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It

November 17, 1978

RegulatingForeignBanks
One day last September, without fanfare or much press coverage, President
Carter signed into law the International Banking Act of 1978, which established for the first time a national
policy, regulating foreign banks' activities in the United States. Previously,
foreign bank entry and expansion had
been largely determined by individual
state laws. In other words, each state
determined whether to permit foreign
banks to operate within the state, the
types of banking activities they were
permitted to conduct, and how much
reserves (and in what forms) they had
to hold.
Amidst this kaleidoscopic network of
state banking regulations, foreign
banks' operations have grown phenomenally in this country. In November 1972, when the Federal Reserve
started collecting such statistics, there
were 52 foreign banks operating 100'
banking facilities in the United States.
By May 1978, both the number of foreign banks and the number of banking
facilities had more than doubled, to
123 and 268, respectively. Foreign
banks' standard banking assets (excluding interbank clearing balances and
due from related institutions) rose 260
percent from $18 billion in November
1972 to $65 billion in May 1978,
whereas the assets of the 300 or so
largest U.s. domestic banks increased
by only 57 percent over that period,
from $353 billion to $556 billion. Thus,
the ratio of foreign banks' banking assets to those of large U.s. banks rose
from 5 percent in 1972 to about 12
percent in 1978. Furthermore, over
the same period, the ratio of foreign
banks' commercial and industrial loans
to those of large U.s. banks rose from

1 0 to 20 percent, and the ratio for
standard banking liabilities rose from 3
to 11 percent of the total. (Standard
banking liabilities exclude clearing
Ii?bilities and lia,bilities to related institutions.)

AcrossstateBines
This phenomenal growth, combined
with the lack of a national policy, has
created several problems in the area of
bank competition. These are related
to the fact that U.S. domestic banks are
forbidden by the McFadden Act to
engage in inter-state branching. That
does not mean, however, that domestic banks are completely precluded
from inter-state banking. In fact,
through the Fed-funds and the C D
markets, domestic banks can tap
short-term funds on a nation-wide basis; through their out-of-state representative (loan-production) offices,
they can solicit loan business across
state lines; and through their Edge Act
corporations, they can engage directly
in international banking. Again,
through their parent bank-holding
companies, they can conduct nonbanking financial businesses- such as
leasing, mortgage banking, consumer
financing, and credit-related insurance - anywhere in the nation. However, unqer the McFadden Act, domestic banks cannot establish branches
and tap retail deposit bases out of
their home state, nor can they maintain
agencies out of their home state for
booking loans and servicing local customers.
Foreign banks, on the other hand, can
and do conduct inter-state branching
and maintain agencies across state
lines, because they are not subject to
(continued on page 2)

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Opinions expressed in this newsletter do not
necessariiy reflect the views of the management of the
Federal Reserve Bank of San francisco, nor of the Board
of GO\/ernors ortr1 f2cJerai Reserve 5yst-ern.
E

the McFadden Act. Fully half of the 123
foreign banks operating last May in
this country - 63 banks with a total of
122 banking offices - operated in two
or more states, and their assets outside
their home states totalled nearly $25
billion. For example, the Bardays
Group (U.K.) operates state-chartered
banks in both New York and San Francisco, as well as branches in Boston,
New York, Chicago, and the Virgin Islands, plus agencies in Atlanta and San
Francisco. A number of French, Swiss,
and Japanese banks operate similar
wide-flung banking networks across
the United States.

Other
.
A second competitive issue has arisen
from the fact that foreign banks operate some 21 securities affiliates that
underwrite and sell stocks in the United
States. Again, these are activities in
which domestic banks cannot engage,
in this case because of prohibitions
written into the Glass-SteagallAct. This
reflects a difference in banking tradition. In Europe, banks are the principal
factors in the securities-brokerage
business; indeed, European branches
of U.s. banks actively participate in
that business. But in the United States,
as a result of speculative abuses occurring in the 1920's, domestic banks
have been excluded from the securities business. Foreign banks have been
able to get around that prohibition,
however. To the extent that they confine themselves to branch or agency
operations and do not own subsidiary
commercial banks in this country, they
are not considered as U.s. banks or

2

bank-holding companies, and hence
are not subject to restraints of the Bank
Holding Company Act.
Thirdly, despite the size of these foreign banks - nearly all have worldwide assets of more than $1 billionthey have not been subject to Federal
Reserve reserve requirements. In contrast, nearly all the large u.s. domestic
banks are Federal Reserve members,
and as such must maintain reserves in
non-interest-earning vault cash and deposits at Federal Reserve Banks. Depending on the state in which they
operate, foreign banks can either escape reserve requirements entirely (as
in Illinois), or hold the required reserves in correspondent balances or in
interest-earning assets such as government securities. (California, for instance, permits state-chartered
banking institutions to hold up to fourfifths of their required reserves on
time and savings deposits in U.s. Government securities.) This lower reserve cost has given foreign banks an
advantage over the large u.s. banks
with which they compete.

Towarrd a §oiutioll'D
The International Banking Act of 1978
redresses some of these competitive
inequities. On inter-state branching,
each foreign bank must now select
one stale as its
stateN of operation, and it can establish a new
branch or agency outside the home
state only with that state's express
New branches and agencies operating outside the home state
may conduct full banking services to
the extent permitted under state law,
but those new branchescan accept
deposits only from non-residents or
from activities related to internationaltrade financing.

