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For Release on Delivery 10:00 a.m., E.D.T. June 11, 1991 Testimony by Alan Greenspan Chairman, Board of Governors of the Federal Reserve System before the Committee on Banking, Finance and Urban Affairs U.S. House of Representatives June 11, 1991 I am pleased to have the opportunity to appear before this Committee today in support of the Foreign Bank Supervision Enhancement Act, which is designed to strengthen the supervision and regulation of foreign banks operating in the United States. As you have requested, Mr. Chairman, I will also comment on section 231 of the Financial Institutions Safety and Consumer Choice Act of 1991 (H.R. 1505), the banking reform proposal, which deals with proposed restrictions on activities of foreign banks in the United States. Each of these legislative proposals has far-reaching significance for the U.S. financial system. The liquidity and depth of the U.S. banking environment has to a great extent been made possible by the participation of foreign banks. The active presence of foreign banks in this country has helped to assure the continued importance of the United States in international financial markets and has contributed to the growth of banking, including international banking, in a number of U.S. cities. Of equal significance, foreign banks have been a substantial source of credit for all types of American businesses in all parts of this country. It is clear that foreign banks occupy an important and growing place among banking institutions in the United States. At the end of 1990 there were 290 foreign banks with operations in the United States having aggregate assets of $800 billion. The great bulk of these operations are conducted in branches and agencies, which alone had aggregate assets of $626 billion, or 2 18 percent of total banking assets in this country, as of the end of 1990. The Board is concerned that the framework for supervising the U.S. operations of foreign banks is not as strong as it could be. The discovery of fraud and other criminal activity at a small number of foreign banks has convinced us of the need to direct greater attention to these operations on a coordinated basis. For this reason and because we have a strong interest in ensuring the soundness and integrity of the U.S. banking system, the Board has proposed the legislation being considered here today. To this end, the legislative proposal would establish uniform federal standards for entry and expansion of foreign banks in the United States, including, importantly, a requirement of consolidated home country supervision as a prerequisite for entry into the United States and the application of the comparable financial, managerial and operational standards that govern U.S. banks. The proposal would also grant regulators the power to terminate the activities of a foreign bank that is engaging in illegal, unsafe or unsound practices and provide regulators with the information-gathering tools necessary to carry out their supervisory responsibilities. The proposal would clarify the Board's examination authority over foreign banks by providing that it may coordinate examinations of all U.S. offices of a foreign bank. 3 At the same time, my colleagues and I believe that, with proper supervision and subject to appropriate regulatory standards, foreign banks should be able to continue to participate in the U.S. market through branch operations. Consequently, the Board has serious concerns about section 231 of the banking reform legislation, which requires that such branches be closed as a prerequisite to conducting new financial activities. I shall first discuss the Foreign Bank Supervision Enhancement Act, and then turn to section 231 of the banking reform legislation H.R. 1505. Foreign Bank Supervision Enhancement Act As I have already stated, foreign bank operations in this country are large and growing, accounting now for approximately 21 percent of U.S. banking assets. The criminal activity that was discovered in several foreign banks over the last several years has convinced the Board that there needs to be greater, more comprehensive, and better-coordinated attention paid by state and federal regulators to the U.S. offices of these institutions. There is no evidence at this time that the problems are widespread in relation to the overall presence of foreign banks in the United States; nevertheless, recent experience in other areas of the financial services industry demonstrates that early warning signs of trouble should not be ignored. 4 As a result of these recent supervisory problems, the Board conducted a review to determine whether the existing statutory framework governing foreign bank operations in this country is adequate. From that review, we have developed and recommended for enactment the Foreign Bank Supervision Enhancement Act. The legislation is not intended to impose sweeping new requirements or to alter radically the framework governing foreign bank operations in the United States. Rather, its purpose is to build upon and complement the existing supervisory structure in order to fill those regulatory and supervisory gaps that experience has demonstrated exist. The Board has proposed this legislation not only to provide better tools to deal with potential illegal activity, but also because of our continuing strong interest in ensuring that all banking institutions in the United States observe the same regulatory and supervisory standards and operate in a safe and sound manner. The proposal is also intended to ensure that the banking policies established by the Congress are implemented in a fair and uniform manner with respect to all entities conducting