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FOR RELEASE ON DELIVERY
EXPECTED AT 1 0 :0 0 a.m. (E .D .T .)
Statement by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
before the
Committee on Banking, Housing, and Urban Affairs
United States Senate
July 16, 1979
I am pleased to testify before your committee on three current issues in
international banking.
First, I should like to give you my views on the proposal by the New York
Clearing House that banks in the United States be permitted to establish special
international banking facilities (IBFs) that could accept deposits from foreign
customers free of reserve requirements and interest rate limitations, and could
make loans only to foreigners. As you know the Board has twice sought public
comment on specific features of the proposal, and this afternoon, the Board will
review the comments received most recently.
The proposal has a number of important
implications, and I cannot promise you that this will be the last occasion for Board
discussion of this proposal.
The comments received by the Board have been useful in identifying two
principal issues posed by IBFs:
the implications of IBFs for U.S. monetary policy
and credit availability and their implications for competition among banks.
Because IBFs, as proposed, would offer attractive obligations with highly
flexible maturities, free of reserve requirements and not subject to risks associ
ated with asset holdings in foreign countries, they are likely to be attractive to
some foreign investors that now hold funds in the United States or in the Eurodollar
market.
Shifts of foreign funds from deposits in U.S. banks to IBFs would affect
the. monetary aggregates whereas shifts of foreign funds from the Euromarket would not.
Most foreign demand deposits in the United States are held by banks and official
institutions, and under a proposed redefinition of the aggregates, these deposits
would be excluded.
Demand deposits held by foreign nonbanks represent only a little
more than 1 percent of M^.
Time deposits held by nonbank foreigners are about
-2-
1 percent of
It has been argued that shifts of foreign deposits would be
sufficiently small in size so that — with adequate monitoring —
they would not
lead to major problems in assessing the monetary aggregates.
There is a danger, however, that IBFs could pose difficulties for domestic
monetary policy by attracting funds that U.S. companies might otherwise keep in
U.S. banks.
The readiness of domestic companies to place funds in IBFs through
their foreign affiliates would likely depend on the availability of alternative
domestic facilities.
If the Board were to take action to reduce the availability
or attractiveness of alternative domestic investments (such as RPs), U.S. companies
might seek to use (or to establish) new foreign affiliates to take advantage of the
attractive features of IBFs.
It would be extremely difficult and costly for the
Federal Reserve to control such shifts through supervisory action or to monitor such
shifts in order to make adjustments to the monetary aggregates.
In its request for comment on the IBF proposal, the Board suggested two
possible safeguards against circumvention of the ground rules for IBFs by domestic
companies:
limiting maturity of deposits to 7-day or longer, and prohibiting IBFs
from accepting deposits from foreign affiliates of U.S. companies.
The response of
the banking community was that these restrictions would impair the usefulness of
IBFs for conducting customary international business.
An alternative method of dealing with the problem might be to establish
limits on the rate of growth of IBFs - thereby limiting the extent of possible
shifting.
In my judgment, this issue remains unresolved.
-3-
IBFs could affect availability of bank credit in those markets where
foreign deposits are used to fund local lending.
So long as IBFs were able to lend
to their parent banks free of reserve requirements the parent bank could fund local
credits using deposits placed in the IBFs.
But, if for monetary policy reasons, the
Federal Reserve were to re-establish a reserve requirement on borrowings by U.S.
offices from foreign branches - and, as has been proposed, apply this requirement to
borrowings from IBFs - the IBFs might cease financing their U.S. parent banks and
extend loans abroad.
In that case, there could be increased foreign lending by IBFs and - in
the first instance - reduced domestic lending bv U.S. offices of those IBFs.
If
those domestic offices could not find alternative sources of funds on comparable
terms (as, for example, by borrowing in the Federal funds market) availability of
bank credit in certain markets could be adversely affected.
I might note that increased foreign lending under those circumstances
could also adversely affect the exchange rate for the dollar.
The second issue regarding IBFs - competition among banks - has been the
focus of comments by the banking community.
Banks located outside New York have been
concerned that they should have an effective degree of competitive equality with
New York City banks.
Some banks have indicated that they would favor IBFs only if
they could have a physical presence in New York that would enable them to compete
for deposits on a comparable footing with New York banks, and could have access to
a mechanism for settlement of international transactions on terms that they would
deem equitable.
-4-
The Federal Reserve is currently engaged in reviewing the role that it
might have in facilitating international settlements; once that review is completed
it may be possible to determine whether a settlements mechanism can be developed that
would meet the need of IBFs as well as of the international banking community
generally.
