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Bank Expansion Through Foreign Branches Under the Federal https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Reserve Act W. S. KIES Vice-President The National City Bank of New York AN ADDRESS BEFORE The Association of the Reserve City Bankers Fourth Annual Convention Detroit, Michigan May 12,1916 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Bank Expansion Through Foreign Branches Under the Federal Reserve Act The idea of branch banking, as it is carried on in other parts of the world, is new to the United States. Until the passage of the Federal Reserve Act, there were no provisions in our National Banking Laws per mitting the establishment of branches in foreign coun tries. It is true that the laws of some of the States have permitted state banks to establish branches, but these laws generally limit the location of these branches to the city in which the bank is located. Under a special charter granted in 1901 by the State of Connecticut, the International Banking Corporation was empowered to establish branches in any part of the world, but this charter is unique, and none other approaching it in scope has been issued to any banking association. Certain trust companies incorporated under the laws of the State of New York have, for a number of years, maintained what in reality are branches in France and England, and under the laws of Connecticut there has been recently incorporated a bank which does a general commercial banking busi ness and which has established branches and agencies in certain of the Central American countries. But for nearly a century and a quarter the branch bank has had no place in our national banking system. Forty English banks operating in foreign countries have 1,325 branches; in South America alone five Ger- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis man banks have forty branches and five English banks have seventy branches. The South American foreign banks and their branches are active agencies for the promotion of trade relations between the South American republics and the home countries. These banks have entered actively into the industrial and economical lives of the com munities in which they are located. They have fur nished money for the development of the resources of these countries; have financed railroads, harbor works, public utilities and warehouses. They have been in strumental in building up markets at home for the raw materials produced by South America, and have in this manner established a basis for a reciprocal ex change of products. The money of England and Ger many has been freely invested in the future of these countries. England and Germany have put into Argentina, Brazil and Uruguay in the last twenty-five years, approximately four thousand million dollars, and as a result enjoy together 46 per cent, of the total trade of these three countries. Of course these investments do not represent money taken from the capital of the banks, but the investments of the people of England and Germany in South Amer ican securities. A ready market has existed in Europe and on the Continent for South American bonds and stocks, and capital for development projects has been heretofore obtained with little difficulty. Germany has been able to do her share in the constructive work of upbuilding South America because of the effective aid of paternal government, which has worked hand in hand with the commercial and financial interests of the empire for the development of German commerce. German investors have been taught that the prosperity https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 4 of the country depended upon the development of for eign markets, and have felt secure in their investments, knowing that the power of the German Empire would be exerted in the protection of contracts entered into in foreign lands. England’s position as a world power is in the largest measure due to the development of her foreign com merce. She has not only been the world’s largest carrier and ablest merchant, but at the same time its greatest banker. England has loaned money in all parts of the world whenever she has been able to see trade returns as a result of the loan. . Through her system of English-owned foreign banks, with their branches, she has ever been ready to finance the needs of countries whose raw materials could be used by her factories, and whose people in return could be con verted into customers for her manufactured products. During the early years of our history, there was perhaps little need of foreign branches of our banks. We were a nation in the process of making, and in the development of our resources we sought and used the surplus capital of all the world. Our exports in our earlier days were what might be termed largely non-competitive. We sent to the other parts of the world our surplus food products, lumber, minerals and raw materials, such as wool and cotton, receiving in return from the older well-established manufacturing nations their manufactured products. The invention of the steam engine and the use of steam as a motive power, the wonderful ingenuity of the Yankee mechanic in the perfecting of labor-saving devices and machinery, and, later, the marvelous de velopments in the electrical field, have worked a trans formation in the industrial history of this country. As the' largest producer of raw materials, with the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 5 greatest coal supply of any nation, with countless water powers capable of generating hundreds of thousands of horsepower, and with an abundant supply of intelligent labor, it was perfectly natural that this country should become a great manufacturing nation. The profits of manufacturing are the surest source of wealth to a nation. When raw materials are ex ported, it is the exportation of the natural resources of a country, and is in effect drawing upon the savings bank. These natural resources, when once used up, can never be replaced. There is treasured in our mountains a given quantity of oil, coal and minerals. There is in the soil of our land a given quantity of potash, nitrogen and of the various other chemicals which are needed to make it productive. Therefore, the cotton, the corn, the wheat, and the hay which we grow and send to other countries is taking from our soil that which must be replaced if its fertility is to be continued. Nature has