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Reading copy INTERNATIONAL BANKING: A CENTRAL BANKER* S VIEW Remarks of John J. Balles, President Federal Reserve Bank of San Francisco International Bankers Conference Seattle Branch Federal Reserve Bank of San Francisco Seattle, Wash ington November 11, 1975 International Banking: A Central Banker’s View I would like to extend to all of you a varm personal welcome to this conference sponsored by the Seattle Branch of our Bank. I would also like to say congratulations for a job well done to Bill Donovan and Jim Curran, who conceived and organized this conference. I think they have put together a first-rate program, and I am glad that you could all par ticipate* It is good that people with a common Interest In International banking can get together to take stock of recent developments in the field, and to exchange views with each other and with persons in the regulatory agencies. We at the San Francisco Fed are glad to be able to host this con ference. Too often, people view government agencies at worst as harmful meddlers, and at best, as influential but disagreeable old uncles whom one has to humor occasionally, but normally would hope to avoid. That imagery of government bureaucracy, I suspect, holds true throughout history and in all lands. However, I should hope that in our democratic society, it holds less true than in others. Certainly as a Federal Reserve Bank President, I intend to emphasize and enlarge the positive role our institution plays in serving our community. ference in Seattle today, and next week seminar in San Francisco. We are sponsoring this con we shall hold a foreign exchange Through these and other means, our Bank seeks to be a prime mover in bringing together experts like yourselves to dis cuss topics In national and international finance. In the process of establishing good communications with the financial community, we hope to acquire a better understanding and thereby improve our services to the community. 2 Growth of World Banking Recently, in a speech I gave at the A»B.A*fs School for International Banking at Boulder, Colorado, I drew a distinction between flinternational banking” and "world banking." To my mind, "international banking" covers the standard financing of international trade and investment, such as letters of credit, bank acceptances, foreign-project loans, and so on— activities that have been part of the banking tradition since the Renais sance, But by "world banking," I mean the very recent phenomenon of bankers viewing the world!s money and capital markets as a whole in the gathering and placement of funds. International trade is as old as history-~but only in recent decades have business firms broadened their outlook to consider the world as a whole in making their production and marketing decisions. We are now seeing the dawning of a parallel move ment in the world of banking, with worldwide banking organizations opera ting as the counterparts of industry!s multinational corporations. This conference, in a small way, bears witness to the emergence of world banking in this part of the world, the great Northwest gateway to the Pacific and beyond. World banking, in the sense I have in mind, requires a certain mini mum size that Is quite beyond what the majority of the banks in this country can hope to attain* Nonetheless, 125 American banks now operate abroad, with some 730 branches and with net foreign assets amounting to more than $125 billion. Within this single Federal Reserve District, as Hang-Sheng Cheng reported this morning, there are 18 banks with foreign operations, and they have more than 130 overseas branches and hold a 3 total of more than $30 billion in foreign assets. Thus, contrary to the common view, world banking is not the exclusive reserve of the banking giants. Indeed, quite a few medium-sized banks here on the West Coast and elsewhere are now engaged in this activity. The expansion of world banking has been nothing short of spectacular, as several recent studies indicate. Total foreign assets of the world!s commercial tanks nearly quadrupled from $108 billion to $410 billion during the first half of this decade. This high expansion rate brought in its wake a remarkably high rate of growth of earnings from foreign operations. Over the last five years, the overseas earnings of a group of nine U.S. bank-holding companies increased at a 37-percent annual rate, compared to only a 3-percent rate of grox^th in their domestic earnings. In 1974, international earnings accounted for 42 percent of their total earnings before security gains. Individually, for Citicorp, International earnings accounted for nearly two-thirds of its total earnings, and for BankAmerica Corp, the ratio was about 40 percent. Problems of World Banking Thus, both in terms of absolute size and as a source of earnings, world banking has become very important for our major banks, and hence for the nation*s entire banking system. The world's central bankers may have been content in the past to watch passively the growth of world banking, but its rise has been so phenomenal that we must now devote some hard thinking to what all this means for the national and interna tional economy. Now, as soon as I mention "hard thinking/* you might conclude that I'm about to propose some rigid controls over this type of activity. 