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FE D E R AL R ESER VE B AN K O F N E W YORK Circular No. 8 4 7 6 1 December 20, 197S J REGULATIONS D AND Q Proposed Exemption for Designated Internationa! Banking Facilities To AH Ban&otg tnytMufions in fhe Second Federal Bc^erce District; On December 14, the Board of Governors of the Federal Reserve System released for public com ment a brief statement of the issues raised by a proposal of the New York Clearing House Association to exempt the deposits of specially designated International Banking Facilities (IBFs) from the reserve requirements and interest rate limitations of the Federal Reserve. In its announcement, the Board invited comment by March 15, 1979 and explained: T h e Clearing H ouse proposal contemplates that an I B F : — W o u ld be allowed to accept funds only from foreign customers, the IBF's own U .S. head olBce ( a U.S. ban k) or from other IB F s; — C ould offer only obligations subject to withdrawal on call (after a specified notice p erio d ), or obligations with a fixed maturity and a m inim um maturity o f one day; — W o u ld not be authorized to offer deposits subject to im m ediate withdrawal or to offer negotiable C D s. T h e Board's statement noted: "E stablishm ent of IBFs would be expected to result in the creation of a new dollar deposit in this country com petitive with Euro dollars but subject to U.S. laws and hence not subject to 'foreign country risk' . . . . Obligations issued by IB F s probably w ould carry somewhat higher yields than comparable deposits at dom estic offices of m em ber banks because of the absence of reserve requirements. As a result, foreigners m ight shift funds from other international banking centers and from banking offices in the United States to IBFs fin mu/cr dom estic m onefan/ centers]. M oreover, U.S. corporations . . . might be encouraged b y favorable terms to find ways of placing funds with IB F s." Under the proposal, IBFs could not advance credit to U.S. customers, except to other IBFs or to their own head offices subject to the same Regulation M reserve requirment that is applicable to member banks' net borrowings from their own foreign branches. This requirement currently is at zero. The Board's press release also indicated that the statement — . . . noted the implications of possible deposit shifts to IB F s for measuring the monetary aggregates, the level of required reserves and competitive relationships; implications o f IB F s on the availability of credit dom estically; the possible effects of IB F s on foreign exchange rates and on the relative positions of banks and of their foreign and domestic customers. T h e Board invited com m ent particularly on the follow ing issues: — W h eth er the minim um maturity of accounts at IBFs — should they be established — day, or a longer period, perhaps seven days; should be one — W h eth er reserve requirements should be applied to head office borrowings from an IB F , and, if so, at what rate; — W h eth er obligations offered by an IB F should be available to foreign subsidiaries o f U.S. corporations, and — W h a t implications IBFs w ould have for competitive balance among banks. Printed on the following pages is the text of the Board's statement. Comments on this matter may be sent to my office, and any inquiries may be directed to Thomas C. Sloane, Senior Vice President and Senior Adviser, at this Bank (Tel. No. 212 - 791 - 6086). PAUL A . VoLCKER, P resident. B O A R D OF G O VER NORS OF TH E FEDERAL RESERVE SYSTEM International Banking Facilities parable deposits at domestic ofRces of m em ber banks because of the absence of reserve requirements. A s a result, foreigners might shift funds from other inter national banking centers and from banking ofBces in the United States to IBFs. M oreover, U .S. corpora tions — particularly those with foreign afBliates — might be encouraged by favorable terms to Bnd ways of placing funds with IBFs. T h e Board of Governors has been asked to con sider a proposal by the N e w York Clearing H ouse Association that the Board am end Regulations D and Q to provide that deposits of specially designated In ternational Banking Facilities (I F B s ) be exempt from reserve requirements and interest rate regulations. T hese facilities w ould be operated separately from other ofBces of the bank. T h e Clearing H ouse m ain tains that such an action, coupled with special State and local tax treatment of IB F s, w ou ld: enhance the role o f major dom estic monetary centers as interna tional banking centers b y attracting business from abroad; stimulate local economies by providing new jobs and raise local tax