given us great forests, but with their destruction many years must elapse before new trees shall be usable for lumber purposes. If, on the other hand, we use our lumber to build factories our coal to furnish power to run them and manufacture our raw materials into finished products, we are adding largely to their value by the labor and skill used in their making, and this addition in value is a source of wealth which comes to us without the sacrifice of our natural resources. How great has been the change in our industrial life is indicated by the following very striking figures : From 1899 to 1909, the capital invested in manu facturing establishments in the United States grew from approximately nine billions to over eighteen bil lions. For the fiscal year 1914, which ended just before the beginning of the war, and would, therefore, be con- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6 sidered normal, 18 per cent, of the total of our exports was of foodstuffs, as against 44 per cent, in 1894, whereas manufactured products formed 47 per cent, of our exports, as against 23 per cent, in 1894. The value of the products of our factories increased 81 per cent, from 1900 to 1910, and the number of persons em ployed in the United States in manufacturing and mechanical pursuits increased 90 per cent, in the period 1890 to 1910, while the number of persons engaged in agriculture increased but 37 per cent, in the same period. If the same proportionate decrease in our exports of foodstuffs continues and our manufactured articles increase in the same ratio, it will be but a comparatively few years before we shall be importing foodstuffs and the permanent prosperity of this country will depend upon our ability to find markets for our manufactured articles. Our domestic market is the largest in the world and is capable of absorbing a very large percentage of the output of our manufacturing establishments. Just prior to the war, there had been indications that we were fast reaching the point of saturation. For a number of years, our manufacturing plants had not been running anywhere near capacity and concerted efforts had been made toward the development of foreign markets. The growing friendliness of our sister republics to the South had focused the attention of those of our manufacturers, who had the foresight to see the need of new markets, upon South America as a natural market for our surplus products. In the cultivation of new markets, our manufac turers at once felt the need of American banks to aid them in the extension of their business. They found it necessary to rely upon the financial representatives https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 7 of their keenest competitors in order to transact their necessary banking business. Their invoices with their terms and prices were thus open to the agencies of their competitors. They were without the friendly advice of skilled bankers, and had no source for obtain ing credit and trade information. There was no market for dollar exchange, and tribute had to be paid to English bankers in every transaction, because all settlements were made in pounds sterling. There was the theoretical risk at least of two exchanges, from the local currency into the pound sterling and from the pound sterling into American currency. As American trade grew in foreign markets, the handicaps under which our manufacturers were work ing, by reason of the lack of banking facilities, became more and more pronounced, and as a result of the de mands of exporters generally throughout the country, the new Federal Reserve Act provided for the establish ment of branches of our national banks in foreign countries. The provisions in the Reserve Act granting the right to establish branches are contained in Section 25. They are very general in their terms, and quite in definite. It is provided that any national banking asso ciation possessing a capital and surplus of a million dollars or more may file application with the Federal Reserve Board, upon such conditions and under such regulations as may be prescribed by the board for the purpose of securing authority to establish branches in foreign countries or dependencies of the United States for the furtherance of the foreign commerce of the United States. It is not plain from the foregoing whether the Federal Reserve Board is to make regulations merely https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 8 governing the filing of the application or whether the Board shall have authority to establish such rules and regulations as it sees fit for the control and manage ment of the branches. The Board is specifically given power to approve or reject any application if in its judgment the amount of capital is not sufficient, or if for other reasons the granting of such application is deemed inexpedient. The second paragraph of the section deals with the furnishing of reports to the Comptroller of the Currency, and gives authority to the Federal Reserve Board to order special examina tions whenever it deems necessary. It further pro vides that the bank shall conduct the accounts of each foreign branch independently of the accounts of other foreign branches established by it and of its home office, and shall at the end of each fiscal period trans fer to its general ledger the profit or loss accruing at each branch as a separate item. While there has been no direct decision upon the point, it may be said that it has been assumed that section 25 does not alter any of the provisions of the National Banking Act, and that branches of national banks are under the same control and subject to the same restrictions as are the parent banks in this country, with the exception that it appears to have been the intent of Congress to place foreign branches under the exclusive control of the Federal Reserve Board. Generally speaking the relationship between the parent bank and the branch is that of principal and agent. The home bank is responsible for any of the acts of the branch, and the branch itself can do nothing which the parent bank has no authority to do. ' Of course, working along these lines, many dif ficulties have been and will be encountered. Our https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 9 branches are handicapped in their competition with foreign banks, especially in view of the fact that bank ing in foreign countries is conducted on an entirely different basis than