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NOTE TO LIBRARIES
The following changes should be noted in title and frequency of publication:
Monthly Review-monthly through December 1972
Business Review-bimonthly all of 1973, quarterly 1974 through
1975
Economic Review-( name change only), quarterly beginning
December 1975
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2
The One World dream of a generation ago
has now become reality, and nowhere is this
more true than in the sphere of international
trade and finance. The growth of a worldwide
financial network has brought cheaper commercial credit to developing countries and higher
living standards to everyone, and in the process
it has created many profitmaking opportunities
for the world's bankers and businessmen. This
issue of the Economic Review discusses several
aspects of this banking achievement, including
the impact on the banking system itself of an increasingly interdependent world economy.
Robert Aliber suggests two possible theoretical approaches to this subject. One approach,
based on industrial organization theory, assesses
the market structure of banks in different countries through comparisons in mark-ups or
spreads between borrowing and lending rates.
Another approach, based on international trade
theory, emphasizes comparative costs of banking in different countries and "barriers to trade"
which prevent costs from being equalized, such
as banking regulations and exchange-market
controls. Aliber suggests that an analysis of
banking based on such underlying cost differences could be more appropriate for future research efforts than analyses based on trends in
lending flows or numbers of banking offices.
Industrial organization theory suggests that
inferences about the relative efficiency of banks
in different countries may be obtained from a
comparison of the spreads between the interest
rates paid on bank liabilities and the rates earned
on bank assets. The narrower this spread, the
more efficient is a country's banking system, and
the greater is its potential for further growth.
Trade theory, however, suggests that free trade
in money would cause depositors to shift funds
to those banks paying the highest interest rates,
while causing borrowers to shift to the banks
charging the lowest rates. Banks with higher
markups would be forced out of business, eliminating observed differences in spreads across
countries.
Aliber notes that the persistence of sharp differences in spreads would indicate that "barriers
to trade" in money exist, permitting evaluation
of the underlying efficiency of each country's
banks. These differences would be independent
of business-cycle trends or changes in exchange
rates, because interest rates paid on liabilities
and assets would be equally affected. The trade
theory and industrial organization approaches
thus are complementary ways of viewing the
phenomenon of international banking.
A related theme is discussed in the second article, which analyzes the growth of a major international financial center - the U.S. West
Coast. As Hang-Sheng Cheng relates, the West
Coast has become a major center within the span
of only a brief half-decade. For example, foreign assets of West Coast banks rose from $7
billion to $32 billion between the end of 1969
and the end of 1974, at which point they accounted for one-fourth of the foreign business
of all U.S. banks. This expansion went hand-inhand with the growth of other types of institutions, such as Edge Act corporations (for foreign-trade financing) as well as foreign banks'
agencies, branches and subsidiaries.
Cheng notes that economic theory has largely
ignored the phenomenon of regional financial
centers. However, recent studies have empha3
sized the central role of financial markets in promoting economic growth, in both developed and
developing economies. Regional financial centers have evolved in both types of economies to
provide important links between national money
and capital markets on the one hand and broader
world markets (such as the Euro-currency market) on the other. With the expansion of the
West Coast's commercial-banking community,
a growing number of banks in the past half-decade have attained a size sufficiently large to reap
the benefits of portfolio diversification through
international operations. Moreover, the rapid
growth of the West Coast's foreign trade has attracted many Edge Act corporations and foreign
banks to the region.
A separate theme concerns the rapidly growing role of commercial banks as a source of
finance to developing countries (LDC's).
Commercial-banking credits today account for
one-fifth of the total net flow of resources to
developing countries, compared with a very
modest share as late as 1960. Reviewing this
development, Nicholas Sargen finds a significant
narrowing of the differential between what developed countries pay and what developing
countries pay on their borrowings.
Yet Sargen asks, "Are commercial banks vulnerable to LDC defaults?" The answer apparently is no, despite the rapid growth of LDC
trade deficits and despite the debt problems of
individual developing countries. The danger is
less than it might seem because of the slower
growth of debt in real than in nominal terms, the
availability of funds from non-bank sources, and
the heavy concentration of commercial-bank
lending in developing countries which have a
relatively strong economic base.
Sargen goes on to ask, "Are commercial
banks adequately compensated for the added
risks incurred in lending to developing countries?" Apparently they are, even though the
differential rate of return between developed and
developing country loans appears low by historic standards. Commercial banks are aware,
of course, of higher risks in some cases, but they
have responded through above-average increases in spreads to major borrowers and to
the largest debtors, and also through the curtailment of new lending to those LDC's with debt
problems. Also, governments of creditor nations have played an important role in mitigating
the possibility of LDC defaults.
Turning to the regulatory side of this ques~
tion, Robert Johnston analyzes in detail various
legislative proposals that have been made to increase Federal control over the foreign-bank
segment of the international-banking community. These proposals have gained new urgency
because of the rapid growth of foreign banking
inside this country. The number of U.S. banking institutions owned by foreign banks rose
from 85 to 104 between 1965 and 1972, and
then accelerated to reach 181 by September
1975. But this expansion has taken place under
rules laid down by state law, not Federal law.
Johnston notes that the several pieces of legislation now being debated in Congress follow
the principle of nondiscrimination-equality of
national treatment-in their approach toward
foreign-banking operations, but that they all
have the same goal of establishing effective Federal control over such operations. "Whichever
approach is taken, the era of regulatory dominance by state regulators is coming to an end.
In the process, foreign banks will lose some
privileges and gain others, but the trend will be
to national treatment under the primary control
of the Federal government."
4
Robert Z. Aliber*
In the next few years, the geographic scope
of the market for individual banks will increase
sharply with the growing use of electronic
funds transfer mechanisms. The costs and the
inconvenience of using banks based in distant
locations will decline. Inevitably, the change
in the technology of payments will enlarge the
market for major banks across the national
borders; u.s. banks will find it easier to attract foreign customers and foreign banks will
find it easier to attract U.S. customers and international banking will expand.
Currently over one-hundred U.S. banks have
foreign branches or offices; five have sizable
branch networks. More than 60 foreign banks
have set up one or more branches in the United
States and several have established branch networks in California. The assets of U.S. banks
operating abroad are about 15 percent of domestic U.S. bank assets, although 70 percent of
the foreign assets involve off-shore transactions
in dollars. Foreign banks now account for
nearly 7 percent of bank assets in the United
States.
This article presents two theoretical approaches for viewing the phenomenon of international banking. One approach, based on
international trade theory, emphasizes compara-
tive costs of banking in different countries and
"barriers to trade" which prevent costs from
being equalized. The second approach, based
on industrial organization theory, assesses the
market structure of banks in different countries
through comparisons in mark-ups or spreads between borrowing and lending rates.
Trade Theory Approach
more efficient banks would increase. If the less
efficient banks set their interest rates to maintain their market share, their profit rates and
the rate of growth of their capital would decline.
The efficient, low-cost banks would be able to
attract capital and increase their market shares,
while the higher-cost banks-and the banks
most susceptible to loss charge-offs-would incur declines in market shares.
Several questions arise when competition
among banks is examined in an international
context - as an international industry, with
firms based in different countries competing
in the same market or in overlapping segments
One set of hypotheses about the competitive
position of banks in different countries is based
on theories of international trade. Thus, banking will be most substantial in those countries
which have a comparative advantage in producing bank products in those countries' services.
Imagine that there were free trade in money
and in loans, convenience (e.g., bank office location) would be much less important to borrowers and depositors in choosing among
competing banks. The market share of the
"Professor of International Trade and Finance, Graduate
School of Business, University of Chicago; Visiting Scholar,
Federal Reserve Bank of San Francisco, Fall 1975.
5
ket prices, to earn the profits necessary to maintain their capital position.
Banks face a similar problem-if they are
less efficient than their competitors, they are
less able to acquire the capital necessary to finance their expansion and maintain their market share. But if they raise their selling prices
to realize a higher rate of return, their market
share may fall.
The reduction in the number of firms noted
in the world automobile industry has already
occurred in most national markets for banks.
In the Netherlands banking is dominated by two
firms; in France, by four firms; in Canada,
Great Britain, and Japan by about ten. Within
the United States, in contrast, the combination
of anti-trust legislation and limits on branch
banking across state boundaries has resulted
in much less concentration.
International trade in money is less extensive than international trade in autos, even
though the apparent costs of trade in automobiles are larger. The national markets for
bank products are segmented by the costs of
using the foreign-exchange market. Segmentation of national money markets also may result from the inconvenience of using distant
banks. As these costs fall further, competitive
pressures should insure that buyers of bank
products and users of bank services shift to the
more efficient banks, even if national borders
must be crossed.
of various national markets. One is the comparative cost of production of banks based in
different countries, which concerns the relative
efficiency of banks operating in different countries; this is the standard international-trade
question of comparative advantage. Answering
this question requires a model of the inputs, outputs, and the production function in banking. A
related question involves the impact of national
regulation on the costs of producing bank services; in part the rapid growth of offshore banking results from efforts to circumvent the costs
of national regulation. A final question is
whether firms based in some countries have advantages in owning banks overseas-the traditional international-investment question.
One analogy to competition in international
banking is provided by the international automobile industry. Currently about 15 companies supply the world market for autos. Most
countries import autos. Trade in autos is extensive, even among the producing countries; the Swedes buy many Fiats and the Italians buy some Volvos. Over the last 20 years,
competition in national and international markets has led to a sharp decline in the number
of automobile firms. Within the United States,
old-line firms such as Studebaker, Packard,
Hudson, and Willys have disappeared, as have
Citroen, Sunbeam, Audi, Simca, Wolsey, and
Maserati abroad. It is a truism that the defunct
firms have not been able, given the level of mar-
Industrial Organization Approach
Another set of hypotheses about the competitive potential of banks is based on industrial
organization studies. Profits and the numbers of
firms are inversely related; the smaller the number of firms in the industry, the higher their profit
rates. The implication is that banks based in
countries with high concentration ratios would
be more profitable-and better able to satisfy
capital expansion needs-than those in countries with lower concentration ratios. Thus the
margins of banks-the spread between the interest rates they receive on loans and the interest
rates they pay on deposits-would be higher in
the countries in which the concentration ratios
are high. High margins provide the necessary
condition for high rates of profit, but not the sufficient condition; the less extensive competition
may have led to higher wage rates and costs and
less pressure for efficiency. To some extent, differences in margins may reflect differences in
costs of reserve requirements.
A comparison of the efficiency of commercial banks in several countries requires an answer to the question, "What do commercial
6
banks produce?" The experts do not agree on
an answer, in part because the output of banks,
in contrast to that of auto companies, is not
visible. ' In the absence of clarity about the inputs and outputs, comparisons of efficiency
across national frontiers are likely to be futile.
Commercial banks are one class of a family
of financial intermediaries. All financial intermediaries perform similar functions - they
issue liabilities to primary lenders, largely households, and use the funds to buy the securities
issued by primary borrowers, largely firms and
governments. The interest income paid by the
borrowers exceeds that on the liabilities issued
by the financial intermediaries.
The liabilities issued by financial intermediaries differ from those issued by primary borrowers in several respects; for instance, they are
more liquid, in that they can be more readily
exchanged into money at a fixed price. In addition, the liabilities issued by financial intermediaries are less subject to default risk, since
intermediaries hold a diversified group of primary securities. Morover, the liabilities issued
by some financial intermediaries are guaranteed by the government. Finally, the liabilities
issued by financial intermediaries sometimes
have attached associated services: life insurance
policies provide a fixed payment contingent on
death, while annuity and pension policies provide a variable payment contingent on living.
Demand deposits are used for money payments.
Financial intermediaries are grouped by the
unique types of financial liabilities they produce. Commercial banks produce demand deposits-by definition any institution which produces demand deposits is a commercial bank.
At any time the size of the commercial bank
sector relative to the size of every other type
of financial intermediary depends on the primary lenders' demand for the risk, return, and
service attributes of liabilities of each type of
intermediary. The reserve requirements applied to commercial banks provide an upper
limit on the volume of the liabilities at any
time, given the volume of their reserves created by the central bank. Moreover, the re-
serve requirements reduce the interest that
banks can pay on their deposits, since they
constrain the interest income earned by banks.
Banks and non-banks acquire similar types of
assets, although not necessarily in the same proportions. The interest rates that each type of
intermediary can pay on its liabilities will-in
the absence of regulatory constraints-depend
on how successful it has been in acquiring assets whose returns are high related to their
risks.
Each financial intermediary performs two
different functions. On the one hand, each
intermediary sells its liabilities and buys money;
on the other hand, each buys loans and sells
money. The more successful the intermediary is
in selling liabilities, the larger volume of interestbearing assets it can acquire. Intermediaries
in marketing their liabilities attempt to optimize
the risk-return aspects of their assets.
For financial intermediaries as a whole, the
acquisition of liabilities of primary borrowers
must equal the sale of liabilities to primary lenders. But this statement is not necessarily true
for each bank, or for each life insurance company, nor is it true for banks as a group or for
life insurance companies as a group, or for any
other sub-set of financial institutions. At any
time, some commercial banks may be more successful in selling liabilities than in finding attractive loans; these banks can "sell" or lend
their excess money to other banks. If some
banks have an excess supply of deposits, then
other banks must have an excess supply of assets or loans. Transactions among banks would
clear the market.
Once an individual bank has sold an additional deposit to a primary saver, it compares
the prospective return and risk from acquiring
additional primary securities with the return and
the risk from lending to other banks. Most financial institutions specialize in either selling
deposits or in buying loans. The implication is
that there are significant economies of scale in
grouping the liability transactions and the asset
transactions in one institution.
