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M A R 2 7 1987
For release on d e l i v e r y
9:30 a . m . E . S . T .
M a r c h 25, 1987
Statement
by
M a n u e l H. J o h n s o n , J r .
Vice Chairman
Board
of G o v e r n o r s of the F e d e r a l R e s e r v e S y s t e m
b e f o r e the
S u b c o m m i t t e e on I n t e r n a t i o n a l F i n a n c e and M o n e t a r y P o l i c y
of the
*
C o m m i t t e e on B a n k i n g , H o u s i n g , and Urban A f f a i r s
United States Senate
March
25, 1987
I
am p l e a s e d
to appear before you today to d i s c u s s the
topic of b a n k - a f f i l i a t e d export
In
its
consideration
legislation
in 1982,
performance
was
especially
foreign
markets
expertise
therefore
could
in
companies
for
sought
supply
and
the
the
in
of
the C o n g r e s s
inhibited
small-
trading c o m p a n i e s .
the
export
determined
that
medium-sized
their
companies,
products
mechanics
be d e v e l o p e d w a s
a bank h o l d i n g
Now
operation
of
necessary
of
due
to
that
by
company
export
develop
lack
The
of
Congress
expertise
exports
in order
of
their
permitting
to
goods
assist
and
("BESA"),
U.S.
services.
the C o n g r e s s
trading c o m p a n i e s could
affiliations
with
banks
through
company structure.
that
we
have
bank-affiliated
experience
consideration
to
their
exporting.
method by w h i c h export
l e g i s l a t i o n , we thought
on
U. S.
to p r o m o t e the e s t a b l i s h m e n t of c o m p a n i e s that
increasing
one
that
company
by the inability of U. S. b u s i n e s s e s ,
In e n a c t i n g the B a n k Export S e r v i c e s Act
decided
trading
of
concept.
some
export
experience
further
you
in
to
share
c o n n e c t i o n with
refinements
a
with
the
trading c o m p a n i e s under
it w o u l d be useful
with
While
had
beginning
to
has
the
information
the C o m m i t t e e ' s
export
been
the
made
trading
in
the
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
holding
companies
to
upon 43 notifications by bank
establish
export
Sixteen of these have been acted
trading
companies.
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,
For those export trading companies responsive
the
assets
size
ranged
from
$210,000
to
$21 million, with the average being $8.2 million, and gross
revenues
ranged from $110 thousand
to $18 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
the
others
services.
received
their
income
sale of goods, while
largely
from
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
bank-affiliated export trading companies are
broad
range
of
services
under
the
able
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
43
no
longer
operational.
In
a
others
have
bank-affiliated
export trading companies of which the Board
14 are
export
few
received
notice,
instances,
cessation of export trading company activity was
the
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
company.
In
experienced
in
operating
an
export
addition to poor economic conditions in their
first years of existence, described below, which
diminished
have
also
profit
potential,
encountered
unfamiliarity
encountered
trading
with
are
these export
start-up
the
trading
peculiar
companies, regardless of
to
the
in
trading companies
difficulties
business.
resulted
resulting
Other
activities
of
from
problems
trading
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.
-4To 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, in the course
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
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
climate
for
exchange
primarily
to
the
U.S. exports that
rate
for
the
U.S.
highly
unfavorable
economic
resulted from the overvalued
dollar,
the
lack
of
adequate
economic growth in foreign industrial countries, and the need
for adjustment in many developing countries.
period
Therefore, the
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
conditions
faced
by
export
In addition
trading
companies, there are other factors contributing to their slow
development.
It is still a fledgling industry; the oldest of
the bank-affiliated export trading companies is not yet
years old.
