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DOCUMENT RESUME 00321 - [A10517931 [Federal Supervision of the International Operations of Banks]. March 24, 1977. 9 pp. Testimcny before the Hceuse Committee on Banking, Currency and Housing: Financial Institutions Supervision, Regulation and Insurance Subcommittee; by Fred D. Layton, Director, Task Force on Federal Supervision of Banks. Issue Shea: Accounting and Financial Reporting (2800). Contact: Office of the Comptroller General. Budget Function: International Affairs: International Financial Prcgrams (155). Organization Concerned: Federal Reserve System; Federa, Deposit Irsurance Corp.; Federal Reserve System: Board of Governors; Office of the Comptroller of the Currency. Congressional Relevance: House Committee on Banking, Currency and Hou-;ing: Financial Institutions Superv!sion, Regulation and Insurance Subcommittee. Only about 130 of the 14,000 U.S. banks had overseas branches and/or foreign subsidiaries at the end of 1975, and most of these are either national banks supervised by the Comptrcller of the Currency or State member banks supervised by the Federal Reserve. GAO reviewed the bank examination reports on 18 national banks and 12 State member banks having substantial international operations. The mocst prevalent problems in international operations found by examiners were: a high percentage of classified assets; inadequate controls over foreign exchange operations; and inadequate overall internal controls. The Federal Reserve Board cf Governors and the Ccuptrcllcr of the Currency need to use all available information to develop and use a single approach for classifying loans subject to "country risk." Procedures should be implemented to examine (where permitted by the ccuntry involved) major foreign branches and subsidiaries onsite. They should be examined periodically and whenever adequate informaticn about their activities is not available at the home office. The Federal Peserve Board of Governors and the Ccapt.ccller of the Currency should utilize each other's examiners tc cut expenses for foreign examinations. Some clarifying legislation on the interagency use of examiners might be necessary. (Author/QM) .-UIi Sa-L57LES GD:-2LRAL ACCIt'UiY G OFFCE WASINlGTON, D. C. FOR FELE:_E ON DIVVERY Expected at 10:CO a.m. EST arch 24, 1977 Thursday, STAEMET OF FDBa D. LAYTON DLMEC0R, BAL.KG TASK FORCE BEFOREU ON FLINANCIAL I21STMITTIONS SUBECOOMEE SUPMVISION, REGULATION AND f;SURANCE, , CNURCY AND HOUSLNGC COMI~T. ON WBAnIK ROF ERESIT.ATIVES OCFUSE U.S. i4. CEAPt4N: We are pleased to be here today to discuss further the GAO stc;udy of Federal s-upervisicn of State and national banki We ',_ll direct our cornerts this morning specifically to supe:vision of nter.na ona! operaticons cf banks by t.Z'Ccatroller of the Cur-ency, t-.he Federal Reserve System and the Federal Deposit Lnsurance Ccrporaticn. As you know, our study was requested last year by several ocr.-gessioralcomr-mttees, includi;ng this one, and our report was submitted by the Corptroller General to the Corsess on Jarnuary 31, 1977. :I-ORTANCE OF Nle I3NAINAL OPERATIONS TO m-%K2 WA71G DUST.Y ,Durng the period covered by our study,interrnatioraL operatcras increased substantialiy. banking Assets held by foreign brnches of Federal Reserve Member Balks increased from $61 b-illin at December 31, 1971, to $176 billion at December 31, 1975--a t.-eefolc increase. Foreign loans of dcmestic banks more tIhu doubled-from $27 billion at the end.of 1971 to $60 billion at the er.d of 1975. Trbese assets are held by relatively small number of Oanks. At the end of' 1975, onl, about 130 of the 14,000 U.S. banks had overseas branches and/or foreign subsidiaries. Foreign branches of the 20 largest banks had al.ohs- .2 percent of total foreign branch assets. Most of the barks involved in internatioral operations are either national banks supervised by the Caoptroller of the Currency or State member bancs supervised by the Federal Reserve. Scope and Purpose of the GAO Review in the z1ternaional Area Cur p,-rmary concern was in detenLrFnizg whether bank examirnaions of internatilornal operatiorns were of sufficient scope to identify banks which were likely to run into serious manageri-al or financial difficulties. MTerefore, our attention was directed towarzs the methodology used by the supervisory agencies for mcnitor-ng international operati.ons of U.S. banks. In or study, we reviewed the examination reports on 18 national bunks and 12 State member banks which had substantial international cperatlons. It is -iortzntthat your Subconsrittee understand our arrwngements with the three agencies for making this study. A principal condition of the agreements was that we would not disclose any information about specific banks, bank officers, oz. customers. We also agreed that we would not examine any barks ourselves but would accept the facts found by the three agencies' examiners. We made no attempt to independently evaluate the :oundnes. of any of the banks in cur samples or to evaluate the We depended on the cr-edit-worthiness of any of the bank customers. examiners' experience an identifying bank problems. -2A. How do ExaMi-ners review .ntern.Aticrca~-! ?Feraior of