Nevertheless the loans of some banks exceed
7
other banks. The interest rate at which deare traded among banks can be used as
a transfer price to determine the distribution of
the gross income of the bank between its two
activities.
In fact, at any moment a family of transfer
prices exists; these prices differ by maturityone on Federal funds, one on short-term certificates of
another on
certificates of deposit, one on longer-term government bonds. 2 Moreover, the prices for each mamay differ in the foreign money markets
and in the external currency market, because risk
attributes for foreign and domestic securities
differ. 3 The bank must decide which interest rates
are most relevant for the internal transfer price.
rec:eif:l1s :[rom sale of deposits to primary lenders,
their funds
obtained
borrowing from
other banks and other large lenders; such banks
are known as wholesale banks. Specialization
function
be a
banks in the
function of
and of restrictions on
branching; the large wholesale banks are located
in the major cities where most of the large borrowers also are based.
more
the wholesale banks may have an advantage in
information about
borrowers which other banks find it
At
moment, each bank compares the return available on
additional primary
assets with the return from selling deposits to
Conclusion
The two approaches outlined in this paper
eliminating observed differences in spreads
view commercial banking as an international in-
across countries..
dustry. Industrial organization theory suggests
that inferences about the relative efficiency of
banks based in different countries may be obtained from a comparison of loan-deposit
spreads. The difference between the interest
rates paid on bank liabilities and the interest
rates earned on new assets covers the banks'
costs and provides them with the profits necessary to finance their expansion. Trade theory,
however, suggests that free trade in money
would cause depositors to shift funds to those
banks paying the highest deposit rates, and cause
borrowers to shift business to the banks charging the lowest interest rates. Banks with the
higher markups would be forced out of business,
The persistence of very large differences in
such spreads would indicate that "barriers to
trade" in money exist, permitting assessment of
the underlying efficiency of each country's
banks. These differences would be independent
of inflation or recession or changes in exchange
rates, because interest rates paid on liabilities
and assets would be equally affected. The trade
theory and industrial organization approaches,
thus, are complementary ways of viewing the
phenomenon of international banking. In a
world of integrated financial markets, an analysis of banking based on underlying cost differences could be more appropriate for future
research efforts than one based on trends in
lending flows or numbers of banking offices.
FOOTNOTES
3. In a world without transaction costs and political risk
neutrality, yields on assets denominated in one currency
would differ from those on assets denominated in other
currancies by the anticipated rate of change in the exchange
rate; all yields in one currency would be a simple transformation of those in every other currency. Bid-ask spreads
would be everywhere equal. In the real world, these spreads
are not equal. The bank must choose between the transfer
price in the domestic market, and that in the foreign
market.
1. See W. F. Mackara, "What Do Banks Produce?" Monthly
Review. Federal Reserve Bank of Atlanta, May 1975, pp.
70-75.
2. Note the choice of the relevant trar.sfer price is independent of how much banking risk the firm should acquirethat is, to what extent the bank should mismatch the maturities of its assets and liabilities. Once the bank decides
on the appropriate mismatch, then it should trade securities whenever the market spreads differ from those it deems
offer the best risk-return combination.
8
take into consideration the rise in the last decade
or so of regional international financial centers
such as Singapore, Panama, and the U.S. West
Coast. These new regional centers have contributed importantly to the growth of international finance by being both competitive with,
and complementary to, old-established centers
such as London, New York,
and
Zurich.
A number of studies have now appeared on
various regional financial centers, both old and
new, but none as yet on the rise of the U.S. West
Coast as an international financial center. The
purpose of this study is to fin that gap.
The study of regional international financial
centers is a long-neglected subject. In the literature on international finance, it is customary to
consider the world as consisting of separate national money and capital markets, linked together by international capital flows, with each
national market assumed to be a uniform, homogeneous entity. Alternatively, the entire world is
regarded as a single market in which competition
for national funds takes place through various
institutional channels such as banks, international bond markets, etc. By and large, these
analytical approaches have served their purposes welL But, with their emphasis on national
and international developments, they do not
Economic Factors
Despite these recent contributions, a conceptual framework for the study of regional financial centers is still lacking. Regional economics,
with its sophisticated theoretical models of locational distribution of industry and intra-urban
land use, 2 rarely concerns itself with the location
of finance. There appears to be no obvious way
to apply the factor-endowment approach
(Heckscher-Ohlin) or the distance-from-center
approach (von Thunen) used in regional economics to the explanation of regional financial
centers. On the other hand, a growing literature
on the pivotal role of money and capital markets
in economic development" leaves largely unexplored the question of the location of financial
centers and the functional links among these
centers.
It is beyond the scope of this study to develop
a rigorous theoretical framework for analyzing
the factors underlying the rise and fall of regional international financial centers. Nevertheless, it would be useful to consider briefly a few
relevant hypotheses in economic literature that
might throw light on the subject.
First, we may consider the portfolio-balance
theory of finance, as used in the anafysis of international diversification of asset-holdings and international capital flows.' In essence, it states
that an asset-holder (say, a bank) that desires
maximum return from his investment portfolio
with minimum risk can improve his welfare
through international diversification of his asset
holdings, and that his gains are the larger the less
(algebraically) the returns from the various as-
9
booming economies of the countries located
around the Pacific Basin. 7
Fourth, insights obtained from studies of industrial structure might throw some additional
light on the subject. Among the West Coast
banks now active in international banking, by
far the largest are California banks. Besides its
substantial economic base, California is also
noted for a liberal banking law that permits
statewide branching. Presumably, the resultant
sharp competition among banks may have
driven profits from domestic operations down
to a level that provided a strong incentive for
expansion in areas where competitive conditions
were less severe, as in the less-developed areas
of the world.
Keeping these factors in mind, we may now
turn to an examination of the rise of the West
Coast as an international financial center during
the 1970's. Following a quick overview, we will
look into the various components of the growth
process: the overseas expansion of West Coast
banks, the activities of Edge Act corporations
on the West Coast, and the activities of foreign
banks in the region. One section analyzes the
experience of West Coast banks during the turbulent 1974-75 period, and another the profitability of international operations. Finally,
some preliminary conclusions are drawn concerning the future of the West Coast as an international financial center.
sets are correlated with one another. This paper
contains partial evidence suggesting that, in the
1973-74 environment, an internationally diversified portfolio apparently assisted a number of
West Coast banks in improving their overall
earnings.
Second, we may consider economies of scale.
The portfolio-balance theory, while accounting
for banks' desire for international asset diversification, can not tell us why, at one particular
juncture in the early 1970's, so many West Coast
banks initiated or expanded international activities. Obviously, overseas branching is costly,
requiring a certain minimum scale of operations
to undertake. In this respect, it may be pertinent
to note that loans and investments of all commercial banks in the San Francisco Federal Reserve District nearly doubled from $51 billion
in 1967 to $101 billion in 1974, increasing at an
average rate of 10 percent per year. 5 Presumably, during this period a number of West Coast
banks must have attained a size sufficiently large
for them to initiate profitable international
operations.
Third, growth of international banking is related to that of international trade. Between
1967 and 1974, the total value of West Coast
foreign trade (exports plus imports) rose three
and a half times to $37 billion"-at an average
growth rate of 24 percent per year. About twothirds of this trade was conducted with the
Overview of Growth, 1969-75
Five of these banks-Bank of America, Security
Pacific, United California, Wells Fargo, and
Crocker-each had more than $1 billion in foreign assets; together the five accounted for $30
billion of the $32 billion of total foreign assets
of all West Coast banks in 1974.
The number of banks having branches abroad
increased from nine in 1969 to twenty in 1975.
The number of branches rose from 102 to 138,
and the number of representative offices from 28
to 61, while foreign-branch assets jumped from
$5.6 billion to $35.7 billion.
Table 1 summarizes the growth of West Coast
international banking from 1969 to 1975. Not
all the series are available for the entire period,
but the overall impression of rapid growth is
unmistakable.
Between 1969 and 1974, total foreign assets
of West Coast banks increased from $7 billion
to $32 billion. s Moreover, there was a broad
participation of West Coast banks in this rapid
expansion. In 1969, only five West Coast banks
had more than $100 million in foreign assets;"
by 1974, the number has increased to eleven. H )
10
Increased activities of Edge Act corporations
also testified to the growth of international banking in the region. The number of such corporations increased from 7 in 1969 to 23 in 1975,
while their total assets increased more than 11
times from $80 million in 1969 to $930 million
in 1975.
Another measure was the expansion of foreign banks' activities on the West Coast. Agencies and branches of foreign banks increased
from 16 in 1969 to 50 in 1975, and foreignowned state-chartered banks increased from 7
to 15. The total assets of these foreign banking
offices increased from $1.6 billion in 1969 to
$13.5 billion in 1975.
The growth phenomenon was also reflected
in a substantially enlarged volume of international capital flows reported by West Coast
banking institutions. Over the 1974-75 period,
U.S. capital outflows reported by West Coast
banks (measured by changes in U.S. foreign
assets) averaged $3.2 billion per year, or about
18 times the average rate of the 1969-70 period.
Foreign capital inflows reported by West Coast
banks (measured by changes in U.S. foreign liabilities) averaged $740 million per year during
the 1975-75 period, or about three times the average 1969-70 rate. U.S. capital outflows
through West Coast banks accounted for 20 percent, and foreign capital inflows 6 percent, of the
respective total flows reported by all U.S. banks
during the 1974-75 period. By coincidence,
these percentages were almost the same as the
West Coast banks' shares at the end of 1975 in
the total U.S. claims on foreigners and liabilities
to foreigners reported by banks-20 percent
and 7 percent, respectively.'1
Table 1
Growth of West Coast
International Banking
1969.75 a
1969
1975
7.0
32.0
Total foreign assets oi
West Coast banks
(billions of dollars)
Overseas Branches
Number of West Coast
banks
9
Number of branches
102
Branch assets (billions
of dollars)
5.6
Number of representative
offices abroad
28
Edge Act Corporations
Number of Edge
corporations
Total assets (millions
of dollars)
Foreign Banks
Number of agencies
and branches
Agency assets (billions
of dollars)
Number of subsidiary banks
Subsidiary bank assets
(billions of dollars)
20
138
35.7
61
7
23
80
930
16
50
0.7
7
9.0
15
0.9
4.5
aData for total foreign assets are as of end-1969 and end1974; overseas branch data, end-1969 and end-I975;
Edge corporation data, end-1969 and mid-1975; and
foreign bank data, mid-1969 and mid-I975.
Sources:
Based on subsequent tables.
Overseas Branch Activities
ventures in a handful of foreign countries. '2
Bank of America opened its first foreign
branch in 1931, but did not add another until
1947. It added a total of 21 foreign branches in
the 1947-63 period. But then, in a burst of expansion covering the 1964-68 period, it opened
another 64 branches-more than one new overseas branch a month on the average. Despite a
West Coast banks were relatively late starters
in overseas banking. As late as 1968, Bank of
America was the only West Coast bank with
branches abroad, although a few others-Bank
of California, Crocker, United California, Wells
Fargo, Security Pacific, and National Bank of
Commerce of Seattle (now Rainier)-maintained representative offices and interests in joint
11
Table 2
Growth In Overseas Operations of Individual Banks
1969·1974
(Deposit and loan volume In mlilions of dollars)'
Ratio: 1974/1969
1969
1974
21,509
5,040
23%
45,348
18,110
40%
Total
Overseas
Percent Overseas
13,842
2,402
17%
27,649
8,459
31%
1.99
3.52
Secnrity Pacific
Deposits:
Total
Overseas
Percent Overseas
4,474
20
0%
10,047
2,276
23%
2.25
113.80
Total
Overseas
Percent Overseas
3,873
36
1%
8,612
1,068
12%
2.22
29.67
United California
Deposits:
Total
Overseas
Percent Overseas
3,934
270
7%
7,098
1,799
25%
1.80
6.66
2,709**
87**
3%
5,114
598
12%
1.89t
6.87t
4,542
101
2%
9,065
1,670
18%
2.00
16.53
Total
Overseas
Percent Overseas
3,386
29
1%
7,336
941
13%
2.17
32.45
Total
Overseas
Percent Overseas
4,169
283
7%
7,896
1,431
18%
1.89
5.06
Seattle First
Deposits:
Total
Overseas
Percent Overseas
1,612
2
0%
3,118
354
11%
1.93
177.00
Total
Overseas
Percent Overseas
1,187
3
0%
2,317
117
5%
1.95
39.00
Total
Overseas
Percent Overseas
1,078
1.72
3.31
8%
1,861
298
16%
Total
Overseas
Percent Overseas
683
II
2%
1,271
130
10%
1.86
11.82
Bank of America
Deposits:
Total
Overseas
Percent Overseas
Loans:
Loans:
Loans:
Total
Overseas
Percent Overseas
Wells Fargo
Deposits:
Total
Overseas
Percent Overseas
Loans:
Crocker
Deposits:
Loans:
RainierH
Deposits:
Loans:
90
*Daily or weekly average balances.
"1970
tRatio. 197411970.
ttExcluding Edge Act subsidiaries.
Sources: J974 Annual Reports of the respective banks.
12
2.11
3.59
later slowdown in the expansion pace, it maintained at the end of 1975 a network of 107 overseas branches and 13 foreign representative offices, with $33 billion in weekly average assets
in the bank's Worid Banking division-about 54
percent of the bank's total average assets. 13
Other West Coast banks started overseas
branching in 1968, with the opening of a London branch by National Bank of Commerce of
Seattle. As shown in Table 1, by the end of
1969 there were nine West Coast banks with
overseas branches,"! with total branch assets
amounting to $5.6 billion. However, aside from
Bank of America branches, all were located in
either London, the Bahamas, or Luxembourg.
