View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

For release upon delivery
Wednesday, December 10, 1975
11 A.M. > G.M.T. (5 A.M., E.S.T.)




THE REGULATION OF BANKING - U.S. VIEW

Remarks of
GEORGE W. MITCHELL
Vice Chairman
Board of Governors
of the
Federal Reserve System

at the
World Banking Conference
sponsored by
The Financial Times
and
The Banker
London, England
December 10-11, 1975

THE REGULATION OF BANKING - U tS. VIEW

The growth of multinational banking in the past decade has
had consequences for both domestic monetary management and banking
regulation.

How material these consequences have been on domestic

monetary policy has been a matter of dispute and frequently doctrinaire
assertion.

What is clear is that contemporary monetary management

needs to take into account foreign influences on the levels of domestic
liquidity and interest rates, as well as growth rates of the monetary
aggregates.
In the U.S. we have up to now, in one way or another, managed
to avoid serious distortions in domestic policy objectives arising
from external forces.

Other countries, more exposed to the external

sector, have not always been as fortunate as we have been and calls
for coordination in monetary policies among groups of countries are
becoming more and more frequent.

Despite the fact that there is coming

into being an international monetary climate, monetary sovereignty is
still a prized national prerogative and being sought by more nations
year by year.

It is not my task today to speculate on the half-life

of monetary sovereignty as an instrument of national policy for
managing the domestic economies of our nations in the future but it
would have been an interesting assignment.
I am to deal with the consequences of multinational banking
on the effectiveness of banking regulation.

This is a topic that

has not received wide attention because of its parochial character
and because banking regulation is not widely regarded as having much




-2-

to do with anything except banks.

This is an inadequate, if not a

faulty, view of the nature of banking regulation in any country which
uses monetary policy to affect the performance of its economy for
there are numerous interlocks between regulatory and monetary actions.
Monetary restraint, or stimulus, places banks under the
necessity or incentive to adjust their scale of lending and investing.
The measure of monetary restraint or stimulus to be applied must be
gauged in terms of the banking system1s response capability.

A knowledge

of that capability depends on a first-hand and intimate understanding
of the banking community1s condition and psychology.

That understanding

is an important product of bank examination and surveillance.

Regulatory

guidelines can also have significant effects on the monetary climate
even though their purpose is to modify some banking practices in the
interest of a sounder system or one that is more responsive to public
interests.
The Federal Reserve's concern that there be a strong equity
underpinning for banking organizations is a good case in point.

In the

two years 1973 and 1974 total assets of many U.S. banks grew between
40 and 50 per cent.

As equity capital grew at nothing like that rate,

the deterioration in capital ratios in these institutions accelerated
and reached a point where we felt a break in their over-all rate of
growth was required and that substantial additions to capital should
be sought.

This perception of the situation was subsequently shared

by the capital markets.




The past year has brought on significant

-3-

additions to equity, little growth in bank assets and other corrective
actions that have greatly strengthened our banking system.
Throughout this episode, monetary considerations played a
role and it is, indeed impossible to segregate them from regulatory
considerations.

For part of the period, efforts to restrain growth

and improve capital coincided with a restrictive monetary policy.
More recently, continued encouragement of consolidating actions in
the banking system has run somewhat counter to the thrust of a monetary
policy seeking to foster economic recovery.

Whatever the short-run

consequences for monetary policy of changes in regulatory guidelines,
I think it clear that monetary policy in the United States would be an
ineffective instrument in the long run if there were not a strong,
viable banking system through which pulses of restraint or stimulus
could be conveyed throughout the economy.
There are numerous other illustrations of the interconnections
between regulatory and monetary policies but I would mention only one
which has been an important phenomena in the U.S. in the past decade.
I refer to the ceilings on interest rates that banks and other deposi­
tory institutions can pay for access to interest-sensitive funds.
Such ceilings were originally devised to moderate competitive conditions
among financial institutions.

However, at various times during the

1960!s, these ceilings were used as a monetary tool to constrain com­
mercial banks1 lending authority.

The tool proved a powerful one but

lacking in flexibility for frequent application as its use created




-4-

serious competitive dislocations.