4 That’s not -what I mean. Like most of you, 1 believe that a lot of good has come from this upsurge of growth. World banking has been the re sult of a remarkable burst of ingenuity on the part of private bankers in an environment relatively free of government restrictions* It has greatly enhanced world competition in the provision of financial inter mediation services, and improved the allocation of funds for the world as whole* Moreover, in the past two years, this market has demonstrated remarkable strength and adaptability in coping with the unprecedented problems of petrodollar recycling and wide exchange-rate fluctuations. At the same time, the spread of world banking has raised a number of difficult issues for the world1s central-banking authorities. The close integration of international capital and money markets has made effective monetary control in each individual country cult. much more diffi Moreover, central bankers are not certain how much to take off shore private liquidity into account in setting monetary-policy targets. With the tremendous growth of such funds to more than $220 billion today, it seems odd that they are not included in any country1s money supply, and are not taken into consideration in the determination of any country’s monetary policy. These and other policy issues arising from the growth of world banking are very much on central bankers1 minds today. At the monthly meetings of the Federal Open Market Committee, we are frequently called on to consider the impact of world banking on domestic credit markets, on foreign-exchange markets, and on the U.S. balance of payments. We are in frequent consultation with foreign central bankers, trying to analyze the myriad interactions among policy actions and market developments 5 in the major nations. But I Xvrould be less than candid if I left you with the impression that central bankers have definitive answers to all the monetary-policy questions I've mentioned. In fact, we do not. That is why I said, some hard thinking on those questions is very much needed. The Foreign Bank Act Some of our thinking has already borne fruit in the form of the Federal Reserve’s proposal for legislation to bring the foreign banks operating in this country under effective Federal control. Our bill was first introduced In late 1974, and then reintroduced in March of this year under the title of the Foreign Bank Act of 1975. I am a member of the Federal Reserve System Steering Committee which developed this bill, and I would like to discuss the reasoning which lay behind the System*s proposal. Youfve already heard the details of the legislation from Bob Johnston. The present complex regulatory framework in this country stems from a situation where individual states determine the ^entry rights and powers of foreign banks. Almost all foreign subsidiary banks are state-chartered, since national charters are unattractive to them for various reasons. Branch and agency offices of foreign banksy which have roughly four times the assets of foreign subsidiary banks, operate with state licenses, and since they are not considered banks, they do not come under the Bank Holding Company Act. No other major country allows foreign banks to operate Inside its borders without national regulation. The lack of a national policy on foreign banking operations completely baffles many people who are 6 unfamiliar with the way we conduct our banking in this country— as I can attest from my many conversations with Asian central bankers. The Foreign Bank Act is designed to establish the principle of national control over the entry of foreign banks, while leaving room for the states to exer cise appropriate controls within the framework of the dual banking system. The bill also would strengthen the ability of the Federal government to negotiate with foreign governments on behalf of our banks* Nondiscrimination--and Alternatives What ground rules should regulate the operations of foreign banks? Our Steering Committee considered several possible standards, but finally decided on the principle of V’nondiscrimination.n This means that for eign banks would have the same privileges that are available to equiva lent domestic banks in this country, but no more privileges than that. Nondiscrimination would mean the establishment of competitive equality between foreign and domestic banks. Some observers argue that we should go by the standard of "reciproc ity”--which implies nyou treat me fairly and I111 treat you fairly in return*” Who can be against fairness? Yet in spite of its apparent simplicity, reciprocity is a very slippery concept which is subject to different interpretations. One possible interpretation is the so-called nhome-powersn standard, which means that foreign banks can do the same things here that they do at home. Under this standard, as it was put to us, French banks should be able to offer the same investment-banking and commercial-bank services in their New York branches that they offer their customers in France. It is one thing to argue that France can combine investment and commercial banking if that suits French financial 7 customs, but it is an entirely different matter to suggest that all French practices are suitable for American banking. The home-powers standard interferes with each country!s choice of banking practices, and thus should be rejected, A second unacceptable alternative is "quid pro quo,11 which means that foreign banks in the U. S. should have only those powers which are extended to U.S* banks in their own country. This concept sounds plau sible, but again, it abdicates to another nation the decisionmaking for banking in this country. The powers of a foreign bank in the United States would vary according to country of origin. Under this rule, foreign banks1 activity here would be determined by foreign decisions and not by U.S. needs* I would argue that the rights of foreign banks in this country should be determined on a uniform basis by the needs of the American financial system. Other countries1 treatment of our banks abroad is a separate question and a matter for negotiation, not fixed rules* Reciprocity supposedly would force foreign countries to give our banks more privileges, but it!s a rather crude means of bringing about that result. Some proponents of Reciprocity" probably hope that foreign countries would not reciprocate, thus justifying restrictions on for eign banking operations in the U.S. the threat of retaliation. However, this in turn would bring Let me remind