The issues that I have been discussing pose some as yet unanswered
questions regarding IBFs.
resolved.
There are, however, some areas where questions can be
One is supervision for safety and soundness - which is distinct from the
regulatory aspects to which I have referred.
Supervision of IBFs would logically fall under the jurisdiction of the
agency that supervised the parent bank - the Comptroller for national banks and the
Federal Reserve for state member banks.
Because IBFs would be located in the
United States they could be supervised from the standpoint of safety and soundness
to the same extent as the U.S. offices of the same bank:
there would be no loss in
supervisory capability.
Nor would IBFs be inconsistent with current efforts to establish some
measure of control over Eurobanking.
on measures to be applied —
If broad international agreement can be reached
such as reserve requirements -- those measures or their
equivalent would also be applied to IBFs.
On the other hand, if agreement cannot be
reached, the establishment of IBFs would tend to draw to the United States some of
the banking activity now taking place offshore —
and we would have a somewhat
greater opportunity to influence that business if it were conducted here.
-5The second to p ic which you have asked me to d iscu ss r e l a t e s to the
re g u la tio n o f Edge Corporations»
The In te r n a tio n a l Banking Act o f 1978 (IBA) amended th e Edge Act
and requ ired the Fed eral Reserve Board to r e v is e i t s re g u la tio n s governing
Edge C orporations by June 14, 1979.
The IBA d ire c te d th e Board to remove
unnecessary re g u la to ry r e s t r a in t s in order to make Edge C orporations more
e f f e c t i v e p rovid ers o f in te r n a tio n a l banking s e r v ic e s , enable them to com
p ete e f f e c t iv e ly with s im ila r foreign-owned in s t it u t io n s in th e United
S t a t e s , and f o s t e r ownership o f Edge C orporations by sm a lle r and re g io n a l
i n s t it u t io n s .
However, th e IBA did no t amend th e s p e c i f i c s ta tu to r y language
o f S e c tio n 25(a) o f the Fed eral Reserve Act th a t lim it s th e powers Edge Cor
p o ratio n s may e x e r c is e in th e United S t a t e s .
In ¿unending i t s r e g u la tio n s ,
the Board sought to in cre a s e the e ff e c tiv e n e s s o f Edge C orporations through
the removal o f unnecessary r e s t r a in t s on t h e i r a c t i v i t i e s , w hile a t th e same
time r e ta in in g the in te r n a tio n a l c h a ra c te r o f Edge C orporations and not
making them f u l l - s c a l e dom estic commercial banks.
In some c a s e s , execu tio n
o f t h i s ta s k involved d i f f i c u l t judgments.
Edge C orporations conduct a wide range o f in te r n a tio n a l banking
a c t i v i t i e s both in s id e th e U nited S ta te s and abroad.
a c t i v i t i e s can be summarized a s :
In g e n e ra l, th ese
(1) in v e s tin g in fo re ig n companies (p r i
m arily banking and f in a n c ia l i n s t i t u t i o n s ) ; (2) re c e iv in g and lend ing money
abroad; and (3) providing in te r n a tio n a l banking s e r v ic e s in th e United S ta te s
(on th e lend ing s id e t h i s c o n s is ts la r g e ly o f fin a n cin g in te r n a tio n a l t r a d e ) .
Although th e Board lib e r a liz e d many a sp e c ts o f i t s re g u la tio n s p e rta in in g
to Edge C orp oration s, th e amendments th a t have drawn th e most a tte n tio n are
th ose d ealin g w ith the U .S. a c t i v i t i e s o f Edge C orp oration s.
-6-
One change perm its Edge C orporations to e s ta b lis h branches in
the United S t a t e s .
P re v io u sly , dom estic branching had been p ro h ib ite d .
However, banks had been allowed to own a number of Edge Corporation sub
sidiaries and many of the largest banks owned Edge Corporation subsidiaries
in several States.
In the view of the Board, domestic branching of Edge
Corporations merely provides an alternate organizational form through which
banks can conduct a multi-State Edge Act business that has already been per
mitted through ownership of multiple Edge Corporation subsidiaries.
The
Board regards this change as consistent with the Congressional mandate to
remove unnecessary regulatory restrictions.
The Board does not believe that
this change violates the spirit of the McFadden Act ban on interstate branching
by banks.
Edge Corporations have not been regarded as commercial banks
and, historically, a principal purpose of these Corporations has been to pro
vide a means by which banks could conduct an international banking business
outside of their home State.