Eans? Both the Comptroller of the Currency anr * the Federal. Reserve System way. approach interational examinations in much the samre examndlation international examinations in two phases. Sane formed at the bank's mran office in t.he U.S. Both perform s are per- "l_-v's phase includes and reviewi.g foreign evaluating large international extensions of credit examrinations rel'Y exchange activities of the main office. The credit mirn office with duplicate heavily on the overseas branches providing the car. be made in concredit files on overseas loans. These examinations they may be done junction with the regular domestic examination or operations and thus separately. A few banks have decentralized their b-Ics overseas the regulator rust make the c-edit examinations at the regioral centers. ns Tie other phase of inrernational examInatic are on-site exam.nations of examining smaller exconducted at the foreign branc~hes. they consist exchange activities tenslons of credit by the branches, examining foreign foreign branch of the branches, evaluating main office control over examinations occur activities, arn cfhecking internal operations. These the main office. much less frequently than the regular examination at of activities Because of theiw- special risk, the foreign exchange regulators the banks were of major concern to the examiners. The may be are concerned that the volume of foreign exchange activities risk in foreign excessive or that the bank has taken an unwarranted exchange trns,i Aons. -3-. How are Eainr.ers .Ttained to Maike inations? In.ternational2 Exo. The agencies provide thei- examiners ^who make irternaticral exanminations with special training in foreign exchange transactions ard in e.aluatirg foreign creditLs T.e Federal Deposit Insurance Corporation does not offer specialized international training; officials said that most of the banks supervised by the Corporation tend to be small and are therefore unlikely to be engaged in internatioral bankring. M.e Corpora- tion used the Cormptroller of the Cu-ren:y training program to provide international training when needed. Bank examiners we questioned generally thought the internal courses provided were usefulv;; however, some did say more training in fcreign exchange t-=usactiors would be halpful. We received responses from 1,500 banks to a questiornaire on various aspects of banrik supervision. Eighty-nine per-ent of the barks responrding thought the exaniners' understandirn of Interrztiornal operations was adequate or more than adequate. What Problems did the Examiners Find in the Inter.atiornl Area? The exam-nation reports for the 30 banks included in our study showed that the most prevalen, problems in internatiornal operations fourd by examiners were: (1)a high pemcentage of classified assets, (2) inade- quate controls over fcreier exchang operations, and (3) inadequate overall intern-l controls. The most recent examiL-ation reports available for these banks at the time of our study showed that the 30 banks had outstanding loans to foreign Goverrnernts, businesses and individuals totaling $80.5 billion. The examiners had classified 3.7 percent of these loans as substandard, four-tenths of 1 percent e toubtful, arnd or..-tenth of 1 percent as loss. e-i -tenths of Ipercent What Problers did GAO Find in the ;Way t.e Supervisory .AenciesIbo-niored Foreign Operations of Banks? In our study we found that the F .deral Reserve and the Ccrmtroller took different approaches to evaluating loans to foreign governments, businesses and irndividuals. These different approaches caused some bank loans to be classified differently than other bank's loarns to the sanme country or foreign business. Even within the Federal Reserve System, two approaches were taken to evaluating loans subject to country risk. The term "country risk" is used to describe the special risk e rmc involved when loans are ma n different currencies because the borrower must repay the loan in the currency borrowed. The borrower's ability to obtain appropriate currency may be affected by the political and economic stability of the bor-ower's country. At the New York Federal Reserve Bark, a committee of senior examiners evaluated country risks and assfgend a general classification to loans made to borrowers in some of those countries. All loans to those countries and their businesses were class-ffied the same unless the borrower's ability to obtain the repayment currency was indepenwentr of the country's stability or the loan ms made in the local currency. Ifthe loan was made in the local currency, it was Judged according to the borrower's financial condition. Except for the New York Federal Reserve Bank which used this c-mlttee approach, the other Federal Reserve Banks evaluated foreign loans individually. This approach led to inconsistent classifications ____ -5- '.w.thiln Federal e sa .ee S.ys-en. rFr ex-!le, a !car. to one country was classified by San Francisco exazminers, wrhile emtiners from Now York, P..hiladelphi, ard Rich.nd did not classify loans to the same country. SLnilarly, exaniners fr-o Boston, Chicago aend Sa Francisco criticized loans to another country but the New York examiners did not. The basic problem here was that examiners