During the six years 1970-75, 11 other West
Coast banks opened branches abroad. 15 The
combined assets of the foreign branches of all
West Coast banks increased to $35.7 billion at
the end of 1975. 16 During this period, they undertook extensive branching activities in Japan
and other countries in the Far East
These aggregate data reveal little about the
operations of individual banks. However, seven
individual banks report considerable detail in
their annual reports to stockholders (Table 2).
Over the 1970-74 period, total loans and deposits of each of seven major West Coast banks
about doubled; but in all cases, their overseas
loans and deposits grew at a much faster pace.
Overseas operations more than tripled for Bank
of America, an established international-banking institution, and jumped over a hundred-fold
for such newcomers as Seattle First and Security
Pacific. As a result, overseas loans and deposits
Table 3
Total Assets of Foreign Branches
of West Coast Banks, by Region
December 31, 1975
Region
Total Assets
Share
of Total
(Millions of Dollars) (Percent)
Europe *
Caribbean
Pacific Basin 1
Total
23,188
5,619
6,863
35,670
65
16
19
100
lJapan, Korea, Taiwan, Hong Kong, Philippines, Malaysia, Singapore, Thailand, and Indonesia.
Source: Based on data reported by banks to the Federal
Reserve System.
were by 1974 a substantial portion of portfolios
for all these institutions-from a high of 40
percent for Bank of America to between 10 and
20 percent at other banks.
Overseas operations have remained heavily
concentrated in Europe and the Caribbean (Table 3), reflecting the importance of Eurodollar
operations. The only other measurable activity
was in Pacific Basin countries-almost entirely
in Japan, Singapore, and Hong Kong. 17
Besides overseas branches, West Coast banks
also have invested large sums in foreign affiliates
which are engaged in all sorts of banking or
near-banking activities. These activities include
merchant banking, investment banking, finance
companies, leasing, mortgage, trust, factoring,
etc. Data on the amounts involved, however, are
lacking. 18
Edge Act Corporations on the West Coast
Edge Act Corporations are wholly-owned
subsidiaries of U.S. banks set up under Section
25 (a) of the Federal Reserve Act to facilitate
international banking activities. They may be
established in states outside their parent banks'
home states, and therefore represent an exception to the usual barriers against interstate
branching by U.S. banks. This provision enables banks which are located outside major fi-
nancial centers to engage in international banking in such centers; on the other hand, it also
permits banks which are located in one major
financial center to participate in international
banking in other centers. The establishment of
a large number of out-of-state Edge corporations in a region is, therefore, a good sign of the
region's growing importance as an international
financial center.
13
In addition to their international banking activities, Edge corporations may also make equity
investments in foreign corporations which do
not transact business in the United States-an
activity which their parent banks are prohibited
by law from doing. Hence, many banks which
are located in an international financial center
may set up Edge corporations in the same locale,
often on the same premises, for conducting international equity-investment businesses. These
Edge corporations are commonly referred to as
"investment Edges," in contrast to the "banking
Edges" described above.
Edge activity on the West Coast was quite
modest until recently. As late as 1965, there
were only three such corporations: a banking
Edge in Seattle (International Bank of Commerce) and two investment Edges in San Francisco (Crocker International and Bank of California International). In 1967, First National
City Bank of New York opened a banking Edge
in San Francisco-the first representative from
outside the region-and then five West Coast
banks (Security Pacific, Bank of America, U.S.
National of Oregon, Seattle First, and Union)
established investment Edges. By the end of
1969, seven Edge corporations were operating
on the West Coast, but with total assets of only
$80 million.
The big wave hit the West Coast in 1973 and
1974, when ten new Edge corporations were established-mostly from outside the regionraising the total number to 23 and their aggregate assets to $1 billion. The wave then appears
to have subsided, as the total assets fell to $930
million by mid-1975,lB and the number dropped
to 22 with the merger of two investment-Edge
subsidiaries of Crocker in August 1975. Today,
there are 13 banking Edges-8 from New York,
3 from Chicago, and 1 each from Boston and
Seattle-along with 9 investment Edges which
all represent West Coast institutions.
Measured by asset size, the banking Edges are
far more important than investment Edges. At
mid-1975, banking Edges had total assets of
$841 million, compared to only $88 million for
all investment Edges. Activity is largely concentrated in San Francisco ($418 million in assets)
and Los Angeles ($500 million), with the balance about equally distributed between Portland
and Seattle.
Foreign Banks on the West Coast
Most foreign banks on the West Coast use the
agency form, rather than the branch form of organization. 20 The latter is effectively barred
from California, because the state requires all
domestic deposits to be insured by the FDIC,
and the FDIC insures only U.S.-chartered
banks. A similar situation exists in Oregon, although the branches of two foreign banksBank of Tokyo and Canadian Imperial-have
"grandfather" privileges there. The state of
Washington permits branches of foreign banks,
but with domestic deposits severely limited by
law, the branches in effect act much like agencies. The most effective arrangement has
evolved in California, where foreign banks have
established both agencies and full-service statechartered subsidiary banks, in an attempt to obtain flexibility in both lending limits and deposit-
accepting capabilities. 21 In fact, each of the 15
foreign banking subsidiaries in California, except for Lloyds, operates in tandem with an
agency of the same parent bank.
Foreign banks came early to the West Coast.
Canadian Imperial Bank of Commerce opened
an agency in San Francisco in 1902, and Bank
of Montreal established a subsidiary bank in San
Francisco in 1918 and an agency there in 1934.
Other Canadian and Far Eastern banks followed
in the 1930s and after the Second World War.
Yet by mid-1969, there were only seven foreign
subsidiary banks and sixteen agencies and
branches of foreign banks on the West Coast,
with assets totaling about $1.5 billion.
The pace of expansion was relatively slow
until mid-1971. But within the next four years,
29 new agencies and 8 banking subsidiaries
14
Europe, and the Americas are now represented
on the West Coast. The Japanese banks account
for a full two-thirds of the $13.5 billion total
assets of all foreign banking offices in California;
four British banks account for 15 percent; six
Canadian banks for 9 percent; and seventeen
other foreign banks for the other 9 percent. 2 :'
Foreign banks bring to a region financial expertise and special ties with foreign business
partners which local banks do not possess.
Their comparative advantage in this respect enables them to overcome the cultural and business
barriers of entry into a (for them) foreign environment. Being complementary to the indigenous banks, foreign banks help to broaden and
strengthen a region's institutional base as an international financial center. In addition, as they
become established in the new market, they help
to enhance competition by offering local savers
and borrowers a greater choice of financial
services.
opened in California and 4 new branches opened
in Seattle. At mid-l975, agency and branch
assets totaled $9.0 billion and subsidiary-bank
assets $4.5 billion-13 times and 9 times their
respective sizes only six years earlier. Within
the same period, their share of all commercialbank assets within the San Francisco Federal
Reserve District increased from 2.1 percent to
9.8 percent.
Foreign banks prefer California to any other
state (except New York) as a place to conduct
business. As of last September, 66 branches and
agencies were located in New York, 43 in California, and 35 elsewhere; while 16 subsidiary
banks were in New York, 15 in California, and
only 2 elsewhere. New York accounted for 68
percent, California 26 percent, and other regions only 6 percent, of the $56.5 billion total
assets of all the foreign banking offices in the
United States. 22
Banks from thirteen foreign countries in Asia,
Recent Developments
tions of a number of developing nations and
forcing them to seek substantial loans from the
banking system. Through it all, international
banking underwent considerable strains while
offering unprecedented opportunities as well.
How did West Coast banks manage through
that period of perils and opportunities? In response to the lifting of capital controls and to
the world-wide demand for the financing of oil
deficits, West Coast banks stepped up their foreign lending very sharply during the second
quarter of 1974, both at their head offices and
through their foreign branches, as shown in Table 4. Following the Herstatt debacle, they drastically reduced their lending activities, leading
to a substantial net liquidation of head-office
loans during the third quarter and of foreign
branch loans in the fourth quarter of 1974. Subsequently, however, foreign lending recovered
momentum, and head-oftice lending even surpassed the 1973-74 pace.
Thus, in fact, West Coast banks did not undergo as much of a "consolidation and retrench-
Nineteen seventy-four was a particularly turbulent period for international banking. The
lifting of U.S. capital controls in January 1974
coincided with the liberalization of controls over
international capital flows by other major industrial countries. This coordinated shift in policy
occurred just as the world's major banks were
called upon to help manage the huge flows of
international oil payments. At the time, there
was widespread concern over the banks' ability
to handl~ such flows and to bear the risks involved. Then in May, 1974, came the Franklin
National failure, followed soon after by the Herstatt debacle and a series of other international
banking failures and near-failures. On top of it
all, inflation became rampant worldwide, causing interest rates to soar and the world bond
market to decline during a time of large international-payments imbalances. From late 1974
on, a spreading business recession engulfed the
world, with declining export markets, falling
commodity prices, and continually rising import
costs seriously undermining the payments posi15
Table 4
ment" in 1974 as was alleged in the financial
press. Reports of "an age of expansion in international banking coming to an end" were unfounded. Measured by banks' foreign claims,
any retrenchment. was quite brief~lasting no
more than one quarterQf a year. Foreign lending resumed growth at both head offices and
foreign branches in 1975, although the foreignbranch expansion was at a slower. pace than
previously.
InternaticnalActivities of
West Coast Banks and Their
Foreign .Branches
Quarterly, .1974--75
(MIllions of dollars)
West Coast Banks
Fore!gn
Branches
Change in Change in Change in
Foreign
Total
Foreign
Assets Liabilities Assets
Period
515
1973 1
173
Profitability of International Operations
The feature attracting banks to international
operations must be their profitability. Indeed, a
recent industry study shows that the international earnings of a group of nine major U.S.
banks increased at a 37-percent annual rate over
the 1970-74 period, compared to only a 3-percent rate of gain for domestic earnings. 24 Comparable data for West Coast banks are not available for that period, but scattered data for 1973
and 1974 show the same type of upsurge in overseas earnings (Table 5). In the three cases
shown, earnings from international operations
grew considerably faster than domestic earnings
between those two years. Thus Bank of Amer-
1,944
1974
I
II
III
IV
537
2,138
- 705
487
260
186
766
391
1,199
4,458
1,887
191
1975
I
II
III
IV
1,123
587
780
1,529
68
143
88
41
394
528
458
2,403
'Quarterly average.
Source:
Based on data reported by banks to the Federal
Reserve System and the U.S. Treasury.
Table 5
Assets and Earnings of Selected Individual Banks
1973 and 1974
(Millions of dollars)
Assets
Earnings
1973
1974
Changes
49,400
18,000
31,400
60,400
25,000
35,400
+22%
+39%
+13%
Security Pacific
Total
International
Domestic
9,756
808
8,948
12,069
1,068
11,001
+24%
+32%
+23%
60.0
5.4
54.6
56.0
6.7
49.3
7%
+24%
-10%
Seattle First
Total
International
Domestic
3,595
89
3,506
4,190
117
4,073
+17%
+31%
+16%
25.5
1.5
24.0
29.5
3.4
26.1
+16%
+127%
+ 9%
Bank of America
Total
International
Domestic
Source:
Estimated on basis of data in 1974 Annual Reports
16
1973
1974
219
70
149
257
100
157
Change
+17%
+43%
+ 5%
ica's international earnings increased 43 percent, compared to only 5 percent for domestic
earnings; those of Seattle First increased by 127
percent, compared to only 9 percent for domestic earnings; and those of Security Pacific by 24
percent, compared to an 11 percent decrease in
domestic earnings.
To a large extent, the faster increase in international earnings can be attributed to a greater
growth rate in international assets than in domestic assets. Indeed, between 1973 and 1974,
Bank of America's international assets grew by
39 percent, compared to 13 percent for domestic assets; while the comparable figures were 31
to 16 percent for Seattle First and 32 to 23 percent for Security Pacific.
If the average rate of return is measured by
the ratio of earnings to assets, then changes in
the profitability of an operation can be measured by the difference between the earninggrowth rates and asset-growth rates. Thus, on
the basis of the data in Table 5, the profitability
of Bank of America's international operations
appears to have improved slightly between 1973
and 1974; while Seattle First's improved enormously, and Security Pacific's declined somewhat. In contrast, the three banks' domestic
profitability all declined sharply, apparently as
a result of the U.S. recession in 1974. Thus, in
two of the three cases examined, increased profitability in international operations provided a
cushion against the decline in profitability of
domestic operations. Even in the third case,
where international profitability also declined,
the absolute increase in such earnings helped to
offset the decline in domestic earnings.
A similar picture is presented by recently published 1975 data for Bank of America (Table
6). Clearly, the 23-percent growth in its international earnings in 1975 remained considerably
above its 12-percent growth of domestic earnings. (The comparable growth figures for 1974
were 43 percent and 5 percent, respectively.)
When deflated by the respective growth rates in
earning assets, the bank's international profitability continued to improve, and its domestic
profitability to deteriorate in 1975.
Table 6
BankAmerica Corporation
Growth in Earnings and Assets
International and Domestic
1974-1975
Average Earnings
1974
1975
(Million $)
Total
International l
Domestic
257
136
121
Increase
(Percent)
302
167
135
17.5
22.8
11.6
Average Earning Assets
1974
1975
(Siiiion $)
43.5
23.9
19.6
49.3
27.1
22.2
Increase
(Percent)
13.3
13.4
13.3
'World Banking Division. Data differ from the corresponding figures presented in Table 5, because of "profit center
changes, changes in international allocation of overhead expenses and risk changes and improvements in building block
system."