Moreover, this change may especially benefit
regional and smaller banks that have been constrained the most by the capital
requirements involved in establishing multiple Edge Corporation subsidiaries.
(Banks can only invest 10 percent of their capital in Edge Corporations and each
Corporation must be capitalized at a minimum of $2 million.)
Prior approval of
the Board is needed for all domestic branches of Edge Corporations and the public
will have an opportunity for comment.
A second change perm its Edge C orporations to fin a n ce the produc
tio n o f goods fo r e x p o rt.
P re v io u sly , Edge C orporations were r e s t r ic t e d to
fin a n cin g the tr a n s p o r ta tio n , sto rag e and a c tu a l exp ortin g o f goods sold
abroad (as w ell as s im ila r import t r a n s a c t io n s ) .
This expansion o f powers
-7-
was e s p e c ia lly designed to meet C ongression al concern about th e fin a n cin g
o f e x p o rts.
To in su re th a t Edge C orporations r e t a in t h e i r in te r n a tio n a l
c h a ra c te r and to guard a g a in s t p o s s ib le abuse, th e Board req u ired th a t such
working c a p it a l fin a n cin g be extended only where th e re were firm e xp o rt
o rd ers o r where th e goods being produced were r e a d ily id e n t i f i a b l e a s being
fo r e x p o rt.
Probably th e most c o n tr o v e r s ia l prop osal was one to allow Edge
C orporations to conduct any type o f b u sin ess w ith c e r t a in custom ers, termed
"Q u a lifie d B u sin ess E n t i t i e s " ("Q BE").
d e fe rre d .)
(F in a l a c tio n on t h i s prop osal was
These custom ers were to be firm s engaged p rim a rily in ex p o rtin g
or im porting.
T his p rop osal rep resen ted a marked departu re from e x is t in g
Edge Act re g u la tio n s th a t re q u ire each Edge Act tr a n s a c tio n to be d ir e c t ly
a s s o c ia te d with an in te r n a tio n a l tr a n s a c tio n , u su a lly one in v o lv in g the
import o r exp ort o f goods.
Under t h i s p ro p o sa l, th e tr a n s a c tio n -b y -tr a n s
a c t ion approach would be elim in a ted in the case o f Edge C orp oration s1 d e a lin g s
w ith Q BE's; in ste a d , a l l tr a n s a c tio n s w ith such firm s would be presumed to be
in te r n a tio n a l in c h a r a c te r .
For exanqple, i f an Edge C orporation did b u sin ess
w ith an exp ort-iin p ort firm , under th e p ro p o sa l, th e C orporation could fin a n ce
th e purchase o f a U .S. warehouse by th a t company, and th e company could use
i t s Edge C orporation d e p o sit account to pay dom estic expenses such as i t s
p a y ro ll o r i t s u t i l i t y b i l l s , tra n s a c tio n s c u rre n tly p ro h ib ite d .
T his p rop osal o ffe r e d th re e p r in c ip a l advantages:
F i r s t , i t would
have reduced th e re g u la to ry expense c u rre n tly a s s o c ia te d w ith checking Edge
C orporation accounts to make c e r ta in a tr a n s a c tio n i s d ir e c t ly r e la te d to an
in te r n a tio n a l a c t i v i t y p erm itted under th e re g u la tio n .
Second, i t appeared
-8-
to offer convenience and increased efficiency to the export or import
firm that might have looked to an Edge Corporation to finance most of its
business but could not use the Edge account for certain normal business
expenditures.
Third, enabling Edge Corporations to offer full service
banking to this limited group of customers would make them more effective
competitors vis-a-vis foreign banks, as well as domestic banks.
The primary problem associated with this approach was how to
insure that the business was truly incidental to international business,
so that Edge Corporations retained their international character and did
not, in fact, become domestic banks.
The principal objections to this proposal have arisen from concerns that
it would too broadly expand the domestic banking powers of Edge Corporations and
lead to the creation of a new group of domestic commercial banks that would have
an advantage of being able to do business across State lines.
Some-of this concern
arose because of uncertainty about the administrability of the "qualified business
entities" (QBE) standards and the number and characteristics of companies that might
be covered.
Data on the latter are almost nonexistent.
In the end, the Board decided •o postpone implementation of the QBE
proposal and instructed the staff to explore the matter further.
In the coming
months, it is intended to review the customer accounts of Edge Corporations,
consult with other banks and possibly commercial firms with the aim of developing
alternatives to the present transaction-by-transaction approach to monitoring the
U.S. activities of Edge Corporations.
for public comment.