a banking business in the United States. It is important to note at this point that the legislative proposal will not foreclose every problem that could arise with a foreign bank. Fraud is extremely hard for any regulatory authority to detect, especially when bank employees actively conspire to prevent official scrutiny or when all relevant information relating to the 5 fraudulent activity is maintained outside the United States. The legislative proposal is intended to minimize the potential for illegal activities by creating a bar to entry by questionable organizations and to provide as many regulatory and supervisory tools as possible to investigate and enforce compliance with U.S. laws and regulations. Uniform Standards for Financial and Managerial Strength The Board recommends that the law establish clear and definite standards that would apply to any foreign institution seeking entry into the United States. Under the current system, a state may allow entry by a foreign bank based on its own criteria, which could differ substantially from the criteria applied by another state. There should be a common set of minimum standards that all applicants must meet in order to be participants in the U.S. banking market. These standards must be designed to continue to permit strong international banks to do business in the United States but to deny entry to weakly capitalized, poorly managed, or inadequately supervised institutions. The proposal would not in any way replace or substitute for state regulatory approval of foreign bank branches and agencies. A state must still license a branch or agency of a foreign bank and must apply its own standards to the establishment and ongoing operation of the office, including standards that may be more stringent or rigorous than those proposed here. The proposal establishes a minimum standard that 6 all foreign banks operating in the United States must meet because of the significance and impact of these institutions on our nation's banking system. For these reasons, the Board believes that foreign banks should meet the standards of financial responsibility comparable to those applied to U.S. banks, including the standards that would be applied to a U.S. bank operating internationally. Consolidated Supervision My colleagues and I believe that it is critical that any foreign bank entrant be subject to comprehensive supervision on a consolidated basis by a home country regulator. When an institution operates internationally in separate jurisdictions with differing laws and regulations, consolidated review and supervision is the only means of determining its financial condition and the extent and lawfulness of its operations. Comprehensive, consolidated regulation has in recent years become a necessary response to the globalization of financial markets. This standard of comprehensive and consolidated supervision was not a generally accepted principle of international bank supervision at the time the International Banking Act was adopted, as it is today, and became so only after experience demonstrated the problems associated with fragmented review of an international bank's operations. The Board recommends incorporation of this standard into the laws governing foreign banks operating in the United States. 7 Access to Information The Board also recommends that the uniform standards include a requirement that a foreign bank agree to supply information on its activities and operations that a regulatory agency finds to be necessary in order to determine whether the bank is in compliance with U.S. banking requirements. Recent experience has demonstrated the critical importance of agency access to this type of information. Without this type of agreement, it is difficult for the agency to detect and enforce compliance with the banking laws. The agency is in the position of having to use its enforcement authority to attempt to gain access to information the bank may be trying deliberately to shield by holding it offshore. The provision is not intended to grant authority to the banking agencies for "fishing expeditions" or to allow the exercise of extraterritorial jurisdiction over the non-U.S. operations of the foreign bank or to provide access to the records of customers unrelated to the bank's compliance with U.S. banking laws. Rather, the provision seeks to confirm that a foreign bank that chooses to participate in the U.S. market, with all attendant privileges and responsibilities, will also make available to banking regulators information that is directly relevant to determining and enforcing the bank's compliance with U.S. banking requirements. 8 Requirement for Prior Review As a means of implementing these standards, we recommend that the Congress adopt a requirement of prior federal review applying these standards to the proposed entry by a foreign bank through any form of banking office, whether a state or federally licensed office or a commercial lending company. The International Banking Act gave the Board certain responsibilities for the supervision of foreign banks in the United States, but no federal agency has a voice in deciding whether individual institutions seeking to enter U.S. markets through state branches, agencies, or commercial lending companies meet the standards generally applicable to banking organizations in this country. As the Board is the agency charged with responsibility for the overall supervision of foreign banks in this country, it is our view that the Board should have a role in deciding whether the foreign bank may establish or maintain a U.S. banking presence. This is a practice that applies in other areas of federal bank regulation and, given the size and importance of