you that in any war of retalia tion, we have more to lose, because our banking operations abroad are much larger than foreign operations in this country. Retaliation would also mean your own plans for possible expansion into international fi nance could be blocked. Nondiscrimination;, in contrast, is a good rule which can be applied universally in the field of international-banking regulation. Because it appears to be such a good principle, our bill would grant the Federal government certain powers to negotiate for nondiscriminatory treatment, at least among the developed industrial nations. In practice, we would recognize that unregulated entry of U.S. banks in less-developed countries could swamp local financial institutions, and so in those countries we could accept policies aimed at strengthening local insti tutions. Nondiscrimination in Practice In brief, nondiscrimination avoids the danger of competitive restric tionism, but without giving foreign banks special privileges. It means that foreign banks in this country should have roughly the same privi leges as their domestic competitors. Now let me Illustrate how this principle determined some of the more important provisions of the For eign Bank Act: (i) Redefinition of Branches and Agencies as Banks ’ We bring branches and agencies of foreign banks into equality with domestic banks by redefining them as "banks’* for purposes of the Bank Holding Company Act. This would bring them under the same laws which prevent interstate expansion by domestic banks. A foreign bank entering this country for the first time would find Its new banking operations limited to one state, and its branching or acquisition privileges also limited to that one state. Similarly., existing foreign banks could not expand banking operations across state lines. 9 (ii) Federal Branches and National Bank Charters We support nondiscriminatory treatment for foreign banks by offering them the option already available to domestic banks of operating under either state or Federal law. The Federal Reserve bill would allow as many as one-third of a national bank!s directors to be foreign citizens, thus increasing the attractiveness of national-bank chartering. The bill would offer Federal branch status as a separate alternative to a state license. (iii) Grandfather Rights The question of grandfather rights involves not only nondiscrimina tion, but also legislative tradition and international law. The interstate offices of foreign banks were established in conformity with existing law and in good faith. Moreover, elimination of these offices might violate our international treaty obligations as well as our tradition of grandfathering existing banking operations whenever laws are changed. For these reasons, the Foreign Bank Act would grandfather all branches and agencies brought under the Bank Holding Company Act and in existence on December 3, 1974, the date the bill was first sent to Congress* I might emphasize that a liberal grandfather clause is essential in over coming foreign governments5 objections to our bill. (iv) Federal Banking Licenses Finally, since we think nondiscrimination should be adopted by other countries, the Federal government would be given licensing powers over foreign banks to encourage foreign countries to reduce their own unrea sonable restrictions. In banking matters the bill gives the Federal government a "club in the closet" to use if negotiations are unsuccessful 10 with foreign governments. Specifically, the Act requires that each new foreign bank or branch would apply for a federal banking license issued by the Comptroller of the Currency, If, after consultation with the Federal Reserve and the Department of State, the Secretary of the Treasury rules that approval of an application is not in the national interest, the Comptroller would not issue the license. This is the club in the closet, and merely by being there, I hope its use may be avoided. Concluding Remarks From my remarks, I hope you1ve gotten some flavor of the reasons for the rapid expansion of world banking--a quadruple expansion during a brief half-decade. Obviously, in an age of multinational corpora tions, there is a need for a parallel development on the financial side. World banking has improved the worldwide allocation of funds, and it has won its spurs in meeting the critical problems of the past several years. I hope you!ve also seen why the new era of world banking requires new regulatory approaches. Just as the individual states, by themselves, can no longer expect to control such an important sector of our finan cial system as the foreign banks, individual nations must face the need for international cooperation to control world banking. You can expect greater cooperation among foreign governments in banking regulation that would parallel their exchange of information on monetary policies. The Foreign Bank Act would strengthen the powers of the Federal government in its right to exchange information with other nations. Greater coor dination among regulators to monitor the liquidity of international 11 banking operations, joint ventures, and, perhaps, foreign-exchange dealings is on the horizon. But although you may face greater control and the costs of regulation, the same process may establish greater stability and greater uniformity in the competitive groundrules. On balance, the functioning of the system of world banking should be im proved by international coordination in the regulatory area* To conclude, no doubt exists in my mind that world banking activities will become an increasingly important influence on the operations of U.S. banks overseas. The other side of the coin from U.S. banks1 expansion abroad is more foreign banking competition here* Still, I think you will agree that an equitable environment in our home market is essential for our o\m. banks1 overseas expansion. # # # #
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