We hope Congress will allow this

subsidy to depository institutions extracted from savers to be phased
out in the next few years.
The impact of multinational banking operations functioning of
national banking systems has raised new regulatory problems involving
international coordination and understanding.

Traditional regulatory

and surveillance systems with a largely national orientation no
longer have sufficient reach nor afford effective control.

For

example, foreign operations have brought both profits and losses
back to the home country for sharing and assimilation.

Home country

regulators have often had little basis for predicting what to expect
next.

At the same time, host country regulators worry about unseen

elements and unforeseeable developments arising from foreign infiltra­
tion of their money and banking system.
Multinational banking no longer consists of international
banking networks based on a long-standing colonial or trade dependency
with the parent bank's country.

Multinational banking is now directed

toward networks serving major industrial nations with offices in the
financial and industrial centers all over the world; in those centers
indigenous sources of funds and local loan customers are being developed
as well.

These markets are now open to foreign institutions by way of

de novo entry, foothold acquisitions of small local institutions and,
in a few instances, the merging or purchase of a major banking organi­
zation.




-5-

Offices in less developed countries and in tax and in regulatory
havens are usually of secondary importance to multinational banks.
Many less developed countries still seem inclined to view multinational
banks as a threat to their indigenous banking systems or as having the
capability to thwart their domestic objectives.

That view ignores or

does not give sufficient weight to the services and credit capabilities
which the multinationals have demonstrated.

In a capital- and credit-

short world, exclusion from the financial sector of all foreign
institutions in fact and name— that is, no foreign interest in any bank
or financially related enterprise— seems to me to be self-defeating.
Even exclusions--that is to say, no purely foreign banks, but indigenous
partnerships with foreign banks or foreign financially related enter­
prises such as financing, leasing, or factoring concerns— while offering
operating and technological know-how, may risk losing the advantages of
a superior competitive climate.
So far as the impact on domestic economies and banking systems
are concerned, central bankers and regulators have by now had the
opportunity to view the record of multinational banking under world­
wide boom and recession conditions and thus to reflect on experience
covering a full cycle of economic activity.

That some costly mistakes

have been made in international operations is clear but hindsight
reveals that similar or equally costly errors have occurred in domestic
operations.

Many of the same errors of judgment have appeared in both

domestic and foreign operations; real estate financing is a vivid
example.

Other errors have been unique to one type of operation; in the

international area, an example is foreign exchange operations.




-6-

Because of these various ways in which domestic and international
operations interact, the regulation of multinational banking networks
must, in my view, involve coordination and cooperation among the banking
and monetary authorities around the world.

This is necessary not just

to avoid the layering of compliance burdens and regulatory costs but
to maximize the advantages of multinational banking and minimize the
dangers to which it may be exposed.
The cornerstone for a workable system of international banking
regulation must rest on some broadly recognized principle for the
treatment of foreign banks in host countries.

The Federal Reserve has

accepted this in its proposed bill before the U.S. Congress concerning
the rights and obligations of foreign banks seeking to do business in
the United States.

The principle contained in this bill is "national

treatment11— or, non-discrimination.

It means that foreign banks in

the United States (the host country) will abide by the same rules as
indigenous banks, having the same privileges and being subject to the
same requirements.

An approach along this line preserves for each

national government the right to make the rules applicable to banks
operating in its territory.

There are numerous well established

precedents for Mnational treatment1 and the principle is widely
1
accepted for other business enterprises today.

Still there are some

who reject "national treatment" and who prefer a principle of
"reciprocity" a protean concept which seems to me to have as many
interpretations as adherents.




After considerable exposure to arguments

-7-

along this line, I think it adds up to the contention that banks should
be able to operate in foreign countries as they do at home.

This is

akin to asserting my right to follow the traffic conventions prevailing
in the U.S. when driving in London.

It could be contended that American

driving rules are superior in some way to those in London but no
reasonable person would try to sustain the proposition that these two
traffic conventions can be successfully intermingled.
Beyond agreement on that principle, there needs also to be
a meeting of minds on the locus of financial responsibility for the
operation of a foreign bank.

This is a very difficult issue for regula­

tory policy, both at a conceptual and a practical level.