Any new proposal will, of course, be issued
-9I would like to emphasize that it was never the Board's intention to
aiter the basic international character of Edge Corporation's business.
As
part of any final action, one principle will be that Edge Corporations are
international banking institutions, not domestic commercial banks, and that
the rules governing Edge Corporations must maintain that distinction.
However,
it is my view that this doers not preclude Edge Corporations from taking some
domestic deposits and making some domestic loans to a business that is basically
international in character.
F in a lly I s h a ll tu rn fo the q u estion o f fo re ig n a c q u is itio n s o f U .S.
banks.
Federal Reserve policy on for* ¿n acquisitions of American banks accords
with U.S. policy on foreign investment generally.
We believ* that our economy
and our financial system benefit from foreign competition, and from foreign capital,
so long as the investment is subject to the same rules and regulations that
apply to domestic companies.
This principle of national treatment 'is embodied in
the letter and spirit of the International Banking Act, and it underlies the
exercise of the Federal Reserve's responsibilities regarding foreign banking in
the United States.
The l a s t two years have seen an in cre a se in the a c q u is itio n o f U.S.
banks by fo re ig n p a r t ie s .
However, fo re ig n e rs s t i l l own only a tin y f r a c t io n
o f our more than 14,000 banks and even in clu d ing pending a c q u is itio n s , a s s e t s o f
th e acquired banks would only be about 3 p e rccn t o f t o t a l U .S. commercial bank a s s e t s .
Most o f th e s ig n if ic a n t fo re ig n a c q u is itio n s have been by banking i n s t it u t io n s .
I should lik e to emphasize a t the o u ts e t th a t th e re i s a framework
o f law covering fo re ig n a c q u is itio n s o f U .S. barks and th a t r e c e n t a c q u is itio n s
have been made in accordance w ith law.
I r e f e r to S e c tio n 3 o f th e Bank Holding
-10Company Act.
The Federal Reserve evaluates proposed acquisitions according to
standards set forth in the Act:
the financial and managerial capabilities of
the acquiring company, the convenience and needs of the community to be served,
and the effect on competition and concentration of resources in the United States.
In my view, these are appropriate standards for assessing individual applications.
It is important to recognize the potential benefits from foreign invest
ment in individual banks.
One of the principal benefits of a foreign acquisition
can be an addition of capital to the bank.
This would strengthen both the bank
invested in and the U.S. banking system as a whole —
at a time when U.S. bank
capital has been eroded by inflation and (historically) is costly.
Foreign
purchases of U.S. bank stock reduce the available market supply of that stock,
and tend to raise the price-earnings ratio of stock of that bank ar\d ratios of
U.S. bank stocks generally.
Higher price-earnings ratios may enable banks to
raise capital through stock issues without substantially diluting the equity of
existing stockholders.
Actions that would restrict the flow of foreign capital
to the American banking industry would also reduce the attractiveness of that
industry to domestic investors.
In recent years the nonbanking sector has grown
relative to the banking sector in this country, and if we are to have a healthy,
flourishing banking industry, we cannot afford to discourage investment in U.S.
banks.
Foreign investment may also bring innovation and improved efficiency to
U.S. banks:
traditional bank pricing and lending techniques may be modified and
improved by innovative foreign management — with benefits both for the bank and
for its customers.
It is, of course, essential that a foreign bank seeking to
acquire a U.S. bank be soundly managed.
-11Further , foreign investment can contribute to financial stability when
the bank invested in is a "problem" bank, or is in danger of failing.
Tn this
connection I should note that the Federal Reserve has recommended that the Bank
Holding Company Act be amended to permit domestic banks to acquire a failing bank
in another state; such an amendment would broaden the range of alternatives that
might be open to bank supervisors in cases of failing banks.
On the other hand, some questions have been raised regarding possible
adverse effects of foreign ownership of U.S. banks.
The first concerns the
ability of the Federal Reserve to achieve its monetary policy objectives.
Most
large foreign-owned banks accept membership in the Federal Reserve System, and thus
are subject to reserve requirements and other instruments of monetary policy.
Moreover, the record indicates that foreign-owned banking institutions are likely
to live by the spirit as well as the letter of U.S. monetary policy measures —
just as overseas banking offices of American banks abide by monetary policy and
regulatory actions in force in their country of domicile.
This is not surprising,
since non-indigenous banks generally regard themselves as guests in the host country.