' - -Foreign banks will retain an important
advantage over domestic banks because of 'grandfathering. The activities of all their existing out-of-state
branches, agencies, and subsidiary
banks are 'grandfathered under the
new legislation - i.e., are e)(empt from
new legal restrictions. {v\oreover,
those institutions can establish new
out-of-state branches and agencies to
book domestic loans locally, a privilege denied to domestic banks. The
provision represents a compromise
between two sometimes conflicting
principles, both of which are fundamental to the U.s. banking tradition:
nationwide competitive equity and
states rights in bank regulation. Under
the new legislation, the states retain
their right to attract foreign banks if
they so desire; on the other hand, foreign banks' deposit-taking powers in
new interstate operations are restricted to what domestic banks can do in
their out-of-state Edge Act operations.
N

N

Meanwhile, the existing operations of
security affiliates of foreign banks are
also "'grandfathered but new entry
into the field is prohibited. Although
statistics are lacking, foreign affiliates
apparently constitute only a fraction
of the U.s. security business.
N

,

Finally, on reserve requirements, the
new law provides that all branches and
agencies of foreign banks shall be subject to Federal Reserve reserve requirements if their parent banks have
world-wide assets of $1 billion or
more. These institutions, however,
will not become Federal Reserve members, although they will maintain reserve balances and have access to the
Federal Reserve discount window and
other services on terms comparable
with member banks.
3

' .. ----_.
-

Since nearly all the foreign banks operating in this country are very large
banks, this new provision equalizes reserve costs for foreign and domestic
banks. Still excluded, however, are the
state-chartered subsidiary banks of
foreign banks, which account for
about one-fifth of foreign banks' total
assets in the U.s. - some individual
subsidiaries range up to $2 billion in
size. Their freedom from Federal Reserve reserve requirements, as well as
the amendments to the National Banking Act permitting foreigners to become directors of National banks,
further encourage foreign banks' already substantial interest in that form
of operation in the United States.
National policy
Altogether, the International Banking
Act of 1978 establishes for the first
time a national olicy on the regulap
tion of foreign banks in the United
States. The policy in some respects still
falls short of equal treatment for foreign and domestic banks. However,
given the strong tradition of states
rights in
it may be the best
compromise obtainable at this point.
It should be noted also that the law requires the President to re-examine the
continued applicability of the
McFadden Act, and to submit a report
with recommendations within a year.
In view of the fact that the new law
continues to extend an advantage to
foreign banks in the form of inter-state
branching privileges, it may hasten the
day when branching rules will be relaxed for domestic banks as well.

HangQSheng
Cheng

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BANKING D ATA- TWlElU FEDERAL SlERVE STRI
FTH
RE
DI
CT
(Dollar amounts in millions)

SelectedAssetsand liabilities
Large Commercial Banks

Loans (gross, adjusted) and investments*
Loans (gross, adjusted)- total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.s. Treasury securities
Other securities
Deposits (less cash items)- total*
Demand deposits (adjusted)
U.s. Government deposits
Time deposits- total*
Statesand political subdivisions
Savingsdeposits
Other time deposits:\:
Large negotiable'CD's
Weekly Averages
of Daily Figures
Member Bank Reserve Position
ExcessReserves(+}/Deficiency (-)
Borrowings
Net free(+ }/Net borrowed (-)
federal Funds-:-Seven large Banks
Interbank Federalfund transactions
Net purchases(+)/Net sales(-)
Transactionswith U.s. security dealers
Net loans (+ }/Net borrowings (-)

Amount
Outstanding

11/1178

10/25178

120,482
97,675
1,993
28,440
33,854
18,088
8,395
14,412
115,220
31,696
355
81,006
6,642
31,628
39,769
19,247

+ 1,330
+ 1,469
+ 271
+ 403
+ 116
+ 113
164
25
+
+ 926
+ 1,013
- 604
+ 220
78
+
- 141
+ 229
+ 157

Change from
year ago
Dollar
Percent

Change
from

Week ended

11/1/78
+

-

+ 17,061
+ 17,167
39
+
+ 3,909 .
+ 7,524
+ 4,010
134
+
240
+ 16,106
+ 2,858
120
+
+ 12,859
+ 1,354
74
+ 10,657
+ 8,334

Week ended

10125178

+
+
+
+

+
+
+

-

+
+
+
+
+
+
+

16.50
21.32
2.00
15.93
28.58
28.48
1.62
1.64
16.25
9.91
51.06
18.87
25.61
0.23
36.61
76.37

Comparable
year-ago period

9
44
35

+

70
36
34

218

+

455

+ 1,430

371

+

608

+

+

1
228
227

280

*Includes items not shown separately. :j:lndividuals,partnerships and corporations.
Editorial comments may be addressed to the editor (William Burke) or to the author ••••
free copies of this and other Federal Reserve publications can be obtained by calling or writing the Public
Information Section, Federal Reserve Bank of San francisco, P.O. Box 7702, San Francisco 94120. Phone
(415) 544-2184.

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