The issue em­

braces the responsibility of central banks in host and home countries,
the distinction between legal and moral responsibilities, and the
right of parents to succor distressed operations abroad with the
possibility of weakening the parents1 soundness or profitability.

So

far as parental responsibility is concerned, the answer is clear with
respect to branches, on both legal and moral ground.

Ambiguity arises,

however, in the case of subsidiaries and joint ventures.
Severability is a concept urged by some for subsidiaries and
joint ventures.

The idea is that since members of the family are

legally independent and operationally severable, the credit standing
of each family member is also a severable characteristic.

A wholly

owned subsidiary could under this theory fail and be liquidated with
losses to creditors for borrowed funds without serious consequences to




-8-

the credit standing of the parent or other family members.

The thrust

of this argument is that the viability and soundness of the home
office and branches are determined by the soundness and viability of
the parent and are unimpaired by credit problems of subsidiaries or
joint ventures.

The concept of severability is said to be reinforced

by physical separation of sites from which operations are conducted
and by distinctively different corporate names.
The opposing concept is that so far as credit standing is
concerned, there is no such thing as severability in a family of
financial institutions whose members solicit deposits and borrow in
the world's money and banking markets.

The family name is built on

confidence in the credit integrity of all of its members; one of
them cannot default on its obligations without jeopardizing the
integrity of the others.
Banking history and contemporary banking practice both at
home and abroad are replete with illustrations of the lengths to
which banking institutions will go to protect their credit standing.
It is not a question of the legal ability to avoid meeting outstand­
ing financial obligations; it is not even a moral or ethical issue
in the final analysis.

It is a question rather of survival as a

financial institution in a world where confidence more than anything
else determines the access of such intermediaries to the liquid funds
of savers and investors.




-9~

As between these two concepts of financial responsibility,
I believe there are several reasons for preferring the concept of non­
severability.
practice.

The main reason is that it is in accord with established

There may be cases in which obligations have been shucked off

but few if any have escaped the attention of the financial community
which sets this standard of behavior.

Of course, obligations have been

defaulted by discredited or deposed managements and boards of directors;
these are actions in extremis--not those of an institution that expects
to continue in business.
The other major reason for preferring the latter concept of
family responsibility is that acknowledgement of this responsibility
has a sobering effect on acquisition policy and on parent company
surveillance of the operations of its subsidiaries.
This concept of non-severability is clearest in the case of
subsidiaries but it also extends in my view to consortia or other joint
ventures.

Failure of a partner in such a venture to provide support

commensurate to its interest or to the public's association of the
bank with the joint venture could well have equally adverse consequences
on the participating bank.

In this case, too, acknowledgement of this

type of responsibility would interject a cautioning note on joint venture
investments of making sure there were responsible partners in the
venture and of subsequent close attention to the affairs of that venture.
There are a number of other areas where agreement, coopera­
tion and coordination are necessary among banking authorities if




-10-

banking regulation is to perform its proper function in a multi­
national banking world.

First of all, there should be agreement that

all major banking institutions are supervised in the markets in which
they operate and a general satisfaction that such supervision is adequate.
Coordination is required to assure that supervision does not needlessly
overlap among banking authorities or that some areas escape entirely
through inadvertence.

Cooperation in the form of exchanges of informa­

tion about banking practices, regulatory problems, and even individual
institutions is also a necessary ingredient.
I cannot provide an adequate blueprint of how this all
should or can be worked out.

At the moment, there are legal impediments

in many instances to improved cooperation.

There are, besides, national

sensitivities and sovereign interests to be protected.

I am encouraged

by the work of the committee established under the aegis of the Bank
for International Settlements to promote such cooperation and to
examine possibilities for an international early warning system in the
banking sector.

Although in existence for a very short time and so far

confined to a dozen or so countries, that committee and its work seems
a promising first step.

Its very existence evidences the commonality

of interests among nations in assuring a sound, effective and efficient
multinational banking system.

With that common interest recognized,

central banks and banking authorities can get to work at solving the
problem of putting together an effective and efficient regulatory system
which avoids unnecessary compliance costs and encourages the establishment
of competitive alternatives for banking customers throughout the world.




-0 O 0 -