Source: BankAmerica Corporation, Annual Report 1975, p. 50.
17
Conclusion
As stated atthe outset, the rise of regional fi~
nancial centers has been one of the most interest~
ing developments of the past decade in interna~
tional .finance. These newly~developedcenters
both complement and compete with old~estab~
Iished centers in the allocation of the world's
financial resources. To the extent that these
centers have provided closer contacts between
international and regional sources and users of
funds, they have enhanced the efficiency of in~
ternational financial markets. Moreover, they
have undoubtedly added to the prosperity and
economic growth of the regions in which the
centers are located. 25
This paper has traced the rise of the U.S.
West Coast as an international financial center.
The rise has been remarkably rapid since 1969.
In terms of both the volume of capital flows and
the worldwide financial interests represented,
the West Coast has become today a significant
factor in international finance.
Economic theory has largely ignored the phe~
nomenon of regional financial centers. Yet, for
both regional economics and development eco~
nomics, it should be a topic of considerable in~
terest. Recent contributions to economic analy~
sis have emphasized the central role of financial
markets in promoting economic growth. To a
large extent, the analysis should be applicable
to both developed and developing economies.
Regional financial centers have evolved in both
types of economies to provide important links
between national money and capital markets on
the one hand and broader world markets (such
as the Euro~currency market) on the other. Fur~
ther, the regional clustering of international
banking institutions suggests that the optimal
geographic size of financial markets is perhaps
smaller than a large country (such as the United
States) and larger than most small countries.
At the present stage of knowledge, this paper
is more concerned with what has occurred than
with why. Nevertheless, the brief discussion of
economic factors suggests that as commercial
banking expanded on the West Coast, a growing
number of banks in the past decade attained a
size sufficiently large to reap the benefits of in~
ternational portfolio diversification. Available
profits data appear to reinforce the impression
that banks were indeed able to reap suchbene~
fits by balancing declining domestic loan de~
mand (due to the U.S. recession) with increased
international loan demand (due to large pay~
ments deficits abroad).
Another key factor has been the rapid growth
of West Coast international trade, which has at~
tracted many Edge corporations and foreign
banks to the region while inducing domestic
banks to start or expand their own international
operations. In 1975, the growth of trade slowed
down considerably as a result of the worldwide
recession. Nevertheless, as many as seven new
agencies and branches of foreign banks were
opened on the West Coast, and nine new
branches of West Coast banks were established
abroad. Thus, it appears that the banking indus~
try's interest in international banking on the
West Coast remained undaunted by the reces~
sion. Both domestic and foreign banks appar~
entlY saw the need to maintain their present
stake in the market, and thus set the groundwork
for further profitable operations in the years
ahead.
18
FOOTNOTES
1. Charles P. Kindleberger, The Formation of Financial
Centers: A Study in Comparative Economic History, Massachusetts Institute of Technology, Department of Economics,
Working Paper No. 114 (August 1973). Harry G. Johnson,
"Panama as a Regional Financial Center," Economic Devel·
opment and Cultural Change, (January 1976), pp. 261-286.
Robert F. Emery, The Asian Dollar Market, Board of Gover·
nors of the Federal Reserve System, International Finance
Discussion Papers, No. 71 (November 1975). The older
literature includes Margaret C. Myers, The New York Money
Market (New York: Columbia University Press, 1931); Frank
Tamagna, "New York as an International Money Market,"
Banca Nazionale del Lavoro Quarterly Review, (June 1959),
pp. 201-234; Sidney M. Robbins and Nestor E. Terleckyj,
Money Metropolis (Cambridge: Harvard University Press,
1960).
2. A useful survey of the literature on the subject is Gerard
S. Goldstein and Leon N. Moses, " A Survey of Urban Economics," Journal of Economic Literature, (1973), pp. 471515.
3. Raymond W. Goldsmith, Financial Structure and Devel·
opment (New Haven: Yale University Press, 1969); Arnold
W. Sametz, editor, Financial Development and Economic
Growth (New York: New York University Press, 1972); Ronald I. McKinnon, Money and Capital in Economic Development, (Washington, D.C.: Brookings Institution, 1973); Ed·
ward S. Shaw, Financial Deepening in Economic Development (New York: Oxford University Press, 1973).
4. Herbert G. Grubel, "Internationally Diversified Portfolios:
Welfare Gains and Capital Flows," American Economic Re·
view, (December 1968), pp. 1299-1314.
5. Federal Reserve Bank of San Francisco, Western Economic Indicators, January/February 1976, p. E-4.
6. Ibid., p. A-8.
7. Raymond Jallow, "World Trade in the West," California
Business, (May 16, 1974), p. 2.
8. By convention, a bank's total foreign assets equal the
difference between its global consolidated total assets and
its domestic assets. Global-asset data are published an·
nually in Rand McNally International Bankers Directory
(Chicago: Rand McNally & Co.). Domestic asset data are
reported weekly by large commercial banks to the Federal
Reserve System.
9. The five were: Bank of America, United California,
Crocker, Wells Fargo, and National Bank of Commerce of
Seattle (now Rainier).
10. The newcomers were: Security Pacific, Seattle First,
Bank of California, Bank of Tokyo of California (now California First), U.S. National of Oregon, and Sumitomo Bank
of California.
11. At the end of 1975, the claims on foreigners reported
by West Coast banks amounted to $12.0 billion, and the
liabilities to foreigners $6.4 billion.
12. American Banker, February 29,1968.
13. BankAmerica Corporation, Annual Report, 1969, and
Annual Report, 1975.
14. The nine banks were Bank of America, Bank of Califor·
nia, Crocker, First Western, Security Pacific, Union, United
California, Wells Fargo, and National Bank of Commerce of
Seattle. American Banker, February 27, 1970.
15. The eleven were Arizona Bank, First of Arizona, Valley
National, 1I0yds of California, Tokyo of California, Sumi·
tomo of California, Barclay of California, First of Oregon,
U.S. National of Oregon, Seattle First. and First of Hawaii.
American Banker, February 27, 1976.
16. Data reported by banks to the Federal Reserve System.
17. However, the data do not include assets of a) European
branches whose total liabilities payable in U.S. dollars
amount to less than $10 million, and b) those elsewhere
(except Bahamas) whose total liabilities payable in U.S.
dollars are less than $30 million. Such foreign branches
are exempted from reporting their monthly assets and lia·
bility positions on FR 502.
18. For a listing of these activities at the end of 1974, see
American Banker, February 28, 1975.
19. Data on total assets understate the Edge corporations'
operations. Since their loan limits are tied to the size of
their capital, it is common practice for Edge corporations
to generate loans and then sell them or pass them on to
their parent banks. There may have been about $425 million outstanding in such loans at West Coast banking Edges
in 1975.
20. The differences between the various types of organizations are discussed elsewhere in this issue. Robert John·
ston, "Proposals for Federal Control of Foreign Banks."
21. U.S. Department of Commerce, Foreign Direct Invest·
ment in the United States, Interim Report to Congress (Oc·
tober 1975), Volume 2, Appendix VIII: "Foreign Banking in
the United States," esp. pp. VIII 5-10.
22. George W. Mitchell, Vice Chairman, Board of Governors
of the Federal Reserve System, Statement Before the Sub·
committee on Financial Institutions of the Senate Banking
Committee, January 28, 1976, Appendix, Tables 1-6.
23. Two banks each from France, Italy, Switzerland, Brazil,
Mexico, and Hong Kong; and one each from Germany, the
Netherlands, Korea, and the Philippines; plus a multina·
tional bank, the European American Banking Corporation.
24. Cited in C. Frederic Wiegold, "Overseas Earnings in
Sharp 5-Year Rise," American Banker, October 20, 1975,
page 1.
25. See Harry G. Johnson, op. cit., for an attempt at mea·
suring the welfare gains from the rise of a regional financial
center.
19
Nicholas Sargen
Throughout the earlier part of the postwar
era, the majority of developing countries had
only limited access to international capital markets, and instead had to rely on official sources
to supply the bulk of their external financing
requirements. In the early 1960's, bilateral official assistance accounted for over 60 percent
of the total net flow of resources to developing
countries, while multilateral assistance averaged about 6 percent. Funds supplied by private sources-the remaining third-consisted
almost entirely of direct investments and suppliers' credits.
Over the last fifteen years, however, several
developments have occurred to make commercial banks an important financing source to developing countries. They include (1) rapid
economic growth in the developing countries
and failure of official assistance to keep pace
with this growth; (2) emergence of the Eurocurrency market as a funding source; and (3)
the impact of the oil crisis and the worldwide
recession on the external payments positions
(and hence the credit demands) of the devel-
oping countries. Consequently, commercialbank credits today comprise approximately 20
percent of the total net flow of resources to developing countries, bringing the share of private
financing to nearly half of the total. '
This article reviews the factors contributing
to the rapid growth of commercial-bank lending to developing countries-primarily the nonOPEC countries-and addresses itself to two
basic issues. First, how exposed are commercial banks to potential default or rescheduling
problems? Second, to what extent are commercial banks compensated for added risks they
incur in lending to developing countries? The
principal finding is that the differential rate of
return commercial banks receive from investing
in developing countries vis-a-vis developed
countries is low by historic standards. However, this does not imply that the differential is
insufficient to cover the added risk of default,
given the long-run prospects of the major recipients of commercial-bank credits and given
the institutional arrangements available for
handling their debt problems.
Rise of Commercial-Bank Lending to Developing Countries
As a group, the developing countries
(LDCs) have amassed an impressive economic
record over the last fifteen years. During the
1960's, their real national product rose 5.5 percent annually, in the aggregate, and in the first
half of the 1970's their annual growth approached 6 percent. These figures far exceed
rates in the first half of the century, when
growth in real output averaged two percent,
and less than one percent in per capita terms. 2
Economic growth was far from uniform,
however. Nearly half of the lower-income
countries (per capita incomes of $200 or less,
1972 prices) recorded growth rates of less than
one percent per capita in 1960-72, whereas
over 60 percent of the higher-income countries
20
Table 1
Gross Publicized Eurocurrency Credits
to I.B.R.D. Member Countries
($ mlUions)
Country
Category
1971 a
1972 a
1973 a
1974 b
1975 b
Developing Countries
1,475
4,080
9,116
9,605
11,530
432
918
62
63
1,117
2,632
94
130
3,013
5,280
507
317
773
6,980
1,562
291
3,137
7,216
1,105
71
16,915
4,627
2,645
3,771
11,125
2,103
3,373
28,624
19,530
1,108
2,530
of which:
Oil Exporters
Higher-income
Middle-income
Lower-income
Industrial Countries
Other
Total, IBRD Member Countries
Non-IBRD members
4,120
7,851
20,241
c
Major Developing Country Recipients
Country
Category
Oil Exporters
Algeria
Indonesia
Iran
Venezuela
Higher-income
Argentina
Brazil
Greece
Mexico
Peru
Spain
Yugoslavia
1971
1972
1973
1974
1975
cumulative
'71-'75
120
275
98
461
258
1,352
478
712
63
348
114
58
500
1,536
245
200
2,247
2,460
1,756
657
420
10
264
577
330
509
209
253
255
87
715
600
1,572
734
467
235
559
1,668
438
1,478
366
1,169
549
34
2,069
239
2,159
423
931
73
994
5,241
1,667
5,858
1,732
3,240
1,122
40
55
61
30
90
142
287
883
264
71
213
312
27
1,157
788
530
224
78
50
212
60
140
Middle or
Lower-income
Philippines
South Korea
Zaire
aSource: OECD, Development Assistance Committee, Development Co-operation Review, 1973-74. Data on Eurocurrency loans are based on tombstone advertisements, which were not as commonly used in 1971-72 as in
later years.
bSource: IMF Survey, February 16, 1975.
cPrimarily represents lending to Socialist Bloc countries and Hong-Kong. Major 1974-75 recipients are Poland ($894
million), USSR ($750 million) and Hong Kong ($715 million).
21
(over $375 per capita) had growth rates of
U.S., as well as intensification of controls on
more than 3 percent per capita. As bilateral
capital inflows in the major European countries
assistance became increasingly scarce in the
and Japan, which affected borrowings of their
1960's, a larger percentage of the restricted
residents from the Eurocurrency market."
flow was concentrated in the poorest countries.
The flow of medium-term credits from banks
Consequently, a number of the higher-income
operating in the Eurocurrency market (includdeveloping countries were forced to seek altering credits syndicated and funded by foreign
native sources of financing to sustain their high
branches of U.S. banks) has grown rapidly since
growth rates. Multilateral lending institutions
1971. The amount of Euro-credits with maturwere able to narrow the gap by extending
ities over a year, for example, increased from an
estimated $1.5 billion in 1971 to an estimated
credits through their "hard loan" windows, but
they could not completely satisfy the large loan
$11.5 billion in 1975 (Table 1). Flows from
demands of these rapidly growing countries.
banks in the U.S. market, on the other hand,
Commercial banks in the Eurocurrency marhave increased from less than $1 billion in 1971
ket and in the United States began lending to
to about $7 billion in 1975 (Table 2). Most of
developing countries on an extensive basis in
this growth in U.S. bank (head-office) claims
the early 1970's. The developing countries
on LDC's, however, reflects increases in shortbenefited from a change in Eurocurrency marterm credits (a year or less), which are related
ket conditions, from a phase of strong demand
to trade financing, whereas U.S. long-term
for funds at high interest rates in 1969-70 to a
credits have grown at a slower pace. Excluding
phase of rapidly increasing supply in 1971.
short-term loans, developing countries received
The shift reflected the large-scale replacement
about 45 percent of the commercial bank credits
of funds previously borrowed by banks in the
extended abroad since 1971. The latter have
Table 2
Claims on Foreigners Reported by Banks in the United States a
($ millions)
long Term Claims
changes in long term claims
Region
Developing Country Total b
Total, all countries
long term
Claims Outstanding
As of Dec. 31, 1975
1971
1972
1973
1974
Nov.