were'evaluating the loans based on their individual knowledge of the country. _he Conptroller of the Currency has also used a committee approach since 1S74 fcr evaluatirng cour;try risk. Each quarter ernior international exm.iners ret to evaluate the risk involved in loans to certain to thocse loans. The examiners ccun.rles and t - assig± class2ficat-toss classify t.hose lcns if repayment appears to be as much deperdent on the br.r-ower' s ablJity to obtain the approcriate repayre.nt currency as on the borrower's finsncial condition. Class4icaticns arrived at by the co=--itt-ee a-e tenr used for all lons to those countries. A'though the New York Federal Reserve Bank and the Comptroller have both used ccnr.lttee approach. for evaluating country risk, they have often a-rrived a2 different assessments of loans to the same country. sn July 1976, for exarple, the New Y':rk Fed's cormmittee and the Comptroller's ccrittee each developed ratLngs for loals to foreign countries. The CoT;roller' s ccomittee concluded that certain loars to several countries should be classified as substandard; the New York Federal Reserve Bank them. assign.ed the substandard classification to loans of only one oft' -6-. Usigr t-ree cbuntry risk evaiu2aticn rethcds -has resulted in. different treatment of the barns th Ccptrolllr supervise. the Federal Reserve and the rvther, the =ethcd used by the Federa- ?F.eerve Banks depends on individual examiners keeping abreast of economic ccr.ditions in many countries and being able to Judge loa-ns .nr.any countries. We believe that a team of experts who evaluate econcrmic conditions in each courtry should produce r.ore accurate -adconsistent results thsn n=uerous irdividuals who evaluate corditions on a case-bycase basis. Iherefore we recomr..ended that the Federal Reserve Board of Governors and the Cciptroller of the Currency, usirg all :avalable information, develop and use a single approach for classijying loans subject to this country risk. In corr.enting on our report the agencies pointed out some special problems involving country risk evaluaticn, but they agreed that a uniform approach is desirable. Are Examirations Made of Branches and Subsidiaries? ~Foreig Federal Reserve end Ccmptroller examriners usually evaluates foreign loans from information at the hore off-ce of the parent banks. Both agencies required that banks maintain adequate records at the head office for the examiners to appraise the risk ard exposure of the bank through their foreign operations. In our review of the 30 banks with significant internatioral operations, we noted that two State member banks were experiencing scme problems which were related to foreign subsidiaies of the banks. Both banks' forcign activities had been examined by the Federal Reserve at - - the home office; however, the examiners had stid the mnfcr=.ation available was inadequate. The subsidiaries were not examined onsite until after the banks had begun experiencing problems. We believe that these subsidiaries should have been examined onsite as soon as possible, once the hoce office files were found inadequate. Early onsite examinations of the subsidiaries might have disclosed their problems before parent banks were injured. We recommended that the Federal Reserve Board of Governors and the Conptroller off the Currency implernent procedures to examine (where permitted by the country involved) n2jor foreign branches arnd subsidiaries onsite-periodicaily and whenever adequate ieforrma';ion about their activities is not available at the hcme office. . According to the Federal Reserve, it began in the fail of 1976 to nake onsite exar,mnatiors of foreign branches of State member banks where it had previously used irfornation at the head office or f-=om nspectioLns rade by State examiners. According to the Federal Reserve a numrber of foreign subsidiaries were directly examined for the first time with the agreement of the host goverrnent. The OCC advised us that examinations to determine the cuality of the bark's operations are made onsite overseas when necessary. According to the OCC, their examiners made on-site examinations during 1976 at 141 overseas branches and subsidiaries of 25 banks located in 37 countries. -8- Mhe Ccotsrol'er of .e Cu-rency hs a Londcr. charge of exar_.-ng branches and subsidiaries 'L 4 off'ce 'J.:. Europe. is i4.. Th.e Cc.-t-'ler also uses staffs frtm its 14 recr.s to :rdce onsite i ex-._i-ato.ns of foreisn branches and subsid'Jaries. The Federal Reserve has internatioral examlner staffs in New York, Chicago, and San Francisco. We recommnr.ded that the Federal Reserre Board of Governors and th= Comptroller of thle Currency utilize each other's excaminers to cut expenses .when conducting examinations in foreign countries. Th.e Corptroller agreed that interagency use of examiners when concdlctirg xadriations in foreigi countries would be bereficial but that some clarifying legislation might be necessary. Wle would be glad co work A:ith the C=nmittee on any legislation needed to clarify the authority for intear2gency use of exa1T1ners. That concludes our statement, Mr. Chairman. We would be happy to answer any questiorns you may have. -9-
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