believe that the current statutory and
regulatory framework achieves these goals.
The recent past did
not provide circumstances for the best test of the current
framework.
Changing economic conditions should make it easier
for these export trading companies to operate more successfully
in the next few years.
While we believe that the foregoing is a realistic
assessment of both the current law and the proposals that have
been introduced into the Congress, the Federal Reserve is, as
always,
willing
to work
with
the
Congress
in
developing
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16
necessary legislative reforms.
-
We urge you, however, to keep
in mind that some of the proposals raise serious supervisory
concerns.
Others
bank-affiliated
are
aimed
export
at
trading
changing
companies
the
purposes
from
an
of
export
orientation to encouraging trade outside the United States or
even U.S. imports.
In the final analysis, of course, the goals
for any new legislation are established by the Congress,
and
the Board always endeavors to adopt implementing regulations
that reflect those goals.
Thank you very much.
@FedFRASER