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
the
legislation
bank-affiliated' export
trading
companies, which we all see as a desirable effort, it should be
remembered
providing
that
two
banking
essential
trading company —
organizations
elements
for
were
a
a source of capital
perceived
successful
and
as
export
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
export
companies
bank
trading
in
the
safety
and
soundness.
companies
were
export
their
of
intended
to
goods and
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
activities,
agriculture,
manufacturing.
safeguards
be explicitly excluded, such as
The Act contains
that
banking and
dealing
are
intended
commerce and
supervisory goals.
that one goal of
to
in
commodities,
these
and
other
to maintain the
avoid
securities
and
important
separation of
compromising
significant
These measures were adopted in recognition
national importance —
export promotion —
should not be achieved at the expense of another —
a safe and
sound banking system.
The
designed
to
Board's
carry
regulations
out
the
implementing
statute's
intent.
the
BESA
Because
are
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
subsidiaries.
than
Under
the
this
export
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.
-7Let me at this point clear up some confusion over one
aspect
of
the
regulations.
50
A
percent
revenues
bank-affiliated
test
export
in
the
trading
Board's
company
may
provide services not only to unaffiliated persons, it can also
help
to
promote
the
goods
and
services
of
any
of
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.
directly
in
such
Accordingly, the Board's regulations,
consistent with the purposes
of
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.
be an insurance company
and
casualty
insurance
An
that underwrites and
policies
to
foreign
- 8 -
This
situation,
in
which
a bank
holding
company
becomes the producer of the service to be exported, would be
inconsistent
facilitator
formation
of
of
facilitate
abroad.
with
export
exports.
a
the
an
The
trading
company's
regulations,
role
however,
as
permit
joint venture with an insurance company
sale
of
the
insurance
company's
a
to
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
taken
issue
of
the
legislative
with
the
Board's
proposals
regulation
have
implicitly
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
by
the
surveyed
companies, i.e., 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
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
from
U'.S. companies
providing
that
need
assistance in exporting.
Moreover, it is not
readily apparent that, as many
claim, third country trade would not
foreign country
buying
them
therefore
trade.
If a
is buying computers from Germany, it is not
from
can
harm U.S.
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
-10-
which
with the help of
exported.
company could be
Such a result seems perverse in two ways.
reduces any
trading
an export trading
incentive on the part
companies
companies.
to
market
First, it
of bank-affiliated export
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
proposals
which
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
flexibility
in
some
life
holding
United
States
companies and
that
Edge corporations
provides
considerable
in both activities and investments.
instances,
permitted
sell
bank
U.S.
banking
organizations
For example,
have
been
to establish foreign companies that underwrite and
insurance.
This
has
been
done,
however, under
statutes that allow the Federal Reserve to consider fully the
effect on banks and the banking
system, taking
factors not applicable to the BESA.
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.
The Board's regulations requiring a predominance of
exports 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 23k.
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
appropriate
the extension of credit.
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
-12-
export trading company.
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 of
relate to section
the proposed
23A
and
to
amendments to the BESA that
capital
substantial supervisory concerns.
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, by exempting all transactions from the
collateral requirements of section 23A and by permitting an
export trading company to be less than adequately capitalized.
These
changes
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
to
and
the
extent permitted by the provisions of section 23A.
As the
Board
export
has consistently stated,
trading company
if
a bank-affiliated
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
approach
legislative proposals, 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
cannot
support
any
proposal
that
would
affected.
permit
a
We
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
-14typically
at
least
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, to
increase
capital
international
of
banking
activities.
bank-affiliated
export
organizations
Moreover,
trading
it
companies
involved
would
from
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.
kept in mind
that a bank
can be harmed
with
It should be
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
these
addition to the supervisory
proposals
on
section 23A
and
questions raised by
capital
adequacy,
the
-15proposals 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 flexibility
appropriate
constraints
to allow them to succeed but within
on
their
ability
to
harm
their
affiliated banks. . 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
-16-
necessary legislative reforms.
We urge you, however, to keep
in mind that some of the proposals raise serious supervisory
concerns.
Others are aimed
bank-affiliated
export
at changing
trading
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