1975
6,134
274
9,393
589
Short Term Claims
821
1,287
658
933
685
1,172
1,446
2,199
changes in short term claims
Region
Developing Country Total b
Total, all countries
Short term
Claims Outstanding
As of Dec. 31, 1975
1971
1972
1973
18,492
49,683
608
2,368
907
2,199
1,473 5,963 5,432
5,049 18,307 10,653
1914
Nov.
1915
aLong term claims are those over a year, while short-term claims are those a year or less.
bTotal for Latin America (except Bahamas, Panama, Netherlands Antilles), Asia (excluding Hong Kong and Japan),
Africa, and Greece, Portugal, Spain, Turkey, and Yugoslavia.
Source: U.S. Treasury Bulletin, February 1976.
22
been heavily concentrated in a small number of
higher-income developing countries. Three
countries in this group-Brazil, Mexico, and
Spain-received nearly 40 percent of the longterm credits extended to developing countries
since 1971, and roughly half of the credits made
in the last two years.
Federal Reserve data collected from 21 large
U.S. banks indicate that about two-thirds of
total U.S. bank lending to the non-OPEC developing countries is concentrated at the six largest
banks-Bank of America, Citibank, Chase
Manhattan, Morgan Guaranty, Manufacturers
Hanover, and Chemical (Table 3). As of December 31, 1975, the six banks had almost $12
billion in loans outstanding to a select group of
developing countries, representing about 5 percent of their total assets. Claims on Mexico and
Brazil were each about 1Y2 percent of total
assets of the six largest banks, whereas claims
on all other developing countries were less than
one-half of one percent.
Table 3
Comparison of Claims on Selected Non-OPEC LDC's with
Total Loans and Total Assets of 21 Large U.S. Banks: December 31, 1975 a
(millions of dollars)
Claims over a year
Total Claims
6
b
6
Largest
Banks
Developing
Country
21 Banks
Largest
Banks
Mexico
Brazil
South Korea
Argentina
Peru
Colombia
Philippines
Taiwan
India
Egypt
Zaire
Zambia
Uruguay
Pakistan
Guatemala
5,810
5,540
1,473
1,071
1,066
756
740
677
197
177
162
99
54
51
38
3,573
3,734
972
725
665
571
597
397
178
162
123
99
54
51
23
2,614
2,980
313
242
492
157
237
143
105
31
120
18
1,480
1,924
184
144
311
23
12
17,911
11,924
7,475
4,690
218,397
394,094
136,078
237,621
Total claims on
15 countries
Memorandum - ------Total Loans
Total Assets
21 Banks
111
181
78
105
26
116
18
aData are for 21 banks reporting foreign assets and liabilities for Senate Subcommittee on Multinational Corporations
(Church Committee). These data include claims held by head offices and significant branches and pro-rata share ofclaims
held by significant majority-owned subsidiaries with intra-bank claims netted out; the data exclude claims guaranteed
by any agency of the U.S. Government (such as the Export-Import Bank), and claims on which reporting banks believed
they had an enforceable guarantee from a U.S. corporation.
bBank of America, Citibank, Chase Manhattan, Morgan Guaranty, Manufacturers Hanover, and Chemical.
Source:
"Memorandum on Foreign A ssets and Liabilities of U. S. Banks" prepared for Subcommittee on Multinational
Corporations by staff of the Federal Reserve Board.
23
Impact of the Oil Crisis and World Recession
Until recently, this trend towards increased
commercial-bank financing was generally applauded as a means whereby LDCs could become less dependent on official assistance. In
the wake of the oil-crisis and worldwide recession, however, many analysts have begun a
critical reappraisal of the situation. According
to OECD estimates, the combined current-account deficit of all non-OPEC developing countries reached a record $38 billion in 1975, compared with $26 billion in 1974 and $9 billion
in 1973, so that a question has arisen regarding
the ability of at least some of these countries to
continue accumulating debt at such a rapid rate
without defaults or reschedulings. 4
Both structural and cyclical forces help account for the pronounced deterioration in the
trade situation of non-OPEC developing countries over the last two years. The initial impact
was structural, as the developing countries encountered considerable problems adjusting to
the higher price of OPEC oil. With their consumption of petroleum relatively unchanged
(Chart 1), they have had to spend $10-11 billion more annually for oil imports than in 1973. 5
Their annual exports to OPEC countries, on the
other hand, have increased by only $1 billion.
In addition, food and fertilizer supply shortages
and price increases for other imports in 1973-74
posed further problems, especially for the worsthit countries in Asia and Africa. Altogether, oil,
food, and fertilizer imports cost non-OPEC developing countries about $14 billion more in
1974 than in 1973, and this represented more
than 80 percent of their current-account decline.
In contrast, most of the $12.5-billion trade
deterioration in 1975 reflected cyclical influences, as developing countries lagged the industrial countries into recession. The volume
of non-OPEC developing country exports to
OECD countries rose far less rapidly in 1974
than in 1973 (8.5 percent vs. 16.5 percent),
and then actually declined in 1975. Their import volume from OECD countries, however,
did not begin to slow down until well into the
second half of 1974. Prices of raw commodi-
ties-the staple exports of developing countries
-also began to fall in the latter part of 1974
from their earlier peak levels, while OECD export prices continued to rise, and these softening terms of trade accentuated the deterioration
in their trade balance.
External Debt Accumulation
Prior to the oil crisis (1967-72), the external
public debt of non-OPEC developing countries
(public and publicly guaranteed external debt
over a year's maturity) grew at a steady rate of
14 percent per annum, while debt service grew at
an annual rate of 13 percent (Chart 2). There
was a noticeable acceleration in debt outstanding and debt service in 1973, but this was offset
by extraordinarily high commodity prices. Thus,
when deflated by the LDC export-price index,
excluding oil (1967= 100), the 1973 figures
show no acceleration in growth of "real" debt
service payments, and a decline in "real" debt
outstanding. Similarly, other debt-burden indicators (e.g., debt service as a percent of exports
Chart 1
Public and Publicly Guaranteed External Debt of Non*OPEC LOC's
Billions of
1967 dollars
~,=".,
r-
70
,"bHo ,," -
(undeflatedl
~//
"
70
50L~~:::
50
30
30
10
10
8
8
Debt service payments (un,deflate,dl
6
6
4
4
2
2
o L---L_---'-_-'-_..L-_L---L_--L_...I
1967
Source'
24
1969
1971
1973
0
1975
World Bank, World Debt Tables, Vols. I-II. World Bank data excludes all debts
with maturity of one year or less as well as private non-guaranteed external debt.
The price deflator used is the LDC export-price index, excluding oiL (1967 = 100),
~xtrapolations are based on DEeD estimates of net long-term borrowings of oillmportiml: countries. (See text.)
or of GNP) indicate no dramatic changes in
1973 compared with other periods.
Although World Bank data are not available
beyond 1973, it is possible to make rough estimates of the external public debt of developing countries from OECD balance-of-payments
data. On this basis, net long-term borrowing
of the oil-importing countries was about $15
billion in 1974 and $20 billion in 1975. 6 These
figures, added to external debt outstanding in
the previous year (disbursements basis), yield
total debt estimates of $87 billion in 1974 and
$106 billion in 1975.
These 1974-75 estimates are not exactly comparable with World Bank data for earlier perriods since they include total net commercial
bank credits from the Euro-currency and U.S.
markets with over one year's maturity, whereas
World Bank data omit private debt which is not
publicly guaranteed. 7 Precise comparisons thus
cannot be made, but it is still fairly evident that
there has been a marked acceleration in LDC
external debt in nominal terms. Our estimates,
for example, suggest an annual rate of increase
of over 20 percent in the last two years.
It is less apparent what has happened to the
LDC debt burden in real terms. Real debt
outstanding probably declined substantially in
1974 as a result of favorable export price movements, but increased in 1975 when commodity
prices fell. Our estimates, based on fragmentary export price data for 1975, indicate an accelerated growth of real debt outstanding-an
annual rate of about 11.5 percent in 1974-75,
compared with 8 percent in 1967-73. This
means, however, that debt has grown much
more slowly in real terms than in nominal
terms. 8
private banks. These countries had combined
current-account deficits of over $18 billion in
1974 and $20 billion in 1975, but their 1975
increase was considerably smaller than the average for other developing countries. Thus, their
share of the combined non-OPEC LDC currentaccount deficit fell from 70 percent in 1974 to
about 55 percent in 1975, and it is expected to
fall further in 1976.
Six of the countries (Brazil, Republic of
China, Greece, Mexico, Spain and Yugoslavia)
were able at the least to prevent sizeable deteriorations in their international accounts in 1975
through a combination of reduction in growth
rates and stabilization of inflation rates. Three
other countries (Mexico, Peru, and the Philippines) recorded substantial increases in their
current-account deficits, albeit relatively modest
reductions in real growth rates. 9 Finally, three
Charl2
Comparison of Reductions in Petroleum Consumption and GNP
Growth Rates in Developed and Developing Countries
% Change (l973-75)
14
REDUCTION IN PETROLEUM CONSUMPTION.i!l
12
10
8
6
4
2
o
Non-OPEC
LDCs
REAL GNP GROWTH
Percent
10
RATES~
8
Balance of Payments Prospects
6
From the commercial-bank standpoint, the
relevant issue is how readily the countries with
substantial bank debts can adjust to higher oil
prices and world business-cycle fluctuations.
Among the key areas to watch are the twelve
countries shown in Table 4, which account for
over 80 percent of long-term outstanding debt
owed by non-OPEC developing countries to
4
2
o
-2
u.S.
25
Japan
Western
Europe
Non-OPEC
LDCs
Sources: For developed countries, F.E.A., Monthly Energy Review, January 1976. For developing
countries, Wouter Tims, "The Developing Countries," Chapter 5 in Higher Oil Prices and the
World Economy, Edward Fried and Charles Schultze, eds., Brookings Institution, 1975.
hSources: For Developed Countries: GEeD, Economic Outlook. For developing countries, 1975.
of the countries (Argentina, Chile and Zaire)
each suffered a sizeable reduction in its real
growth rate and a substantial deterioration in its
trade account.
The debt problems of these three countries,
however, were only remotely related to oil.
Rampant inflation and political instability contributed to the foreign-exchange crises in Argentina and Chile, where consumer prices have
increased over 200 percent and over 300 per-
cent, respectively for 12-month periods ending
in late 1975. Inflation and government spending were also factors in Zaire, although the foreign-exchange crisis there was ultimately triggered by a sharp drop in the world price of
copper." O
None of these three countries has formally
defaulted in the sense of repudiating its debt,
and all three are now developing programs to
improve their long-run balance of payments
Table 4
Economic Indicators of Twelve Non-OPEC lDC's
With large Commercial Bank Debts
CPI
Current Account a
Growth Rate a
Inflation Rate b
Balance
of Real Output
($ billion)
(percent)
(percent)
Country
Higherincome
Argentina
Brazil
Chile
China, Republic of
Greece
Mexico
Peru
Spain
Yugoslavia
Middle or
lower
income
Philippines
South
Korea
Zaire
Total, above
countries
Total, all
non-OPEC
developing
countries
Industrial
countries
actual
est.
proj_
actual
est.
1974
1975
1976
1974
1975
0.22
-7.15
-0.38
-0.97
-7.20
-0.54
-0.05
-6.0
-0.3
7.2
9.6
5.2
2.5
4.
-1.12
-1.24
-2.56
-0.68
-3.15
-1.20
-0.12
-1.35
-1.15
-2.70
-1.20
-0.1
-1.35
-3.25
-1.2
-2.0
-1.0
0.6
-3.1
5.2
6.6
4.
0.75
4.5
4.0
-0.28
-0.85
-1.88
-0.17
-18.4
25.5
-17.5
2.
23
27
585
48
258
29
(Sept.)
338
(Nov.)
(Nov.)
5.0
O.
17
16
7.5
5.
22
3
14
17
26
17
24
-0.85
5.8
5.6
34
2
(Nov.)
-1.60
-0.45
-1.40
-0.40
8.7
3.5
7.5
24
(-2 to -5)
30
26
31
(Sept.)
-20.4
-15.25
29
28
(Sept.)
12.6
10.7
-3.50
(-35 to -38) (-29 to -34)
+10
(+1 to -2.75)
28
22
(Sept.)
(Sept.)
aSources: For Greece, Spain, Yugoslavia, OECD Economic Outlook, December 1975. For all other countries, Morgan
Guaranty Trust Co., World Financial Markets, January 1976.
bSource:
IFS Survey, March 1976. 1975 inflation rates in parentheses are percent changes in last 12 months. All others
are averages of montWy changes.
26
prospects. In early 1975, for example, the
Chilean government agreed to a set of measures recommended by the International Monetary Fund, which included imposition of new
taxes, a freeze on public employment, tightened
credit to the private sector, and adoption of
flexible exchange-rate policies." Last December, the government of Zaire also requested
I.M.P. assistance to develop a stabilization program, and Argentina is expected to follow suit.
Meanwhile, Argentine authorities have undertaken a series of extensive devaluations, designed to stimulate the export trade and improve the trade balance.