revenues; and lower bank costs and im prove bank efficiency. Th e State of N ew York has enacted a law giving eventual tax-free status to IB F s, bu t this is contingent on favorable reserve re quirem ent and interest rate action at the Federal level. So far as is known, no other State has taken similar Implications for D eposit Holdings Various deposit shifts are likely to occur as a result of creation of an IB F . Foreign-ov/ned Euro-dollar deposits m ay shift to an IB F . In addition, existing foreign deposits held in U.S. banking ofBces w ould also be eligible to m ove into an IB F . Foreign dem and deposits in the United States total $18 billion, while foreign-ow ned time deposits amount to $ 1 2 % billion. It is diHicult to estimate the extent to which foreign deposits might be transferred to IB F facilities. The amount of funds shifted from U.S. ofBces would de pend in part on whether drafts could be written on IB F accounts or whether other means could be em ployed for using IB F accounts for ordinary transac tions purposes. For example, although the proposal states that IBFs w ould not be allowed to offer de posits subject to immediate withdrawal, IBFs might instead offer accounts on which drafts could be written that are payable the next business day — in m uch the same w ay as many Euro-dollar transactions are cur rently settled. action. T h e Clearing H ouse proposal contemplates that an IB F w ou ld be allow ed to accept funds only from foreign customers, the facility's own U.S. head ofBce, and other IB F s. It could offer only obligations subject to withdrawal on call ( after a specified notice p eriod ) or fixed-maturity obligations with a m inim um maturity of one busines day; IB F s w ould not b e authorized to offer deposits subject to im m ediate withdrawal or ne gotiable C D s. If funds placed with IBFs were regarded as de posits upon which the reserve requirement w ould be set at 0 percent, they w ou ld be subject to the 3 per cent statutory m inim um average reserve requirement on the sum o f a m em ber bank's domestic tim e de posits. Since the 3 percent m inim um could reduce the attractiveness o f the proposal for m any m em ber banks; as an alternative consideration m ight be given to exem pting obligations of IB F s from deposit treat m ent, similar to the treatment accorded Federal funds borrowings and certain repurchase agreements. T h e volum e of funds placed in IBFs w ould also be affected b y whether the facility is available to foreign subsidiaries of U.S. corporations. D om estic companies would not be able to place funds directly with IBFs, but could do so indirectly through a foreign afBliate. E ven if IB F accounts were not used directly for trans actions purposes, some U.S. depositors — with foreign afBliates — m ight Bnd short-term IB F obligations to be an attractive cash m anagem ent instrument and m ight substitute IB F obligations for other short-term investments— such as RPs— and for dem and deposits. IB F s could not advance credit to U.S. customers, except to other IB F s or to their own head offices; and advances to ow n head offices w ou ld be subject to the same reserve requirem ent that is im posed under R eg ulation M on net borrowings by m em ber banks from their ow n foreign branches (w h ich is zero at present). T h e availability of IB F accounts to various types of depositors has implications for measures of the monetary aggregates; for the level of required reserves; and for competitive relationships am ong foreign cor porations, U.S. corporations with foreign subsidiaries, and other U.S. corporations. W h eth er foreign sub sidiaries of U.S. companies should be permitted to hold funds in an IB F , or whether minim um maturities of funds placed in an IB F should be seven days rather than one day, w ould affect deposit holdings and com petitive relationships. A 7-d ay m inim um maturity w ould, for example, reduce the difference betw een Establishm ent of IB F s w ou ld be expected to result in the creation of a new dollar deposit in this country com petitive w ith Euro-dollars but subject to U.S. laws and hence not subject to the "foreign country risk" generally attached to dollar deposits in banks outside the U nited States. Obligations issued b y IB F s prob ably w ould carry som ew hat higher yields than com 2 offices of the parent bank, the Board could m inim ize any possible adverse effect on the exchange rate that m ight otherwise result from a difference betw een the volum e o f deposits in domestic offices shifted to IB F s and the volum e of foreign credits in the loan port folios of those domestic offices that was shifted to IBFs. T h e Board's policy