I might note, as an example, that foreign banks cooperated with the Federal
Reserve's anti-inflationary voluntary marginal reserve program that was in effect
a number of years ago.
Bills to improve monetary control that are currently under
consideration in the Congress would, of course, help ensure that foreign-owned
banks remained subject to the Board's monetary policy measures.
A second question concerns supervision of foreign-owned hanks.
When
the investor is a foreign bank, the Federal Reserve has authority under the
Bank Holding Company Act.
The Board's policy statement on foreign bank holding
companies makes clear that the foreign bank is expected to be a source of strength —
both financial and manageri/»I -- to its .American subsidiary.
Moreover, the Board
-12recently announced new measures to improve the evaluation of foreign banks at the
time of an acquisition, and subsequently to monitor their condition and increase
surveillance of their subsidiary banks.
When the foreign investor is an individual, rather than a bank or bank
holding company, the standards for approval of acquisitions are those of the
Change in Bank Control Act of 1978.
That Act requires individuals seeking to acquire
control of a bank to give the relevant Federal bank regulatory agency 60 days prior
notification.
The proposed acquisition may be disapproved if it would substantially
lessen competition, result in a banking monopoly in any part of the United States,
jeopardize the financial stability of the bank or otherwise be contrary to the
interests of the bank to be acquired.
Once a bank has been acquired by a foreign
investor, the Board has the same supervLsory powers available that it has in
dealing with possible abuses by domestic owners — notably the ability to issue
cease and desist orders.
A third question concerns the impact of foreign acquisitions on the supply
of banking services to meet the needs of U.S. industry and consumers.
Probably the
best protection in this regard is the competitiveness of U.S. banking.
Banks that
do not meet the needs of their community quickly lose business to those that do.
As they are good businessmen, foreign bankers can be expected to recognize that fact
and act accordingly.
Moreover, the Bank Holding Company Act requires the Board in
acting on any proposed acquisition to consider the convenience and needs of the
community being served.
In this connection, the Board reviews how an acquisition
will affect the services of the bank being acquired and generally expects some showing
of improved services.
Further, foreign owned banks —
like domestic banks -- are
subject to the Community Reinvestment Act, which requires the Federal bank regulatory
authorities to evaluate the extent to which a bank is servicing all elements of its
community, and also the Equal Credit Opportunity Act, which prohibits discrimination
in lending.
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Finally, I should like to emphasize that while we should work diligently
to ensure that our banks receive national treatment in their activities abroad, it
would not be appropriate for us to hold up approval of otherwise desirable foreign
investments in U.S. banks because some countries may not permit non-indigenous banks
(including U.S. banks) to acquire majority investments in their very large banks.
Large American banks have been able to develop extensive foreign operations, and
1 would expect that some U.S. banks will continue to grow internationally both
through branches and subsidiaries.
U.S. banks have in the past acquired sizable ownership interests in
large foreign banks.
For example, in 1974-75, Citibank acquired control of a
German merchant bank and a related German consumer bank.
combined assets of $2 billion.
These two at the time had
Also, in 1975, Citibank increased its ownership
of Grindlays Bank to 49 percent and installed a Citibank employee as chief operating
officer. Grindlays is a major British overseas bank whose assets at the time
approximated $4.5 billion.
It is not possible to state precisely how large a
foreign acquisition might be permitted by foreign authorities because the only
instances that come to the Board's attention are those where a U.S. bank has
successfully negotiated an acquisition that has required U.S. approval.
At the
present time, we have no information that U.S. banks are seeking to purchase very
large foreign banks.
I support fully current efforts under way to ensure national treatment
for U.S. banks abroad.
However, it would be wrong in my view to limit arbitrarily
the growth of sound international banking activity, particularly on the basis of
policies that foreign authorities might follow in hypothetical circumstances.
Nor would T. favor establishing arbitrary limits on the total percentage
of a particular banking market in this country that could be held by foreign-owned
banks as a group.
Such a limit would needlessly interfere with national treatment,
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and, if publicized, might tend to accelerate foreign efforts to acquire U.S. banks
to get in "under the wire."
The Bank Holding Company Act contains protection
against domination of a market by one or more large banks —
domestic.
foreign as well as
Under the Act the Board may not approve acquisitions that would
substantially lessen competition or lead to an undue concentration of resources.
In most cases involving a foreign bank acquisition, the foreign bank would not be
a substantial competitor in the market in question, but it could be considered
a
significant potential competitor.
Thank you, Mr. Chairman.
I appreciate the opportunity to comment on
these important issues.
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