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For release on delivery
10:00 am, EDT
September 28, 1993

Statement by
John P. LaWare
Member, Board of Governors of the Federal Reserve System
before the
Committee on Banking, Finance and Urban Affairs

U. S. House of Representatives
September 28, 1993

Mr. Chairman, I am pleased to appear before the
Committee this morning to discuss the implications of the
proposed North American Free Trade Agreement for the financial
services industry and banking in particular.
Before I begin, let me state that the Federal Reserve
supports the NAFTA without qualification.

Its implementation

will provide overall benefits to the people and the economy of
the United States that will grow over time.

The agreement will

promote the economic and financial integration of the North
American continent, a process already in progress.

The NAFTA

will solidify U.S. access to Canadian markets and provide
significantly improved access for many U.S. firms to the
substantial Mexican markets that will expand rapidly as the
Mexican economy capitalizes on reforms instituted over the past
decade.

Moreover, the long-term beneficial effects for the

United States of a stable, growing economy on our southern border
are hard to overstate and may be more meaningful than any of the
specific provisions in the Agreement.
At this point, I'll summarize briefly the provisions of
the Agreement as they relate to banking and other financial
services.

I will then turn to the other issues raised in your

letter of invitation.
The financial services chapter establishes the rules
governing treatment by each NAFTA country of the other countries'
financial firms, investments in the financial sector, and crossborder service providers.

The obligations set out in the

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financial services chapter, however, do not require any change in
U.S. law or regulatory practice because the United States already
follows its basic principles: market access, national treatment,
and the right to non-discriminatory or "most-favored-nation"
(MFN) treatment.
With respect to market access, each country agrees to
allow financial institutions of the other countries to establish
and operate in its market through subsidiaries.

In doing so,

each country must grant to the financial firms of the other
countries treatment that is no less favorable than what is
granted to comparable domestic financial institutions.

Thus, a

Mexican, or Canadian bank in the United States would be treated as
a U.S. banking organization and any nonbanking activities of
affiliates of the banks will continue to be subject to the
provisions of the Bank Holding Company Act.

Treatment is

considered no less favorable if it grants to the foreign firm
equal competitive opportunities, that is, it does not
disadvantage the foreign firm in its ability to provide financial
services as compared with the ability of similar firms to provide
the services.

The financial services chapter also requires each

country to provide MFN treatment for the firms of the other NAFTA
countries, assuring that no NAFTA country may grant better
treatment to firms from countries outside the NAFTA.

U.S. banks

and bank holding companies already operate subsidiary banks in
Canada under these general principles.

The main benefit to U.S.

banks will be in their ability to establish subsidiaries in

3

Mexico, a market essentially closed to all but one U.S.
institution.

Although Mexico will open its banking market only

gradually, keeping market share limits at least until the year
2000, the NAFTA will allow a number of U.S. banks to form
subsidiary banks and other financial firms and compete on a
national treatment basis with banks and financial groups in
Mexico.
The Agreement will also allow each country to
grandfather, or in the language of trade agreements "to reserve,1
1
certain provisions of existing law that do not conform to
national treatment or MFN principles.

Under this provision, the

United States has reserved a number of provisions of federal law
that limit the national treatment available to foreign banks or
individuals.

However, the degree of discrimination in these laws

cannot be increased and any future measures must conform to the
national treatment and MFN principles.
In addition to these basic requirements, the financial
services chapter also requires each country to abide by the
principle of "transparency" in its regulation of financial
services.

This requires that each country allow an opportunity

for public comment on proposed measures in the financial services
area and make available all requirements necessary for engaging
in financial services activities in the country.

The chapter

also contemplates that any country may request consultations with
another, including consultations with regulators, on any matter

4

affected by the financial services chapter.

In the Federal

Reserve's view, this simply codifies existing practice.
From a supervisory standpoint, an essential feature of
the NAFTA is that it provides a substantial "prudential
carveout," that is, nothing in the services provisions of the
NAFTA shall be construed to prevent a country from adopting or
maintaining reasonable measures for prudential reasons.