regarding reserve require ments on lending to domestic offices w ou ld thus likely receive increased attention if IB F s w ere established. time accounts in IB F s and m inim um maturity time deposits in domestic banks. Implications for Credit Availability Currently, credit extended to foreigners by banking offices in the United States (including their own for eign branches) is estimated to exceed deposit and non deposit liabilities to foreigners b y about $20 billion. H ow ever, it cannot be determined a priori whether the amount of foreign loans that could be shifted to IBFs from domestic offices w ould be larger or smaller than the amount of deposit and nondeposit funds that w ould be shifted, and thus it cannot be determined whether the availability of domestic credit to domestic sectors w ould be affected. It m ay be noted that if IB F obligations w ere re garded as an especially attractive dollar asset, there m ight be an incentive for some foreign investors to shift funds from m oney market instruments den om i nated in foreign currencies to IBFs. As the IB F s advanced these funds to domestic U .S. offices, there w ou ld be a tendency for some m odest strengthening in the exchange rate for the dollar. In the final analysis the im pact on the availability of credit to domestic sectors w ill depend on the de gree to which IB F s are linked to domestic markets. If no restrictions are applied to funds channeled from IB F s to domestic U.S. offices of the parent bank as w ould be the case with a zero reserve requirement on head office borrowings from the IB F , there w ou ld be no, or little, impact on the availability of domestic bank credit from creation of an IB F . A n y difference betw een the volum e of domestic deposits shifted to IBFs and the volum e of foreign loans shifted from domestic offices could be reflected in transactions b y IBFs with their domestic offices. Th e Effects o f Com petitive Balance am ong Banks IB F s could affect the relative positions of banks, as w ell as of their foreign and domestic customers. Th e Board recognizes that if IBFs are to b e estab lished on a nationwide basis, adequate tim e w ou ld be needed to permit an opportunity for changes in State laws and regulations. The Board also recog nizes that IBFs m ight also be operated by banks out side N e w York through E d ge Corporations in N e w York. Various locations and m odes o f operations m ay have differeing impacts on banking institutions under current circumstances. Alternatively, should reserve requirements apply to funds channeled from IBFs to domestic U .S. offices of the parent bank, there w ould be greater scope for a spread to develop betw een the rates at which IBFs w ould lend to head offices or other IBFs and the F e d eral funds rate.i Th e larger the reserve requirement the less closely w ould IB F s tend to be linked to do mestic m oney markets, and the more likely that varia tions in flows of funds from domestic deposits to IBFs w ould be reflected in variations in their foreign lending. s e T h e Board is considering the proposal and its de sirability in light of its im pact on monetary conditions, regulatory control, competitive balance and other factors. C om m en t is invited from all parties on issues raised b y the proposal. The Board w ould be particularly interested in views on the minim um maturity of ac counts that m ight be held in an IB F , on reserve requirements applicable to head office borrowings from an IB F , on the advisability of m aking obliga tions offered by the facility available to foreign sub sidiaries of U .S. corporations, on implications for com petitive balance among banks, on the length of tim e that m ight be required for changes in State laws and regulations and the lead tim e that m em ber banks w ould reasonably need in order to establish IB F s. C om m en t should be sent b y M arch 15, 1979 to the Secretary of the Board, Board of Governors of the Federal Reserve System, W ashington, D .C . 20551. Implications for Foreign Exchange Rates Th e same general considerations w ould affect the extent to which shifts of funds from U .S. offices to IBFs w ould have an im pact on the exchange rate for the dollar. By establishing a zero, or low , reserve requirement on lending b y IBFs to dom estic U .S. i The Federal funds rate and the rate for loans by one IBF to another would tend to be equal in the absence of restrictions on Rows of funds between IBFs and head ofHces; there would be no differences in country risk on loans in each market as there currently is between interbank Euro-dollar loans and Federal funds loans. 3 e
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