banking in the United States. Immediately after the passage of the Federal Re serve Act, steps were taken by The National City Bank of New York to avail itself of the provisions of the Act, and to establish branches of the Bank at such points as would be of most assistance to American ex porters in the development of new markets. About five thousand letters were written to various manu facturers throughout the country seeking information as to those markets in which banking assistance was most needed, and asking for suggestions as to the service to be rendered by these branches. The replies presented a most interesting study. Over 90 per cent, suggested the South American markets as those toward which American efforts during the next few years would be directed. It might be well to point out that these letters were sent out early in May, 1914, nearly three months before the opening of the war. Every letter suggested that the greatest service the Bank could perform would be to assist in obtaining accurate credit and trade information. It was urged that, at least for the first few years, the branches should be equipped with trade experts to assist in studying market conditions and possibilities. Many of the smaller manufacturers indicated a keen desire to enter foreign markets, but frankly expressed their ignorance of competitive conditions and their inability to obtain accurate credit information. With the wants of our manufacturers thus clearly before them, the Directors of the City Bank, in June, 1914, passed a resolution asking the Federal Reserve Board for authority to establish branches in Buenos https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 10 Aires, Argentina, and Rio de Janeiro, Brazil. The first branch of a national bank to be established in a foreign country was opened on November 10, 1914, in Buenos Aires. The following February a branch was opened in Rio de Janeiro, and since then branches have been established in Santos and Sao Paulo, Brazil; Montevideo, Uruguay; and in Havana and Santiago, Cuba. Other branches in South America and in Europe are in contemplation, and to furnish facilities in the Orient, National City Bank interests have acquired the International Banking Corporation with its sixteen branches in India, China, Japan and the Philippines. The branches of the International Banking Corpora tion while operated independently, nevertheless are working in closest harmony and co-operation with the City Bank branches. In order that the branches might be effective agen cies in aid of American Commerce, there has been pro vided in connection with each branch a commercial or trade department and a special credit department. To assist in the dissemination of accurate credit informa tion concerning the South American markets, and to answer the countless inquiries received from American manufacturers, it was found necessary to organize in the Bank a Foreign Trade Department. To furnish a general medium for the publication of trade informa tion, statistical data and general commercial news from South America, and more particularly to create a medium for the discussion of the various problems in connection with our foreign trade, the Department undertook the publication of a monthly magazine, “The Americas”. As an indication of the extent of the work of the Foreign Trade Department, the following may be of interest. There have been received to date from the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 various branches 6,701 commercial and industrial re ports, including 1,200 special market reports from Buenos Aires and 797 special reports from Rio de Janeiro. Approximately 20,000 manufacturers in the United States, large and small, have used to a greater or lesser extent the service of the Foreign Trade De partment. Skilled credit men were sent to all of the branches, and with every steamer have come credit files containing information upon the responsibility and standing of South American merchants. In this work, the manufacturers of the United States have co operated splendidly. There has been collected in the Credit Department of the City Bank the credit experi ence of hundreds of manufacturers in this country with Latin-American merchants. . The development of branch banking is of necessity a slow and difficult process. The American banker has heretofore known little of the customs and character istics of foreign countries, the demands of foreign markets or the intricacies of foreign exchange. He has had no particular part in international finance. His experience as a commodity banker has been limited. He has been handicapped by a lack of knowledge of foreign languages. With the exception of Argentina and Uruguay, the currencies of almost all of the South American countries have depreciated, and under these conditions it is difficult for an American banker, lack ing in experience, to get his bearings. The difficulty of finding men to staff foreign branches is an almost insurmountable obstacle. It is desirable, of course, to have the senior officers of an American branch Americans, but so far it has been impossible to find sufficient men of banking experience willing to leave the United States and take up work in the foreign field. Twice the number of branches https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12 would have been opened during the last year had it been possible to staff them with capable American bankers. ■ It has been necessary too to overcome local prejudices and to demonstrate that the branches of American banks were being established in good faith for the purpose of facilitating commerce between South America and the United States. It can be said, how ever, without fear of exaggeration that much has been accomplished in the past year or so in building up a good will toward American commercial interests and in impressing upon the South American business mind the desirability of closer relations with the United States. Perhaps the greatest single service rendered by the branches already established, and those which Amer ican banks will hereafter locate in foreign countries, is in the building up of a market for dollar exchange. Before the establishment of branches in Brazil, Argen tina and Uruguay, the dollar was not even quoted. During the last year, the volume of direct exchange between these countries and the United States has been remarkable, and practically all the shipments of wool, hides, quebracho, and