foreign bank offices in the U.S. banking market, the practice should be applied to these institutions as well. Supervision of Representative Offices Foreign banks also participate in the U.S. market through representative offices. These are offices at which a foreign bank may promote the services offered by the foreign bank but may not engage directly in a banking business with customers. Representative offices may not make credit or other business 9 decisions but must refer such decisions to the home office. Because their activities are intended to be limited, there is a lesser degree of regulation of these offices. There have, however, been instances in which foreign banks have used representative offices to conduct banking activities without licenses. In order to prevent such instances in the future, we believe that it would be appropriate to require federal review of the establishment by foreign banks of representative offices in the United States and to make these offices subject to examination. Termination of Activities In addition to the adoption of standards for the establishment of a new foreign bank office that would require federal approval, the Board has recommended that federal authority be provided to terminate the activities of a state branch, agency, representative office, or commercial lending company of a foreign bank. The grounds for such termination would be violations of law or the conduct of unsafe or unsound practices where the continuation of the activities would not be consistent with the public interest or the applicable statutory standards. Coordination of Examinations Our experience has demonstrated the need to strengthen and coordinate federal and state examinations of the various branches and agencies of a foreign bank. Many foreign banks operate extensive interstate networks of branches and agencies 10 licensed under the authority of the various states or the OCC. As a result, the timing of the examinations of the various offices and the elements of the various examination processes may differ widely. Our experience has also demonstrated that comprehensive supervision reguires that the branch offices of a bank should be regulated and examined in a consistent manner While the International Banking Act gives the Board the residual responsibility for supervising all of a foreign bank's U.S. operations, it also requires the Board to use the reports of examination of other regulators to the extent possible. The Board believes that the statute should be amended to remove this requirement and to authorize the Board to call for coordinated or simultaneous examinations. Because such coordinated examinations would require the close cooperation of a number of different regulators, the Board believes it is preferable that there be clear Congressional authorization for such coordination, including authority to coordinate simultaneous examinations where appropriate. The proposal is not intended to interfere with state efforts to examine and supervise state-licensed branches and agencies. In implementing a coordinated examination program, the Board would anticipate that examinations of state branches and agencies would be conducted in a manner similar to those of state member banks. The Federal Reserve has a long record in coordinating examinations of state member banks with the states. The Board applies a flexible approach designed to use resources 11 efficiently while obtaining the necessary information from the examination. The Board may conduct its own examination of the branch, participate in a joint examination, or alternate examinations with the supervisor every other year. Examination of branches and agencies may require greater coordination with the states and the OCC because of the interstate aspect of the foreign bank's operations and the number of different regulators that are involved, but it is to be hoped that the end result will provide a more comprehensive picture of a foreign bank's U.S. operations than is currently available. We would hope to enhance existing communications and cooperation with federal and state bank regulators in conjunction with the program of coordinated examinations. Cooperation with Foreign Supervisors In terms of supervising banks that operate internationally, a crucial aspect is cooperation and coordination with the home country regulators of such banks. Consequently, the Board recommends that the International Banking Act be amended to clarify that the federal banking agencies are authorized to share supervisory information with their foreign counterparts, subject to adequate assurances of confidentiality, where such sharing is appropriate in carrying out the agency's supervisory responsibilities. Other Proposals There are a number of other areas where we have recommended either enhancing current requirements in the law or 12 extending to foreign banks in the United States the same legal requirements as apply to U.S. banking organizations. These areas include requiring reports by foreign banks with U.S. operations of loans secured by 25 percent or more of the voting shares of any insured depository institution; requiring that a foreign bank with a branch, agency or commercial lending company in the United States obtain prior approval before acquiring more than 5 percent of the shares of a U.S. bank or bank holding company; clarifying the managerial standards applicable to bank acquisitions in the Bank Holding Company Act; and confirming the authority to impose civil money penalties for violation of the International Banking Act or its implementing regulations. In addition, the proposal calls for designating the relevant federal banking agency to enforce the consumer lending statutes for foreign bank branches and agencies rather than the approach under some existing laws that would leave residual enforcement authority for foreign bank offices with the Federal Trade Commission or in one case the Department of Housing and Urban Development. I would also note that, as part of the Treasury's proposed legislation on banking reform, state-chartered banks would be limited in their activities to those of a national bank, absent agency approval. If that portion of the banking reform legislation were to be enacted, a similar limitation should be applied to the activities of state branches and agencies of foreign banks. 