The

chapter gives a non-exhaustive list of areas for prudential
regulation, including the protection of consumers of financial
services; the maintenance of the safety, soundness, integrity or
financial responsibility of financial market participants; and
ensuring the integrity and stability of the financial system.

We

believe that prudential regulation as implemented in the United
States is reasonable and could withstand scrutiny under this
provision.

In addition, the NAFTA provisions on services do not

apply to a country's monetary and related credit policies or to
exchange rate policies.
Under the NAFTA, a country would have the right to a
hearing on whether another country is abiding by its obligations
under the agreement.

This so-called dispute settlement mechanism

provides that panels, with participants usually drawn from
standing rosters, would hear the dispute and render a final
opinion on whether the measure at issue conforms to the NAFTA.
If the panel finds that a country's law or regulation violates
the NAFTA, the country may change the offending measure.
does not, the complaining country has the right to suspend

If it

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benefits to firms of the offending country that are commensurate
with the harm suffered by the firms of the complaining country.
The financial services chapter contemplates that
experts in financial services will be included on the roster of
persons who hear disputes in the financial services area.
Moreover, the financial services chapter also contemplates
establishment of a Financial Services Committee to supervise the
implementation of the NAFTA, to consider issues on financial
services that are referred to it by another NAFTA country and to
participate in disputes in the investment area where a country
claims the

prudential or monetary policy carveout as a defense

to the action at issue.

In these cases, the decision of the

Financial Services Committee will be final.

Unlike other

chapters of the NAFTA that allow a private party, such as an
individual person or firm, to bring a dispute against another
country, a dispute in financial services may only be brought by a
government of a country.
In summary, the financial services chapter of the NAFTA
incorporates the principles of MFN and national treatment that
have long been applied in the United States with respect to
foreign investment.

The chapter establishes a government-to-

government dispute settlement system that allows for the
participation of persons knowledgeable about financial services.
Significantly, the financial services chapter recognizes the
importance of supervision and regulation of financial services
and provides protections for prudential actions of regulators.

6

Let me now turn to the specific questions raised in
your letter of invitation.

The principles of national treatment

and better access to all markets for all firms have been long
supported by the Federal Reserve.

When multilateral trade

agreements began to be negotiated in the 1980s that would, for
the first time, establish these principles as enforceable
obligations to govern the provision of banking and other
financial services, the Federal Reserve sought to assure that
these negotiated obligations did not interfere with the
legitimate objectives of prudential supervision and regulation.
These views were shared with the Treasury Department as the U.S.
negotiator for banking and securities services in the NAFTA
process.

At the Treasury's invitation, the Federal Reserve and

other regulators provided technical assistance during the course
of the negotiations on how proposed provisions of the NAFTA would
affect U.S. banking and other laws.

There was ongoing informal

contact between Treasury and Federal Reserve officials about
supervisory issues over the course of the NAFTA negotiations and
a member of the Board's staff attended many of the negotiating
sessions.
The Federal Reserve's principal objective has been to
assure that any agreement that might be negotiated contain a
strong protection for the prudential actions of regulators, with
respect to both individual institutions and the stability of the
financial system itself.

In addition, the Board believed that it

was important that any system set up to review disputes in

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financial services should include the active participation of
financial experts.

The presence of financial experts in the

dispute resolution process assures that persons with an
understanding of the basis of financial services regulation will
generally decide issues involving regulated financial entities.
Finally, the Board believes that it is important that the
financial services sector be protected from retaliatory measures
resulting from disputes in other sectors.

Because of the

potential spillover effect into other areas, financial services,
and the banking system in particular, should not be disrupted by
potentially ill-considered actions resulting from disputes in
other sectors.
The NAFTA contains provisions that satisfy the concerns
of the Federal Reserve.

There is a strong provision that

protects the actions of regulators.

Financial experts will

generally participate in settling disputes in financial services
and must be included where prudential or monetary policy reasons
are cited as the basis for the dispute.

A Financial Services

Committee will assist in implementation of the financial services
chapter and retaliation across sectoral lines is limited.

In

sum, the NAFTA appears to protect the interests of prudential
supervision in the U.S. market and of financial institutions
while creating opportunities for U.S. banks and other financial
firms in the Mexican market.
U.S. banks and bank holding companies have a long
history of following their U.S. customers to foreign markets.

8

When U.S. businesses began their substantial foreign expansion in
the 1950s and 1960s, U.S. banks increased their foreign presence
to continue to provide banking services to American commerce.

As

the Mexican economy opens under the NAFTA, there will be an
increased demand for U.S. goods.

American banks and securities

companies will have opportunities to provide sophisticated
financial services to U.S. companies, as well as to the Mexican
firms that will increasingly need the types of innovative
services at which U.S. financial services companies excel.
Of course, U.S. banks and bank holding companies will
be subject to the same regulation of their Mexican operations by
the Federal Reserve as currently apply to all of their other
foreign operations, as well as the same supervision of their
foreign operations through the regular reporting and examination
process.
The NAFTA does not change in any way either the manner
in which U.S. banks may make investments in foreign companies or
the way that banks are regulated with respect to their activities
outside the United States.

As you know, the Board's Regulation K

governs the international operations of member banks, bank
holding companies and Edge corporations.

Permissible activities

of foreign subsidiaries of these investors are listed in
Regulation K and include banking, leasing, fiduciary activities,
and securities and insurance activities within certain limits.
Regulation K also requires that a U.S. bank or holding company
must provide 45 days' prior notice to the Board before investing

9

in any foreign company in an amount that exceeds the lesser of
$25 million or 5 percent of its capital.

The Board analyzes such

proposals in light of the financial condition of the bank or
holding company and for compliance with U.S. law.

In this

regard, the investing U.S. banking organization must provide
relevant documentation on the investment.

If there are issues

raised by the proposal, the Board may suspend the prior notice or
deny the investment.

All of these measures will be in effect

with respect to investments in banks and other companies in
Mexico.
After an investment is made, the U.S. bank or bank
holding company must provide detailed financial reports to the
Federal Reserve for analysis to determine the condition of the
foreign entity.

This analysis is included in the ongoing

performance monitoring of the bank or bank holding company.

In

addition, the Federal Reserve often conducts on-site examination
of foreign subsidiaries of U.S. banks and bank holding companies.
Of course, neither the NAFTA nor the Mexican and U.S. legislation
to implement it have been passed.

Nevertheless, the Federal

Reserve has held discussions with regulators in Mexico concerning
sharing of information, including possible on-site examinations
of subsidiaries of U.S. banks.

In this regard, I note that the

Mexican authorities conduct on-site examinations of Mexican banks
on a regular basis.

In most of the large Mexican banks, the

National Banking Commission has established and staffed permanent
on-site examination offices for constant surveillance.

We

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believe that we will be able to work cooperatively with the
Mexican regulators to obtain necessary information on Mexican
subsidiaries of U.S. banks through examinations or other
mechanisms to assure that these investments would not pose any
undue risk to the safety and soundness of the U.S. banks.
The subsidiaries in Mexico will be subject to the same
restrictions that are currently in place with respect to any
foreign subsidiary under Regulation K.

Foreign companies owned

by U.S. banks and bank holding companies are generally prohibited
from engaging in any activities in the United States.

Foreign

subsidiaries of U.S. banks are not permitted to underwrite or
deal in securities in the United States.

Similarly, foreign

subsidiaries are prohibited from underwriting insurance in the
United States.

Consequently, foreign affiliates of U.S. banks

cannot be used to evade the nonbanking restrictions of U.S. law.
These restrictions are monitored in the ongoing review of each
banking organization.

If a banking organization were to ignore

such restrictions and conduct impermissible activities in the
United States through a foreign company, the Board has
enforcement authority to deal with such violations.
The NAFTA provision regarding cross-border services
provides that no new restrictions shall be placed on cross-border
activities that are permitted on the date the NAFTA may enter
into force.

With respect to banking in the United States, this

provision relates primarily to cross-border lending and deposittaking.

Currently, there are no restrictions in federal law

11

preventing a foreign bank from advertising in the United States
the services that the bank offers outside the United States.
U.S. residents may place deposits with the foreign offices of
foreign banks, and also may and do borrow from the non-U.S.
offices of foreign banks and other firms.

Similarly, U.S. banks

could lend cross-border to Mexican or Canadian residents or
accept deposits from such residents.

Of course, this provision

is also subject to the prudential carveout, which allows
reasonable measures to be taken to protect depositors or other
users of financial services, even with respect to cross-border
services.
The provision does not require that the cross-border
service providers of the other countries be allowed to "do
business" or "solicit" business, such as by advertising or
setting up an office, in the country.

Each country retains the

right to define what is meant by "doing business" or "soliciting"
under this provision.

The cross-border provision also explicitly

recognizes, without prejudicing any other type of prudential
regulation, that registration requirements for instruments sold
cross-border and for the cross-border providers themselves are
reasonable prudential measures.

Finally, the NAFTA countries

have agreed that further consultations should be held no later
than January 1, 2000, on further liberalizations in the crossborder area.
With respect to the Foreign Bank Supervision
Enhancement Act of 1991, under which a foreign bank may not

12

establish a branch, agency, or commercial lending company unless
the Board finds that the foreign bank is subject to comprehensive
supervision or regulation by home country authorities on a
consolidated basis, you have asked whether Mexican banks are
subject to comprehensive supervision and on what basis the Board
made such determination.

There are several applications by

Mexican banks that are pending at the Board and it would not be
appropriate to comment on specifics before the applications have
been presented for Board action.

I can say that there have been

very useful and informative discussions with the supervisory
authorities in Mexico on the programs that have been put in place
in Mexico since the banks were reprivatized starting in 1991 and
that these discussions are continuing in order to allow us to
complete the record on the applications.
Let me also say that, as a general matter in
determining whether a particular foreign bank is subject to
consolidated supervision, the Board considers a broad range of
information.

We study the structure of the supervisory system;

how it applies to the particular bank applicant; the extent of
the information on the operations of the bank and its dealings
with affiliates that are available to the supervisors, including
the nature and frequency of reporting by the bank to its
supervisors; whether there are audits required of or commissioned
by the bank; the nature and scope of any examinations or
inspections by the supervisors; the supervisory practices of the
authorities with respect to the bank's operations; and any

13

enforcement authority the supervisor may have.

This is the type

of information under review in connection with the applications
by Mexican banks.

These standards would not be changed if the

NAFTA were to be adopted.
As can be seen from this brief review, the NAFTA would
not in any way diminish the ability of the United States to apply
sound prudential standards to financial institutions from Mexico
or Canada operating in the United States.

Nor would it in any

way affect the requirements imposed on U.S. banks in their
operations outside the United States.

The NAFTA provides no

additional scope for a U.S. bank to underwrite securities or
insurance in the United States; it cannot be used as a back door
to engage in impermissible activities in the United States.
In sum, the NAFTA would provide substantial benefits to
U.S. banks and other financial firms that are currently precluded
from operating in Mexico.

It could also stabilize and strengthen

the Mexican economy while allowing the United States and U.S.
firms to participate in the benefits to be reaped from such
progress.

Finally, because the entire regulatory scheme

applicable to all foreign subsidiaries of U.S. banking
organizations will also apply to any Mexican subsidiaries, we
believe the NAFTA will do no harm to the safety and soundness
the U.S. financial system or its institutions.

of