a large portion of the coffee, have been financed through the medium of dollar credits. The development of dollar exchange is materially aided through the acceptance provisions of the Federal Reserve Act. Those who have been giving the matter serious thought generally appreciate the vast impor tance of the aceptance in internationl business. Sec tion 84 of the Federal Reserve Act reads as follows: “Any member bank may accept drafts or bills of exchange drawn upon it and growing out of transac tions involving the importation or exportation of goods having not more than six months’ sight to run; but https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 13 no banks shall accept such bills to an amount equal at any time in the aggregate to more than one-half its paid-up capital stock and surplus?' Section 82 provides for the rediscount of such ac ceptances, based on the importation or exportation of goods, which have a maturity at time of discount of not more than three months, when indorsed by a mem ber bank. Section 84 has been since amended to in crease the acceptance power of branches up to the full amount of the capital and surplus, with the consent of the Federal Reserve Board, upon proper application being made. England’s pre-eminence as the world’s financial mar ket has been due largely to the service performed by the English acceptance houses, and to the existence of an active discount market for bills on London origi nating in all parts of the world. Exchange on Lon don has been the means of settlement of transactions in international commerce for years, with the resultant large profits to English bankers. The acceptance is a financial expedient practically unknown in this country until the passage of the Federal Reserve Act. The difference between the method pre viously in effect here and in Europe was that commer cial transactions here were financed by notes and in Europe by bills of exchange. The one is practically an unsalable investment. Although no legal restric tions forbid the rediscounting of a note, nevertheless such was not generally considered good banking prac tice. The acceptance, on the other hand, is a prime quick asset, being the promise of a banking house of standing to pay a definite sum at a certain date, the promise being secured in addition by the commodities against which the bill was drawn, to be liquidated within a fixed period by the sale of the commodities. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 14 It can not be expected that the American bill, drawn in dollars, will take, the place of the London bill, but with the establishment of branch banks quite generally in strategic markets of the world, and with the com bination of circumstances now favoring this country, it can confidently be expected that the bill on New York will become a recognized medium for settling balances in international trade. A discount market has been built up in New York and other financial centers of this country, and the national bank acceptance is now recognized by banks as the safest, surest and most liquid of short term investments. The last twenty months have brought great com mercial and financial opportunities to the United States —at the same time, grave responsibilities as well. Within that short period of time, we have changed from a debtor to a creditor nation, and there has been forced upon us, by circumstances over which we have had no control, a leading role in international finance. For the first time in history, countries of the old world, and those formerly financed in Europe, have borrowed hundred of millions of dollars in our markets. We have purchased back from Europe a large portion of the securities heretofore sold her, the proceeds of which have helped to develop our resources. World markets hitherto inaccessible have turned to us for necessary supplies, and the warring nations have drawn upon our factories for munitions of war. On top of all this, there has developed a domestic demand of exceptional proportions. The result is that everywhere through out the country factory wheels in many instances are turning twenty-four hours a day, and both labor and capital are prospering. At a time when fortune is so favorably smiling upon us., it may be well to ask whether we are giving https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 15 sufficient thought to the future. In the fat years, it is well to look ahead and prepare for lean times. When we consider the vast destruction of capital now going on, the huge war debts accumulating, and the appallingloss of life, we must realize that when the fighting nations shall have again returned to sanity and this sickening saturnalia of blood-letting- shall have ceased, then the entire world will be called upon to pay the price and to restore the damage resulting from Europe’s madness. It is absolutely essential to our future welfare as a nation that the United States have permanent markets in which to sell its surplus manufactured products. At the present time, in many of the markets of the world formerly closed to us, we now have practically no com petition. American goods are purchased because they are the only ones which can be obtained. We can not expect this condition to continue when our European competitors are again in the field. American goods must then obtain their place in a market on the basis of price and quality, or as the result of a demand built up by clever advertising and through superior sales manship. We are in a rising labor market. Wages in all lines have been increased. Our experience indicates that wages are easily moved in only one direction, and that is upwards, and that it is almost impossible, when once a wage scale has been established, to lower it. While wages on the other side of the water are also likely to increase, and while production will proceed under certain serious disadvantages, nevertheless we must not fail to recognize the tendency abroad toward a nationalization of industry as a result of the neces sity of concentration of effort in production during the war. The lessons of the war in organization will be https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 16 influential in peace and we may fairly anticipate better organization, greater efficiency and a wider use of labor-saving machinery on the part of our European competitors when the war cloud has passed. The experience of these nations in speeding up pro