13 Foreign Bank Activities in the United States under the Banking Reform Proposal Section 231 of H.R. 1505, the Treasury's banking reform legislation, would require a foreign bank that desires to engage in newly authorized financial activities, such as securities, to establish a financial services holding company in the United States through which such activities would have to be conducted by subsidiaries. The provision would also require any foreign bank that chooses to engage in the new financial activities to conduct all of its U.S. banking business through a U.S. subsidiary bank and to close and "roll up" its U.S. branches and agencies into that bank. Finally, under the provision foreign banks would lose their grandfather rights for U.S. securities affiliates after three years and would be required to obtain approval from appropriate authorities to engage in underwriting and dealing in securities activities in the United States in the same way that a U.S. banking organization would. The supervisory standards that would be the basis for authorizing affiliates of U.S. banks to engage in newly authorized financial activities and interstate banking would apply also to affiliates of foreign banks. appropriate and equitable. Such a policy appears However, in implementing that policy, we question the need for the requirement that foreign banks close their U.S. branches and agencies and conduct their U.S. banking business in a separately capitalized U.S. subsidiary bank of the 14 financial services holding company in order to take advantage of the expanded powers for new activities. It has been the policy of the United States at least since the adoption of the International Banking Act of 1978 to apply the principle of national treatment to the regulation of foreign banks in the United States. The Congress in that Act recognized that foreign banks operating in this country come from jurisdictions with differing and varied banking structures. The Congress determined that national treatment required adaptation of U.S. legal requirements to provide foreign banks, not with identical treatment, but rather with equivalent, or parity of, treatment. Within the context of applying the principle of national treatment, an effort has been made to limit the extraterritorial effect of regulation in the United States while assuring both that appropriate supervisory safeguards are in place and that no competitive advantages accrue to foreign institutions as a result of the form or structure of regulation in this country. In the International Banking Act the Congress balanced these concerns by treating foreign banks as bank holding companies for purposes of the nonbanking restrictions of the Bank Holding Company Act but without specifically requiring foreign banks to establish separate holding companies. worked well for the past 13 years. That approach has In our view the imposition of the additional legal requirement that foreign banks transfer their banking business in the United States to separate 15 subsidiaries, as a precondition to new activities, imposes additional costs on the U.S. operations of foreign banks, but does not enhance the safety and soundness of those operations. We believe that the principle of national treatment does not require that foreign banks operate their U.S. banking business through subsidiary banks in the United States in order to engage in new financial activities. Moreover, if identity of treatment is a prerequisite for national treatment, the question arises whether section 231 may be viewed as denying national treatment because it prohibits foreign banks from branching in the United States from their head offices, when U.S. banks would have that authority. Moreover, the capital and other supervisory standards that are the basis for authorizing affiliates of foreign banks to engage in newly authorized financial activities can be applied without requiring the termination of the branches and agencies of foreign banks in the United States, and without requiring that foreign banks establish an intervening U.S. holding company between the parent foreign bank and U.S. activities. The Federal Reserve has for a number of years taken into account the capital strength of the entire foreign banking organization for purposes of determining whether the organization may commence new U.S. activities under the Bank Holding Company Act. A similar assessment could be made for purposes of the banking reform legislation. Indeed, an assessment of the strength of the entire banking organization would be a better basis for judging a 16 foreign bank's fitness for new powers than would an assessment of only the capital of the U.S. subsidiary bank, and would meet the standards of national treatment and equality of competitive opportunity for U.S. and foreign banks in this country. There are also other reasons to question the approach of section 231 in its current form. As the Treasury proposal recognizes in advocating domestic interstate branching, a requirement that a banking business be conducted through separately incorporated subsidiaries rather than branches imposes additional costs by not permitting a banking organization to use its capital and managerial resources efficiently. In many of the important banking markets, U.S. banks have been permitted to conduct banking operations through branches on an equal basis with local banks. In bilateral and multilateral discussions, U.S. authorities have correctly argued that a restriction against branching discourages the involvement of U.S. banks in foreign markets. It would be inconsistent not to acknowledge that foreign banks could also be discouraged from involvement in U.S. banking markets by requiring foreign banks to operate only through subsidiaries in order to engage in new activities. Foreign banks have made a substantial contribution to the competitive environment of U.S. financial markets and the availability of credit to U.S. borrowers. To the extent the proposal may cause a retreat from the commitment of foreign banks to the U.S. market, it may reduce the availability of credit to American businesses and local governments. Currently, legal 17 lending limits for U.S. branches and agencies of foreign banks are based on the consolidated capital of their parent banks. By contrast, requiring a "roll up" of branches and agencies of a foreign bank into a U.S. subsidiary bank, whose capital is measured separately from the parent, might limit the extent to which foreign banks contribute to the depth and efficiency of markets in the United States and continue to lend to individual borrowers. Moreover, by compelling a switch from branches, whose deposits now are largely uninsured, to U.S. subsidiaries, whose deposits would be covered by U.S. deposit insurance, we would be increasing the extent to which depositors would look to the U.S. safety net instead of to the foreign parent in the event of problems. We also have reservations about the purpose that would be served by requiring a foreign bank to establish a holding company in the United States to conduct new financial activities. In particular, requiring a foreign bank to operate through a holding company is not necessary to assure competitive equity for U.S. financial services holding companies or independent U.S. nonbank firms. A foreign bank's U.S. operating company, whether a securities firm or the bank itself, would have to meet at least the same standards required for any other U.S. firm engaged in that business. The question then is whether the requirement of a financial services holding company removes some other potential competitive advantages for foreign banks. We think not. The 18 foreign bank itself would have to be well-capitalized. Moreover, any cost advantage a foreign bank may have in its own home market would be available regardless of the structure of its U.S. operations. Requiring the termination of U.S. branches and agencies of foreign banks and a holding company structure could create inducements for foreign banks to conduct banking operations in less costly environments outside the United States. Such requirements could also encourage foreign authorities to enact similar restrictions on branching activities by foreign banks, including U.S. financial firms, possibly setting off a mutually destructive spiral of escalating restrictions. Finally, we support the policy reflected in section 231 that would allow a termination of the grandfathered securities activities of foreign banks if foreign as well as domestic institutions are given the power to engage in securities activities under the new structure for financial reform. Conclusion In sum, the Foreign Bank Supervision Enhancement Act is designed to be consistent with the policy established in the International Banking Act of national treatment for foreign banks and to provide federal regulators with the same authority over the U.S. operations of foreign banks as they have with respect to domestic banks. The proposed legislation does not establish a new scheme of bank regulation; it applies to foreign banks the same structure of regulation as currently applies to domestic 19 banks. The dual banking system is served in the same way as with domestic banks, and the proposed legislation recognizes that states have an important role in determining whether to permit foreign banks to enter their states under a scheme of state regulation. The proposed legislation also recognizes, however, that the presence of an international bank in the U.S. market has implications that go beyond the boundaries of any one state and that the national policies established by the Congress with respect to banking must also be served. This legislative proposal will enhance the ability of U.S. regulatory authorities to assess the ability of a foreign banking organization as a whole to support its U.S. operations. The comments I have made on section 231 of the Committee Print of H.R. 1505 also emphasize that such an assessment is a more reliable basis for determining whether a foreign bank should be given new financial powers in the United States. The "roll up" and the holding company requirement run counter to that interest. It would appear that the underlying intent of section 231 is to provide a firm basis for U.S. regulation of foreign banks. We believe that there are other ways to achieve an appropriate level of supervision of foreign banks. The provisions of the Foreign Bank Supervision Enhancement Act would serve that goal without the negative side-effects of the "roll up" and the holding company requirements of section 231. I appreciate having the opportunity to testify on these important issues and would be pleased to answer any questions.
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