In sum, prospects for most of the major recipients of commercial-bank loans suggest an improving trend in current accounts. Their export
growth rates should revive due to recovery in the
OECD nations, while their import growth
should continue to slacken as their domestic
economies slow down. Even in instances where
countries have incurred debt problems, moreover, the causes are largely unrelated to oil but
are predominantly related to domestic difficulties. In these cases, the key to an improved
long-run trade position is the ability to bring
inflation rates back into line with those of other
countries.
Market Assessment of Developing Country Risk
The recent debate over commercial bank
lending to developing countries has focused
attention on the alleged high risks entailed in
LDC loans. Economic theory, however, leads
one to expect that commercial banks will require added compensation if they perceive defaults or reschedulings on LDC loans to be
greater than those on loans to developed countries. Hence, commercial banks will not necessarily be vulnerable to LDC external-debt
problems, provided their perception of LDC
lending risk is generally accurate. On the other
hand, if commercial banks systematically understate the risks involved in lending to developing countries, the added revenues they receive on LDC loans will not be sufficient to
cover the added costs incurred, and their profit
and liquidity positions will be squeezed by
LDC defaults or reschedulings. In examining
developing country lending risk, therefore, it is
important to separate two issues: (1) On what
basis do commercial banks form their perception of LDC lending risks, and to what extent
are they compensated for the added perceived
risk? (2) Is the market perception of LDC
lending risk "correct"-i.e. is the compensation
sufficient to cover added costs?
To answer these questions, we have analyzed
data compiled by the World Bank on publicized
Eurocurrency credits completed between the
third quarter of 1974 and the third quarter of
1975-altogether, 67 loans to developed countries, totaling $3.8 billion, and 177 loans to developing countries amounting to $10.0 billion.
Information in each case included the borrower
and borrowing country; the leading creditor institutions; the month of the loan agreement; the
amount of the credit; the commitment period;
and the spread over the London Inter-Bank
Offer Rate (LIBOR).
Average premium on loans to lDCs
First, we were interested in the premium
investors receive on credits to developing countries compared with their credits to developed
countries. This involves an analysis of the most
typical form of Euro-credit, a revolving credit
at a floating interest rate. Funds are drawn as
a short-term advance, usually renewable at the
end of three-month or six-month periods
(called the "renewal period" or "rollover period") for a designated term (called the "commitment period"). Rates to borrowers are
quoted on the basis of the three-month or sixmonth LIBOR rate plus the "spread." The latter covers overhead cost, profit, and risk, and
is determined on the basis of the borrower's
creditworthiness and competitiveness of the
market when the commitment is made.
The first regression equation in Table 5 illustrates how the spread varied depending (1) on
the recipient of the Euro-credit, whether de-
27
veloped or developing country, (2) on the date
of commitment, whether 1974 or 1975, and
(3) on the length of the commitment period.
Each of the variables is statistically significant,
although the maturity of the loan has a relatively small coefficient and small t-statistic. The
latter finding is not surprising, however, in view
of the variable interest rates on Euro-credits. 12
The regression results show that borrowers
from developing countries paid an average
spread of about 140 basis points in 1974,
whereas developed country borrowers paid
about 25 basis points less on average, reflecting
the lower perceived lending risks. In 1975, although the spread was about 40 basis points
higher for each of the two groups, the LDCDC differential did not change significantly.
Expressed as a percentage of borrowing costs
(LIBOR
spread), the developing-country
premium translared into an additional 2-to-3
percent rate of return on investment over that
on developed-country 10ans.13
+
Variation in spreads
Further analysis takes into consideration the
fact that there are variations within the group
of developing countries. Typically, they are
separated into prime and non-prime categories,
based in part on each country's per capita income. The second regression in Table 5 takes
Table 5
Regression Results: Variations in Spreads on Euro-credits, 1974.3-1975.3 a
(t-statistics in parentheses)
(i) Developed (DC) and Developing Country loans b
Constant
Spread
Average reduction
for
developed countries
Average
1975
increase
1.41
(18.3)
-.25
(6.70)
.40
(10.4)
=
R2
.48
1.58
D.W.
S.E.E. = .25
240
D.F.
Maturityd
-.017
(1.78)
(Ii) Developing Countries OnlyC
Constant
Income
"effect"
Mexico
"effect"
Debt d
Service
Ratio
1.46
(15.9)
.10
(2.80)
-.27
(4.40)
.006
(2.35)
=
Spread
R2
.54
D.W.
1.86
S.E.E. = .21
170
D.F.
Avg.
Inflation d 1975
Rate
increase Maturityd
.005
(3.80)
-.04
(3.96)
.26
(5.58)
aData Source: World Bank, Borrowing in International Capital Markets. 5 issues, November 1974-November 1975.
.,
.
bR egressIon equatIOn IS 0 f"
,orm: Spread = ao + a, {LDC=O} + a2 {1974=0} = a3' ( M ' ).
DC =1
1975 =1
atunty
Hence, the constant term can be interpreted as the average 1974 LDC spread, unadjusted for maturity.
C
_
LDCSpread-bo+b,
{High Inc. =O}
{ Other=O } .
•
{ 1974=0
Other =1 +b2 Mex. =1 +b3 (DebtSer.)+b. (lnf.)+bs 1975=1
+b6 ·(Mat.)
Hence, the constant term can be interpreted as the average 1974 spread for higher-income LDCs, unadjusted for
maturity, debt-service ratio, and the inflation rate.
dCoefficient must be multiplied by the value of the variable. Maturities are usually 5-8 years; debt-service ratios are
generally between 10-20%; inflation rates are usually in the 15-30% range.
28
cits. The regression indicates that developing
country spreads increased about 25 basis points
on average between the second half of 1974
and the first three quarters of 1975. Increases in
spreads for major Eurocurrency borrowers other
than Mexico, however, were well above the developing country average. The spread which
Brazil paid, for example, increased from 3;.4 of
one percent on 12-year loans in late 1974 to
1% percent for 5-year loans in 1975, while the
spread for Spain increased from 1 percent on
8-year loans to 13;.4 percent on 5-year loans.
Hence, the relatively small difference in spreads
between higher-income countries and lowermiddle income countries reflects, in part, bankers' revised perceptions of lending risks to heavy
borrowers. Countries which incurred debt problems generally paid the highest spreads, in addition to experiencing sharp reductions in new
lending flows.
this into account by distinguishing between
higher-income countries and lower- or middleincome countries (using World Bank definitions) . In addition, we have included a separate dummy variable for Mexico, in view of
that country's long experience as a borrower in
international capital markets.
The choice of other variables is less clearcut. For example, banks differentiate between
government and private borrowers, but that distinction is not very meaningful if a loan to a
private borrower carries a government guarantee, or if the institution is quasi-official. The
data also indicate that project risk is less important than country risk in setting spreads 14
-but there is no generally accepted framework for assessing country default risk. In the
absence of such a framework, analysts have
tended to use those economic indicators which
reflect a country's capacity to service its debt,
although there is no general agreement as to
which indicators are important in this regard.
Despite the large number of possible measures,
we have limited ourselves to two of the most
commonly used; first, the inflation rate, and
second, the debt-service ratio, i.e., the proportion of foreign-exchange earnings on current account absorbed by public-debt service. '5
All the variables included in the regression
are statistically significant and have the anticipated signs. The coefficients of the inflation
variable and the debt service variable are quite
small, however, so that each adds only about
10 basis points to the spread on average, assuming a 20-percent inflation rate and IS-percent debt-service ratio. Lower and middle income countries paid only about 10 basis points
more than higher income countries, whereas
Mexico paid about 25 basis points less than
other higher income countries and about 35
basis points less than lower-middle income
countries. In sum, no single factor appears to
dominate in explaining variations in LDC
spreads, although Mexico clearly is in a separate category from other developing countries.
It is also instructive to note how commercial
banks responded to the large LDC trade defi-
Comparisons with earlier periods
Comparisons of Eurocurrency loan premiums over longer time periods are difficult to
make, since calculations for earlier periods are
based on bond flotations rather than bank
loans. The evidence, however, strongly suggests that the premium attached to portfolio
investment in developing countries today may
well be at an all-time low. The yield premium
between developed and developing country
bond issues is much lower today than in 195865, when the average LDC yield was nearly
one-half to two-thirds higher than that of highgrade U.S. domestic corporate bonds, and between one-third and one-half higher than that
on Canadian issues. 'G Differential yields in the
1920's were somewhat smaller (40 percent
over U.S. corporate bonds and 25 percent over
Canadian public issues in the U.S.), but still
well above the differential developing countries
pay today.
The narrowing LDC premium in part reflects
the increasingly impressive economic performance of the higher-income developing countries. While these countries have been adversely
affected by the events of the last several years,
29
their prospects today are still considerably
brighter than they were fifteen or twenty years
ago. In addition, the banking system has developed various risk-reducing mechanisms, such as
variable interest rates, for example, or syndicated bank loans, which provide a means of
spreading country risks that are borne by individual banks.
Finally, attitudes towards default have
changed considerably since the 1930's and
1940's, when there were massive LDC defaults
on bond issues. At that time, developing countries which encountered foreign-exchange crises
had little incentive or option to avoid default.
"Prior to the Great Depression, external longterm debt consisted primarily of bond issues
floated abroad. Only rarely could a refunding
be arranged prior to actual default. Then some
agreement had to be reached by the debtor and
the bondholders, often represented by committees, which could not bind the bondholders but
could merely recommend acceptance of the
proposal. In some instances the debtor made a
unilateral offer to the private creditors, which
they could accept as the alternative to not being
repaid at all. The governments of the creditors
were not parties to the agreements, though they
could use diplomatic means to protect their
nationals."17
The differences in the post-war period are
striking. Since the late 1950's there have been at
least 25 instances, involving 15 different countries, where debt arrearages have had to be ne-
gotiatedY Governments of creditor and debtor
nations were parties to the negotiations, and
the outcome in each case was a rescheduling of
a country's debt, rather than outright default.
Given present institutional arrangements for
handling debt problems, the likelihood of a developing country repudiating its debt is now
perceived to be quite low.
Past experience suggests that the market's
perception of LDC risk has not systematically
understated the costs involved. The relevant
issue today, though, is whether the developing
country debt situation will be the same in the
future as in the past. There are few signs to indicate a hardening attitude in creditor government attitudes, although governments of some
developing countries have urged a moratorium
on foreign debt-service payments. The more
likely development is that future reschedulings
will involve both official and commercial-bank
credits. One can only speculate, however, as
to how often countries will have to reschedule,
whether bank credits will be rescheduled in proportion to their share of external debt-service
payments, and whether credits will be rescheduled at market interest rates. The debt negotiations in Argentina, Chile, and Zaire are significant because they provide the first test cases
of reschedulings in countries where commercial-bank credits comprise a sizeable portion of
the external debt service. As these negotiations
are concluded, it is possible that the market's
perception of LDC risk could be altered.
Conclusion
It is important to separate two issues in the
debate over commercial-bank lending to developing countries: ( 1) Are commercial banks
vulnerable to LDC defaults? (2) Are commercial banks adequately compensated for the
added risks incurred in lending to developing
countries?
On the first issue, our analysis suggests that
fears of significant commercial-bank exposure
to LDC defaults are grossly exaggerated. Some
analysts have focused attention on the record
LDC trade deficits and the debt problems of
individual developing countries, and have suggested that developing countries, as a group,
are accumulating debt too rapidly. The aggregate trade statistics, however, can be misleading
in a number of respects. First of all, the LDC
current-account deficits do not translate into
comparable increases in net long-term borrowings due to non-bank sources of financing (e.g.
official transfers, direct investment, etc.). Second, the distinction between nominal debt accumulation and real debt accumulation is seldom made, even though LDC debt apparently
30
risks through above-average increases in
spreads to major borrowers and to countries
with debt problems, and through the curtailment of lending to those with debt problems.
Still, the differential rate of return between developed and developing country loans appears
low by historic standards. However, this does
not imply that the differential is insufficient to
cover added lending risks, especially in view of
governments' increasing tendency to minimize
the possibility of default.
has grown much less in real terms than in nominal terms. Third, countries which are major recipients of commercial-bank credits are in a far
better position to adjust to external shocks than
are most other developing countries. Several
countries have experienced debt problems, but
their difficulty, most likely, is one of rescheduling rather than default. Moreover, their loans
comprise a very small fraction of U.S. bank
assets.
On the second issue, we find that commercial banks have responded to higher perceived
FOOTNOTES
1. The total net flow of resources received by developing
10. Copper prices increased by about 170 percent from
the end of 1972 to mid·1974, but lost almost all of that
gain over the next eighteen months. In the meantime, Zaire
accumulated foreign debt at an extremely rapid rate, more
than doubling its outstanding debt in 1974 with net bor·
rowings of $650 million.
11. Subsequently, Chile formally requested a meeting of
its creditors to consider rescheduling $700 million of debt·
service payments due in 1975. In May, seven of the credo
itor nations agreed to reschedule $230 million of that
amount. Since then, Chile has met all debt·service pay·
ments owed to commercial banks.
12. If interest rates were fixed over the term of the loan,
one would expect a positive coefficient if the yield curve
were upward sloping, and a negative coefficient if the yield
curve were negatively sloped. With variable interest rates,
however, the term effect should be less pronounced.
13. The figure assumes a USOR rate between 8-10 per·
cent, and excludes commitment fees and management fees
for syndicated loans, which are usually on the order of 1,4
to Ih of one percent.
14. For example, governments of countries such as Brazil,
Mexico, and Spain, which typically finance a large number
of projects concurrently, have generally paid about the
same spread irrespective of the project. This does not
mean that individual projects are unimportant, but rather
that the government's ability to repay the loan does not
hinge on the success or failure of any single project.
15. This indicator is used because debt service represents
a fixed obligation which must be paid out of foreign·ex·
change earnings; hence, a higher ratio is thought to imply
increased vulnerability to any foreign·exchange crisis. How·
ever, the indicator has been criticized because a number of
countries have been able to sustain high ratios for long pe·
riods without incurring debt problems. The intent here is
not to resolve this long-standing dispute, but simply to examine empirical evidence about whether commercial banks
actua lIy rely on the ratio.
16. The 1958-65 comparison was based on a sample of
14 LDC issues and included both public and privately
placed issues. Hang-Sheng Cheng, International Bond Is·
sues of the Less Developed Countries: Diagnosis and Pre·
scription (Iowa State University Press, 1969), pp. 46-47.
17. Henry J. Bittermann, The Refunding of International
Debt (DUke University Press, 1973), p.4-5.
18. The list of countries includes: Argentina, Brazil, Chile,
Turkey, India, Indonesia, Ghana, Liberia, Peru, United Arab
Republic, Uruguay, Philippines, Yugoslavia, Tunisia, and
Pakistan. These cases are reviewed in detail in Bitterman,
op. cit.
countries was an estimated $40.8 billion in 1974, of which
commercial bank credits over a year exceeded $8 billion.
GECD Development Assistance Committee, Development
Co·operation (1975 Review).
2. Historical data are from Paul Bairoch, The Economic
Development of the Third World Since 1900 Berkeley: Uni·
versity of California Press 1975. In large part, the eco·
nomic growth in the 1960's and 1970's was export·led, a
response to the rapid growth of the world economy and its
impact on world trade. Thus, the LDC export growth rate
averaged about 8.5 percent per annum in 1960·72 com·
pared with less than 5 percent in the preceding 60 years.
3. Azizali Mohammed and Fabrizio Saccomanni, "Short
Term Banking and Euro-Currency Credits to Developing
Countries," International Monetary Fund, Staff Papers 20,
1973, p. 617.
4. In contrast, the combined current-account balance of
the major industrial nations reached an estimated $10·
billion surplus in 1975-a $27·billion swing from the
$17.5·billion deficit of 1974.
5. Consumption of petroleum in the OECD countries, on
the other hand, has fallen by 9 percent over the last two
years. Given the short time interval, it is difficult to de·
termine how much of this reduction is due to income effects
related to the recession, and how much is due to price ef·
fects, or to energy conservation measures.
6. These figures are obtained by taking OECD estimates of
net aid flows (exclUding official transfers), net "other offi·
cial flows," and net Euro·credits to the oil.importing coun·
tries, and adding U. S. Treasury estimates of U. S. long.
term banking flows. OECD, World Outlook, December 1975,
Table 30, p. 65. Estimates of net Euro·currency credits for
1975 have also been revised to reflect more recent data.
7. There is no easy way of extrapolating the amount of pub·
Iicly guaranteed bank credits. Morgan Guaranty estimates
the increase in disbursed government and government guar·
anteed external debt of over one year's maturity to be about
$30 billion, compared with our figure of $36 billion. World
Financial Markets, January 1976.
8. This is in sharp contrast to the experience of the 1930's,
when sustained price declines brought about just the oppo·
site effect-a much faster accumulation of debt in real
terms than in nominal terms.
9. In the Philippines the trade deterioration was aggra·
vated by sharp declines in sugar prices and copper prices.
Over the long run, the country should benefit from the sub·
stantial reduction in inflation brought about by recent poli·
cies of monetary restraint.
31
Robert Johnston
Foreign banks have operated in the United
States for over a hundred years, but they have
begun to attract attention only recently, primarily as the result of the rapid expansion of their
activities in the nation's major financial centers.
In the past few years, foreign banks have become an important part of the national banking scene, and yet this growth has taken place
under rules laid down by state law, not Federal
law. The entry of foreign banks into specific
markets has been determined primarily by the
laws of the various states, so that foreign banks
have been able to escape almost entirely from
Federal banking control. Consequently, a series
of Congressional proposals have been made to
bring foreign-bank operations under effective
Federal control.
Growth of Foreign Banks
home states, except for international banking
subsidiaries operating as Edge Act Corporations. Foreign banks can open branches or
agencies in as many states as will license them.
These branches and agencies are not separately
incorporated but are legally offices of the foreign banks, so that the usual prohibitions against
interstate branching or acquisitions do not apply, as they would to domestic banks.
Many foreign banks come under the Bank
Holding Company Act (BHC Act), but this
Federal statute affects only those controlling domestically-chartered banks. A foreign bank
controlling a banking subsidiary - that is, a
commercial bank with a state (or more rarely)
national charter-must register as a bank holding company, and as such it is prohibited from
making interstate acquisition of additional
banks. But branches and agencies are not
"banks" for purposes of this Act, which means
that these holding companies can expand
across state lines through new branches or
agencies. Moreover, a foreign bank that limits
its U.S. banking operations to branches or
agencies is not subject to Federal banking laws,
Until the late 1960's, most foreign banks were
located in New York City, being attracted there
by the advantages of direct access to the New
York money market and by the ability to offer
New York facilities to their international customers. Apart from New York, California was
the only state at that time with any significant
number of foreign banks. Most of California's
foreign banks specialized in serving international and business customers, but some differed
from their New York counterparts by gradually
building up a retail banking network.
The foreign-bank sector expanded rapidly in
the early 1970's, in terms of both numbers and
operating volume. The number of U.S. banking
institutions owned by foreign banks rose from
85 to 104 between 1965 and 1972, and then accelerated to reach 181 by September 1975. This
growth was fostered by their ability to establish
an interstate banking network in a form denied
to U.S. domestic banks. Because of legal organizations open to them under various state laws,
foreign banks can establish banking offices
across state lines (see appendix). In contrast,
their domestic competitors are limited to their
32
u.s. banks last year.
and it can also engage in nonbanking activities
closed to U.S. banks and to those foreign banks
which do come under the BRe Act.
Only ten states explicitly permit some kind
of foreign banking, but this group of ten includes New York, California, and since 1973,
Illinois. The ability to operate in the nation's
three largest financial markets gives foreign
banks a useful advantage over their domestic
competitors. Currently, 44 foreign banking organizations have offices in at least two states,
and 20 of them operate in three or more states.
The growth of these interstate banking operations - a privilege denied domestic banks
helps explain the pressure behind the proposals
for expanded Federal control.
Another reason for such pressure is the
growing importance of foreign banks in the nation's credit markets, as shown in recent Congressional testimony by Federal Reserve Governor George Mitchell.' Between November
To a large degree, the foreign banks' rapid
expansion in the U.S. reflects the worldwide
growth of international banking. Foreign
banks, in a sense, are following the U.S. banks'
example by expanding overseas. For competitive reasons, foreign banks have had to follow
their domestic customers to this country, since
a major international bank must have at least
one U.S. office if it expects to match the range
of services offered by competing institutions.
With the rapid development of international
banking, foreign banks have become active in
many national banking markets besides the
U.S.-but in no other major country do national monetary and regulatory bodies have
such little control over the foreign banks operating within their boundaries. Most such operations here are not subject to Federal Reserve
System reserve requirements. Federal regulatory supervision is limited to subsidiary banks,
and does not extend to the more important
branches and agencies.
Further pressure for federal regulation arises
from the recognition that the U.S. government
is at a disadvantage in negotiating with foreign
governments on bebalf of U.S. banks, because
effective control of foreign banking in the
United States is in the hands of the individual
states. A Federal presence in the control of
such operations would increase the U.S. bargaining power when discussing banking issues
with other governments.
1972 and SeptembCi 1975, "standaid" banking
assets of these institutions (after adjustments
for clearing and transactions with the foreign
parent bank or its affiliates) jumped from $18
billion to $41 billion. Their commercial and
industrial loans doubled in this period from $11
billion to $23 billion, equalling one-fifth the
business-loan volume of large domestic banks.
Furthermore, three-quarters of their business
loans were made to domestic (not foreign) borrowers. Yet despite these developments, total
"standard" assets of foreign banks amounted
only to about 5 percent of the total assets of all
Federal legislative Proposals
Legislation to modify the present situation
must consider domestic banking policy but also
recognize possible international consequences.
New regulations for foreign banks would affeet the pattern of domestic competition, but
changes which limit existing rights of foreign
banks could result in new restrictions against
U.S. banks operating abroad. Indeed, American banks and their customers would have
more to lose in any such situation; the assets
of U.S. banks abroad ($135 billion) are three
times greater than foreign banks' assets here.
Legislation now being considered in Congress would eliminate discrimination by following a policy of uniform or national treatment. Foreign banks would have no more
rights than U.S. domestic banks; both would
operate under the same regulatory standards.
A policy of non-discriminatory treatment, even
where it has restrictive effects, is clearly easier
to justify to foreign governments and less likely
to result in retaliation.
33
ination of these eXlstmg rights might be regarded as a violation of our international treaty
obligations.
Congress is now considering three separate
bills that would establish Federal regulation of
foreign banks. They all have the common aim
of achieving equality of treatment between domestic banks and their foreign competitors
while establishing more effective Federal control. The first is the Federal Reserve System's
proposal, the Foreign Bank Act, originally introduced in December 1974 and reintroduced
in March 1975. This bill deals only with foreign banking. The Financial Reform Act of
1976, while aimed generally at a general reform of financial institutions, contains a section
dealing specifically with foreign banks. The
third bill, the International Banking Act of
1976, in many respects resembles the Foreign
Bank Act.
The treatment of existing but nonconforming
activities always presents a policy question,
with several different legislative answers. Existing activities could be forced to conform
fully to new regulations, but on the other hand,
banking legislation commonly exempts or
"grandfathers" existing operations, applying the
new law only to operations begun after a specified date. A good example is the Bank Holding Company Act. Each interstate bank holding company existing when the Act became effective in 1956 was allowed to keep the banks
it owned outside its principal state of operations, but future acquisitions were forbidden.
In 1970, when the BHC Act was revised,
grandfather rights were given to certain nonbanking subsidiaries. In the present context,
grandfathering could be advocated because foreign banks originally established their operations legitimately under state statutes, and elim-
A. Foreign Bank Act of 1975
The Foreign Bank Act is based upon the
principle of nondiscrimination: foreign banks
in the United States should have the same powers as equivalent U.S. banks but no more than
that. The bill came about as a result of Federa I Reserve discussions with foreign banks,
foreign governments, and U.S. banking organizations. Its provisions are detailed and in
many sections very complex, but its goals are
clear-to establish equal treatment consistent
with established rights of foreign banks, and
to achieve effective Federal control over this
growing sector of the banking system.
states of operation. But within those states,
foreign banks could (with Federal Reserve permission) establish new branches or agencies
and bank subsidiaries, on the same basis as
domestic banks. Foreign banks entering the
United States for the first time would be limited
to a single state-in practice, probably either
California or New York.
The BHC Act contains a clause allowing interstate acquisitions if state law gives specific
permission and if the right is available to both
domestic and foreign banking organizations.
Only Maine to date has passed such legislation,
although enabling bills have been introduced
on occasion in both the California and New
York legislatures. In brief, foreign banks would
be unable to open branch offices across state
lines until such time as domestic bank holding
companies are allowed interstate acquisitions.
With all foreign banks brought under the
BHC Act, their activities in nonbanking businesses also would come under Federal regulation. The BHC Act limits nonbanking activities to those approved by the Federal Reserve
Board of Governors as being closely related to
Control of branches and agencies
The Foreign Bank Act deals with the question of interstate expansion by simply redefining all branches and agencies as "banks" for
purposes of the Bank Holding Company Act.
Foreign parent banks not presently covered
would be regarded as bank holding companies.
All interstate expansion by way of branches or
agencies would be stopped. Since the BHC
Act forbids interstate acquisition of "banks,"
foreign banks would be limited to their existing
34
banking. Consequently, foreign banks would
have to conform to the same set of rules which
govern the nonbanking activities of domestic
bank holding companies. For some foreign
banks, particularly those involved in the securities business, this provision would cause problems, but for others it would confirm their
right to engage in approved lines of domestic
financial services.
equality, insurance coverage for branch deposits should be allowed. In California, this
provision would permit agencies to assume the
equivalent of branch status; at present, California law does not permit foreign agencies to
accept deposits of domestic customers, b~
cause their deposit accounts cannot be insured by the FDIC.
Federal Reserve membership
Membership in the Federal Reserve System
would be compulsory for all U.S. offices of foreign banks whose world-wide assets are above
$500 million. This provision would bring almost all foreign banks under domestic monetary control.
Federal authorities would establish effective
control over the entry of new banks and the
expansion of existing offices by requiring any
foreign bank entering the United States to apply for a Federal license. Foreign banks already here would only have to register, but
licenses would be required for all future acquisitions or mergers involving other banks, or
for the opening of additional branches or agencies. The only exception would be de novo offices of bank subsidiaries, because such offices
are not regarded as separate "banks." The
Comptroller of the Currency would issue licenses, after applying the usual regulatory
standards and consulting with the Federal Reserve, the Treasury and the Department of
State. The Secretary of the Treasury could
instruct the Comptroller not to issue a license,
if it was "not in the best interests of the United
States," whenever it appeared necessary to
block entry for foreign-policy reasons.
Federal licensing
Federal branches and national banks
At present, foreign banks have little choice
except to operate under state license, whereas
under the dual banking system, domestic banks
have the choice of operating either under national or state regulations. To make dual
banking an effective option, the Foreign Bank
Act would permit up to one-third of each
national bank's directors to be foreign nationals and would remove the present provision of the National Bank Act requiring U.S.
citizenship for all directors. Secondly, the
Act would establish a Federal equivalent to the
state-licensed branch, and would permit conversion of state-licensed branches or agencies
to Federal status. Each foreign branch would
have all the privileges of a national bank, except that its its lending limits would be based
upon the capital of its foreign parent. For
these reasons, a Federal branch clearly would
represent an important new option for foreign
banks.
Grandfather rights
The Foreign Bank Act follows the precedent of the BHC Act in allowing liberal grandfather rights. In doing so, it resolves most objections to the bill expressed by foreign governments, and thus minimizes the danger of retaliation. The Foreign Bank Act would grandfather all existing offices of foreign banks as
of the date the bill was first introduced (December 3, 1974). Within its principal state
of operations (measured by total assets), each
foreign bank would be allowed to expand according to rights presently existing for domestic banks under state law. In other states, it
could make no more new acquisitions, but
could maintain any existing branching rights.
In the special case of investment-banking
FDIC insurance
FDIC insurance, currently available to bank
susidiaries of foreign banks, would be made
available to branches and agencies as well.
Actually, FDIC insurance does not appear to
b~ necessary now for most branches, which
are engaged mostly in wholesale-banking business, but under the principle of competitive
35
the very small number of these banking organizations, and because of the possible impact
on domestic nonbank corporations of changing the BHC Act definitions of control. However, a number of foreign banks have recently
applied for permission to form joint-venture
banks or New York State investment companies, subsequent to the introduction of the Foreign Bank Act. In view of the potential for evasion of Federal control, the Federal Reserve
has now proposed several limiting amendments.
Future investment companies chartered in New
York to engage in commercial banking would
be subject to the same provisions applicable to
branches and agencies. As for joint ventures,
the definition of control would be changed to
cover cases where shareholders, as in consortia banks, act in concert to control a domestic
bank. This restriction would apply to domestic
cases of joint control as well as to foreign
banks.
subsidiaries, only existing offices would be
grandfathered and no further expansion would
be permitted. This would conform with the
provisions of the Glass-Steagall Act, which
separates commercial from investment-banking
operations-in contrast to the situation in Europe, where the two activities are commonly
combined. Because of the limited number and
size of the securities affiliates controlled by
foreign banks, grandfathering of existing offices would appear to be the most acceptable
solution. Current rights would be protected,
but future expansion in violation of the intentions of the Glass-Steagall Act would be expressly prohibited.
Other provisions
The Foreign Bank Act allows foreign banks,
for the first time, to establish Edge Act Corporations (see appendix). Edge Act subsidiaries
could be established in other states as well as
abroad, but U.S. offices would be limited to a
purely international banking business. Because
of the international specialization of many foreign banks, Edge Act subsidiaries would represent a reasonable alternative to the present
agency form of organization as a mechanism
for conducting business in other financial centers-and they would represent an alternative
already open to U.S. banks.
In its original form, the Foreign Bank Act
excluded from Federal regulation two forms
of organizations used by foreign banks to operate in the United States-joint-venture banks
operated by foreign banks, with none owning
more than 25 percent of the outstanding
shares,2 and New York State-chartered investment companies which can conduct a banking
business. The exception was made because of
Summary
The Foreign Bank Act would bring foreign
banks in the United States under comprehensive Federal control. Federal supervisory and
examination procedures would be applied to
insure that appropriate banking practices are
followed. Federal Reserve membership would
be required to insure that an important sector
of the banking industry is brought under national monetary control. Foreign banks would
lose certain privileges, principally in multistate banking, but generally would exercise the
same rights as domestic banks. Federal licensing procedures on entry and acquisitions would
help strengthen'\the Federal governments' ability to obtain nondiscriminatory treatment for
U.S. banks operating overseas.
B. Financial Reform Act of 1976
The Financial Reform Act of 1976 is the
companion piece in the House to the Financial
Institutions Act passed by the Senate in December 1975. This legislation reflects proposals
contained in the recent Congressional study, Financial Institutions and the Nation's Economy
(the FINE study), as well as the extensive hear-
ings on that study. The FINE study was designed as a general reform of the nation's financial system
including activities of foreign
banks - and the subsequent legislation represents a thoroughgoing, though more limited, revision of the system.
Chapter 4 of Title I of the Financial Reform
36
tional banks." Edge Act subsidiaries would
also be permitted.
Act deals with foreign banks. Although based
on Title VI of the FINE study, this chapter has
been substantially revised as a result of proposals made by Federal Reserve representatives and others at Congressional hearings on
this subject. Chapter 4 is designed to establish
competitive equality between domestic and
foreign banks, but the treatment of foreign
banks is markedly different from that proposed
in the Foreign Bank Act.
The following provisions of Chapter 4 would
affect foreign banks' activities in this country:
Nonbanking subsidiaries
NOllbanking subsidiaries controlled by foreign banks would be subject to the same rules
that are applied to domestic bank holding companies under the BHC Act. This clause is the
same as in the Foreign Bank Act, except that
non-conforming affiliates would have to be
phased out within five years.
Federal Reserve membership
Federal branches and banking subsidiaries
of foreign banks would be subject to the same
reserve requirements that are applied to similar
domestic banks by the Federal Reserve System.
Federal Reserve services and credit would be
available to these institutions. State-licensed
branches and agencies would be subject to System reserve requirements but would not have
access to System services.
Grandfather rights
There would be no permanent grandfather
rights for nonconforming banking offices and
for securities affiliates controlled by foreign
banks.
Federal licensing for entry
The entry of foreign banks would be subject
to Federal licensing requirements. Consultation with the Treasury Department and the
Secretary of State would be required. This
provision is similar to the corresponding one
in the Foreign Bank Act, except that statelicensed branches and agencies would not be
covered.
Summary
The Financial Reform Act now being considered by the House is much closer to the Foreign Bank Act than to the FINE study in its
foreign banking clauses. However, like the
FINE study, it excludes grandfather rights for
existing interstate banking offices. This
amounts to a strict interpretation of the principle of equal treatment for all financial institutions. In the FINE Study, the impact of this
exclusion was largely offset by a liberalization
of interstate branching rights for all banks. In
contrast, the Financial Reform Act makes no
change in branching laws, so that its lack of a
grandfather clause would have a more substantial impact on foreign banks. The Financial
Reform Act, like the Foreign Bank Act but not
the FINE Study, includes such provisions as
foreign directors for national banks, federal licensing, and FDIC coverage of branch deposits.
Treatment of branches and agencies
Federally-licensed branches would be permitted, except in states which prohibit such
branches. Federal branches would maintain a
surety deposit with the FDIC sufficient to give
coverage such as that provided by FDIC insurance. Interstate expansion by either state or
Federal branches would be prohibited.
National Bank Act
Foreign banks would be allowed to have
subsidiaries, under the same terms as the National Bank Act, and up to one-third of national bank directors could be foreign nationals.
These subsidiaries would be known as "interna-
C. International Banking Act of 1976
The third bill now before Congress, the International Banking Act of 1976, resembles
the other pieces of legislation in its basic ap-
proach-giving foreign banks the same rights
as domestic banks while bringing their operations under Federal control.
37
Grandfather rights
state branching would be allowed if permission
is obtained from banking authorities in both
the home state and the state which the foreign
bank wishes to enter. Such rights need not be
granted to domestic banks, as the Foreign Bank
Act requires. All such multi-state branches
would have to operate with Federal licenses.
:r-,1ulti-state acquisitions of banking subsidiaries
would continue to be prohibited under terms
of the BHC Act.
Multi-state banking operations would be
grandfathered, except that state-licensed
branches and agencies outside the principal
state of operations would have to convert to
Federal branch status.
Federal licensing for entry
Federal licenses would be required, and foreign individuals' share purchases involving control of a domestic bank would require Federal
approval.
The proposals described in this article have
the common goal of establishing effective Federal control over foreign banks operating inside
the United States. They also adopt the principle of nondiscrimination or equality of national
treatment. Nonetheless, important differences
remain despite common goals and principles.
On the issue of federal control, all adopt
with little variation the same general approach:
Federal licensing of foreign banks entering or
expanding their banking activities inside the
United States. Consultation with the Treasury
Department and State Department would be required by the appropriate licensing agency to
allow for consideration of foreign-policy goals.
Nonbank subsidiaries and affiliates would all be
brought under the Bank Holding Company Act.
Federal Reserve System reserve requirements
would be imposed for purposes of monetary
control.
The most significant difference concerns the
application of the principle of equal treatment
to nonconforming multi-state banking offices.
The strict view, as embodied in the Financial
Reform Act, would phase out foreign banks'
multi-state banking offices where domestic
banks do not have equivalent powers. The alternative, followed in the other bills, would
grandfather existing banking operations but
prevent new multi-state offices.
The Federal Reserve's view is that no permanent competitive advantage would accrue from
the retention of existing multi-state banking
offices, and that the past legislative precedent
for domestic bank holding companies would
support a liberal grandfather clause in this case
Treatment of branches and agencies
Federal licenses for branches would be available except where state law prohibits such
branches. Interstate expansion by branches or
agencies would be allowed with state permission. As a substitute for FDIC insurance, an
equivalent surety deposit would be required.
Multi-state branches would all have to be Federal branches.
Nonbanking subsidiaries
Nonbanking activities of foreign banks which
control subsidiary banks, branches or agencies
would be limited to those allowed under the
BHC Act. Securities affiliates could deal in
securities to the extent allowed national banks.
Federal Reserve membership
Federal Reserve membership would be required for all banking subsidiaries. Branches
and state-chartered investment companies controlled by foreign banks would be subject to
System reserve requirements.
Summary
The International Banking Act is generally
similar to the Foreign Bank Act. An earlier
draft circulated in 1975 would have prohibited
foreign branches from accepting domestic deposits; this provision has been removed. This
bill gives the states more latitude than they
have under the Foreign Bank Act to control
multi-state branch operations. Individual states
could forbid the entry of foreign branches, but
those that wish to build up a local international
banking market could continue to do so. Multi-
38
as well. Moreover, liberal treatment would minimize the possibility of foreign retaliation
against U.S. banks, and would be more consistent with U.S. efforts to strengthen the international banking system.
The Foreign Bank Act of 1975, the International Banking Act of 1976 and the Financial
Reform Act of 1976 are all under consideration in this session of Congress. The first two
are aimed at foreign banking within the framework of existing banking laws, while the latter
treats foreign banking as part of a general reform of domestic financial institutions. Whichever approach is taken, the era of regulatory
dominance by state regulators is coming to an
end. In the process, foreign banks will lose
some privileges and gain others, but the trend
will be to national treatment under the primary
control of the Federal government.
FOOTNOTES
Mitchell, Vice Chairman,
Board of Governors of the Federal Reserve System, January 28, 1976, before the Subcommittee on Financial
Institutions of the Committee on Banking, Housing and
Urban Affairs, United States Senate.
2. Under the BHC Act, a corporation owning more than
25 percent of the shares of a bank was presumed to control
that bank, and the corporation was required to register as a
bank holding company. Below 25·percent and above 5·per.
cent ownership, a fo'rmal finding by the Federal Reserve
was required to establish that "control" existed.
1. Statement by George W.
APPENDIX: GLOSSARY OF BANKING
ORGANIZATIONS
Domestic banking subsidiary-A domestic bank
with its own board of directors and capitalization.
It is called a subsidiary because a controlling interest of its shares is owned by a foreign parent bank.
The parent bank is regarded as a bank holding company and is regulated under the Bank Holding
Company Act by the Federal Reserve System. The
subsidiary bank is subject to the same regulatory
rules as its domestic bank competitors and has
access to FDIC insurance. Lending limits are determined by the subsidiary bank's own capital and
surplus, not that of its parent. Federal Reserve
membership is optional if the bank is organized
under state law, and in practice most banking subsidiaries are nonmembers.
Branch Office-An office of a foreign bank licensed
to do a banking business by a particular state, but
with no separate corporate charter. A branch can
make loans and accept domestic deposits. The deposits are subject to state reserve requirements but
these can be met partially by interest-earning assets, so that the effective burden is less than that of
Federal Reserve requirements. With some limitations, branches conduct a general banking business
similar to that of a domestic bank. Unlike a domestically-chartered bank, the lending limit of a
foreign branch is determined by the capital of the
parent bank. Branch licenses are available in New
York and Illinois. Some branches also operate in
Oregon and Washington with deposit-accepting
powers by virtue of grandfather rights.
Agency office-An office which, like a branch, has
no separate corporate charter and is regarded as an
office of the parent bank. An agency, unlike a
branch, cannot accept domestic deposits but must
raise its funds through non-deposit sources, including funds of its parent or other commercial banks.
An agency is not subject to lending limits and to reserve requirements. Under New York law, foreign
banks can choose between agency and branch status. In California, because of a state requirement
that domestic deposits have FDIC insurance, foreign bank offices are usually regarded as agencies
(following New York terminology), although the
state law describes them as branches. In Washington, foreign bank branches are effectively "agencies,
because only small amounts of domestic deposits
are permitted.
Representative office-An office which conducts
no direct banking business. Business is solicited on
behalf of and appears on the books of the parent
bank or its affiliates. Under California law, representatives are licensed by the state, but in most
states they are not regulated because they are not
engaged directly in any local banking activity. Representative offices are the most common form of
foreign banking presence in the United States.
Edge Act Corporation-A subsidiary of a member
bank formed to engage in international banking,
through foreign and domestic offices. The domestic
offices may be located in states outside that of the
parent bank. Edge Act operations in the United
States are limited to international banking and acceptance of domestic deposits arising from international transactions. Lending limits are set by the
capital of the subsidiary, not the parent bank. Edge
Act corporations allow domestic banks to operate
multi-state offices for international banking purposes, and they are similar to foreign agencies.
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