duction for the purpose of supplying munitions, and the resulting quantity production on a large scale will make itself felt after the war. We may reasonably expect that foreign manufacturers in many lines will, hereafter, look more to quantity, uniform production and a reduction of unit price, brought about by the use of machinery, than to quality and the diversification of product resulting from hand labor. We can, therefore, look forward to a period of keenest competition, and this will be accentuated by the fact that production on a large scale will be an abso lute economic necessity in Europe after the war. It is only through large production and the sale of a large surplus in the markets of the world that the belligerent nations can again build up their depleted gold supply and restore their shattered credits. Realizing fully what is ahead of us, it is the duty of every citizen who desires to see his country perma nently prosperous to aid in the development of a national export policy which will give support to our manufacturers in their struggle against governmentally supported effort across the water. A successful export policy would contemplate the removal from business of many of the hampering restrictions under which it now suffers. Particularly should there be given to our manufacturers the right of combination in the development of foreign markets. The laws preventing the growth of our merchant marine should be repealed and a policy inaugurated to aid its, immediate upbuilding. But right now we are https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 17 threatened with legislation potentially more destructive to the future of our merchant marine than a fleet of hostile submarines. The Alexander Bill as reported in the newspapers contains provisions so sweeping in the powers granted as to make profitable operation there under an almost impossible problem. It is particularly unfortunate that legislation so discouraging to the efforts of American shipowners should be forced upon the country at the very moment when comprehensive plans for the rehabilitation of the American merchant marine are under favorable consideration by large in terests which are earnestly and sincerely working to better ocean transportation conditions. A commission comprising the best business minds in this country should have in charge the planning and drafting of commercial treaties with various nations of the world. A permanent tariff com mission should be created and clothed with suffi cient authority to take the tariff out of politics for all time to come. Our banking act should Ue broadened, the acceptance extended to cover domestic transactions, the powers of branch banks in foreign countries ex tended to enable them to conform in business to the cus toms of the countries, and, lastly, a definite and con tinuous govermental policy in connection with Ameri can investments in foreign countries. To obtain the necessary legislation for a program of this kind, the country as a whole must be educated to the importance of a permanent export trade to the nation’s welfare. No one can help more in this con nection than the banker. His judgment on financial and commercial matters in the community in which he lives is usually accepted without question, and his in fluence as a citizen is large. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 18 In one respect in particular he has the opportunity to accomplish much, and that is in the direction of de veloping in this country a market for foreign securities. Permanent foreign markets are best developed through investments, the proceeds of which are used in the development of a country’s latent resources. England and Germany, prior to the war, had invested ap proximately four billion dollars in South America. France and Belgium, operating through their mort gage land companies, had obtained a firm foothold in many of the agricultural sections of South America. The investment of money in public utilities, in port works, in railroads, and in the development of large farming areas, means a continued demand for ma chinery, factory supplies, railroad equipment and agri cultural implements. The lender of the money can often control its expenditure, and so, through an invest ment in a foreign country, a permanent source of de mand for American products is provided. We are the richest country in the world, and, at the same time, the most extravagant. If a spirit of economy would prevail among our people, we could easily, during the next few years, save enough money to obtain a strong investment position in all the markets of the world. Upon our ability to accumulate out of our present abnormally large earnings substantial amounts of capital for. investment abroad will depend very largely our permanent success in foreign trade. One of the great handicaps in the matter of foreign investments has been the lack of a proper agency for analyzing and investigating propositions from foreign countries. We have not had the machinery for prop erly handling matters of this kind. In the formation of the American International Corporation, there has been provided an agency through which enterprises in https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 19 all parts of the world may receive expert analysis be fore being presented to the American investor. With the growth of foreign branches of American banks, and additions to their numbers, with proper co-operation between all those interested in foreign markets, and with intelligent support from our Govern ment, we should be able to obtain a foothold in markets hitherto closed to us, and, through our aid in the de velopment of their natural resources, bind to us in bonds of commercial friendship countries whose in terests and trade have heretofore been held by Europe. But this work must not be undertaken in a spirit of cupidity and selfishness, or with even the semblance of a desire to profit from the misfortune of others. We must be moved by a higher purpose— that of service. As the only great nation spared the horrors of war, ours is the responsibility through tact ful co-operative effort to assist in building up and re storing where the war is tearing down and destroying, and to take the place of Europe where needed in sup plying the wants and in aiding the development of those countries which she can no longer serve. 20 6902T https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis