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REC'D IN RECORDS SECTION
i
MAR 27 1987
For release on delivery
9:30 a.m. E.S.T.
March 25, 1987
Statement by
Manuel H. Johnson, Jr.
Vice Chairman
Board of Governors of the Federal Reserve System
before the
Subcommittee on International Finance and Monetary Policy
of the
Committee on Banking, Housing, and Urban Affairs
United States Senate
March 25, 1987
I am pleased to appear before you today to discuss the
topic of bank-affiliated export trading companies.
In its consideration of the export trading company
legislation in 1982, the Congress determined that U. S. export
performance was inhibited by the inability of U. S. businesses,
especially
small-
and medium-sized
companies,
to
foreign markets for their products due to their
expertise
in
the
mechanics
of
exporting.
The
develop
lack of
Congress
therefore sought to promote the establishment of companies that
could supply the necessary expertise in order to assist U.S.
companies in increasing exports of their goods and services.
In enacting the Bank Export Services Act ("BESA”), the Congress
decided that one method by which export trading companies could
be developed was by permitting affiliations with banks through
a bank holding company structure.
Now that we
have had
some
experience
with
the
operation of bank-affiliated export trading companies under the
legislation, we thought it would be useful to share information
on that experience with you in connection with the Committee's
consideration of further refinements
company concept.
to the export trading
While a beginning has been made in the
-2-
development of export trading companies as promoters of U.S.
exports, unfavorable economic conditions have not provided an
atmosphere in which export trading companies can flourish.
Since the passage of the legislation in October 1982,
the Federal Reserve has acted upon 43 notifications by bank
holding companies to establish export
trading companies.
Sixteen of these have been acted upon by the Reserve Banks
under authority delegated to them by the Board in 1983.
This
number represents more than 50 percent of the notifications
processed since the delegation rules were adopted.
The Board
recently conducted
a
survey
of
nine
bank-affiliated export trading companies, selected to provide
diversity of size and geographic location of the bank holding
company parent.
to the survey,
For those export trading companies responsive
the assets size ranged
from
$210,000
to
$21 million, with the average being $8.2 million, and gross
revenues ranged from $110 thousand to $18 million, with the
average also being $8.2 million.
The activities of these export trading companies were
also quite diverse.
Several were engaged almost exclusively in
transactions involving the purchase and sale of goods, while
the others
services.
received their
income largely from fee-based
The services included transportation; marketing and
consulting; acting as an agent for a Foreign Sales Corporation;
and trade
financing services.
The survey suggests
that
-3-
bank-affiliated export trading companies are able to offer a
broad
range of services under the current
statute and
regulations and a number appear to be operating profitably.
While
results
suggest
some bank-affiliated export
trading companies are operating successfully,
experienced
some difficulties.
others have
Of the 43 bank-affiliated
export trading companies of which the Board received notice,
14 are no longer operational.
In a
few instances,
the
cessation of export trading company activity was related to
changes in the ownership of the export trading company, such as
through acquisitions and mergers.
However, this performance
has been largely related to the difficulties that bank holding
companies have experienced in operating an export trading
company.
In addition to poor economic conditions in their
first years of existence, described below, which resulted in
diminished profit potential,
these export trading companies
have also encountered start-up difficulties resulting from
unfamiliarity with the trading business.
encountered are peculiar
to
the
Other problems
activities
of
trading
companies, regardless of how long they have been operating:
for example, a customer breaking the terms of its own trade
agreement, or the inability of an export trading company to
deliver on a major contract, or inadequate controls over the
trading activities.
-4-
To the extent that the performance of bank-affiliated
export trading companies has been disappointing, it should be
noted that there is no evidence that trading companies without
bank affiliation have been any more successful.
While there is
no comprehensive means of tracking the performance of all these
trading companies, the General Accounting Office, in the course
of preparing its February 1986 Report to Congress on the
Implementation of the Export Trading Company Act of 1982,
conducted
a survey of 23 trading organizations that had
obtained certificates of
review from the
Department
of
Many of those firms reported that business was
Commerce.
disappointing, citing economic factors, particularly the high
value of the dollar, as the reason.
Although the experience of bank-affiliated
export
trading companies to date has fallen short of expectations,
this is due primarily to the highly unfavorable economic
climate for U.S. exports that resulted from the overvalued
exchange rate for the U.S. dollar, the lack of adequate
economic growth in foreign industrial countries, and the need
for adjustment in many developing countries.
Therefore, the
period since 1982 has clearly not been a fair test of the
viability of bank-affiliated export trading companies on which
far-reaching changes in the law should be based.
to the macro-economic conditions faced by export
In addition
trading
companies, there are other factors contributing to their slow
development.
It is still a fledgling industry; the oldest of
-5the bank-affiliated export trading companies is not yet four
years old.
Moreover, a review of several articles concerning
bank-affiliated export
trading
companies
in
recent years
indicates that the affiliation of two such different corporate
cultures as banking and trading inevitably creates difficulties
in forging a viable and profitable enterprise.
I might add
that the publications generally do not attribute the lack of
success of export trading companies to the Board's regulations,
but rather to the various economic and business factors that I
have mentioned.
In efforts to make refinements to the legislation
governing the operations of bank-affiliated" export trading
companies, which we all see as a desirable effort, it should be
remembered
that
banking
organizations
providing two essential elements for
were perceived
a
successful
as
export
trading company — a source of capital and financing and a
network of foreign offices able to evaluate foreign markets and
provide necessary foreign contacts.
The legislation therefore
created a very limited exception to the statutory separation of
banking and commerce in order to achieve the goal of improving
the export sector of the economy.
The BESA was not, as we read
it, intended to let bank holding companies perform .every type
of international activity nor to relax to any great extent the
provisions
protecting
bank
safety
and
soundness.
Bank-affiliated export trading companies were intended to
assist other companies in the export of their goods and
-6services and not to compete with these companies by becoming
themselves producers of services for export.
Moreover, the Act
recognizes that there are activities from which export trading
companies should be explicitly excluded, such as securities
activities,
agriculture,
manufacturing.
in
dealing
commodities,
and
The Act contains these and other important
safeguards that are intended to maintain the separation of
banking and commerce and to avoid compromising significant
These measures were adopted in recognition
supervisory goals.
that one goal of national importance — export promotion —
should not be achieved at the expense of another — a safe and
sound banking system.
-
The Board's regulations implementing the BESA are
designed to carry out the statute's intent.
Because the
statute did not focus on promoting trade, but on promoting U.S.
exports through export trading companies, our regulations are
designed to ensure that such companies engage in trade services
that promote U.S. exports.
As a result, the Board's regulation
requires that 50 percent of a bank-affiliated export trading
company's business must derive from exporting or facilitating
the export of goods and services produced in the United States
by persons other than the export trading company and its
subsidiaries.
Under
this test,
a
bank-affiliated export
trading company may provide services to any party, foreign or
domestic,
that
is
connected
to
an
international trade
transaction, as long as the majority of the company's business
is export-related.
-7Let me at this point clear up some confusion over one
aspect of the 50 percent
regulations.
revenues
test
in
the Board's
A bank-affiliated export trading company may
provide services not only to unaffiliated persons, it can also
help to promote the goods
and services of any of its
affiliates; that activity is considered as facilitating a U.S.
export under the regulation.
For example, an export trading
company could market abroad computer software developed by its
bank
holding company parent;
revenues derived from that
activity are considered export revenues.
Thus, contrary to the
perception of some, a bank-affiliated export trading company is
authorized to assist its affiliates in exporting services.
As I have mentioned, one of the fundamental premises
of the legislation is that bank-affili.ated export trading
companies will facilitate the export of goods and services of
other U.S. companies and will not engage directly in such
activities themselves.
Accordingly, the Board's regulations,
consistent with the purposes of the BESA, prevent a bank
holding company, under the guise of an export trading company,
from acting only as a service company for foreigners, that is,
from engaging in a service activity, which might not be even a
trade service, that is provided only to foreign parties.
An
example would be an insurance company that underwrites and
sells property and casualty insurance policies to foreign
customers.
-8This
situation,
in which a bank holding company
becomes the producer of the service to be exported, would be
inconsistent with an export trading company's role as a
facilitator of exports.
The regulations,
however,
permit
formation of a joint venture with an insurance company to
facilitate the sale of the
abroad.
insurance company's policies
Therefore, there is a broad scope in the statute and
the regulation for a bank-affiliated export trading company to
provide services in support of exports.
Some of the legislative proposals have implicitly
taken issue with the Board's regulation requiring that 50
percent of an export trading company's business derive from
exports or facilitating exports produced by others.
This is
also the area of current regulation where the most flexibility
is
sought
by the surveyed bank-affiliated export trading
companies, i.e., in the application of the 50 percent of
revenues test.
These legislative proposals would alter the original
intent of the statute in a fundamental way.
The original bill
was intended to promote exports and build an export-oriented
infrastructure of trading companies.
Some of the proposed
legislation would not seem to further those goals.
First, these proposals would permit an export trading
company to count as export revenues any revenues derived from
third country trade.
company
itself
is
The rationale is that the export trading
providing
a
service
and
that
-9-
the third country trade activity does not hurt U.S.
balances because it does not involve an import.
trade
Our view is
that such proposals sanction the development of bank-affiliated
trading companies that need not facilitate the export of any
product produced in the United States at all.
They would
permit a trading company to set up foreign companies to provide
a broad range of services to foreign parties without any
benefit either to U.S. jobs or toward developing an export
trading industry that can serve companies that actually produce
goods and services in the United States.
This approach would
create a movement in the opposite direction from providing
export
trade services to those U’.S. companies that need
assistance in exporting.
Moreover, it is not readily apparent that, as many
claim, third country trade would not harm U.S. trade.
If a
foreign country is buying computers from Germany, it is not
buying them from the United States.
therefore can hurt U.S.
exports,
Third country trade
as many third country
transactions are substitutions for U.S. exports.
In addition, by permitting bank holding companies to
invest in any company, regardless of its business, as long as
it offers its services exclusively to foreign customers, the
proposed legislation would put bank holding companies into
direct competition with other U.S. companies that are intended
to be the primary beneficiaries of the original act, i .e.,
companies that produce goods and services in the United States
-10-
which with the help of an export trading company could be
Such a result seems perverse in two ways.
exported.
First, it
reduces any incentive on the part of bank-affiliated export
trading companies to market their trade services to U.S.
companies.
Under the proposals, if a bank holding company were
to identify potential projects or markets abroad,
it could
establish a trading company to take on the project or service,
rather than approach U.S. companies either to form a joint
venture to take advantage of the opportunity or to otherwise
assist the U.S. company in exporting its service.
the proposals would expand the kinds of
Second,
activities in which a
bank
holding company may
indirectly through an export trading company.
engage
There is already
a statutory and regulatory framework for the expansion of the
operations of bank holding companies and Edge corporations
outside
the
United
States
that
provides
considerable
flexibility in both activities and investments.
in some
instances,
U.S.
banking
For example,
organizations have been
permitted to establish foreign companies that underwrite and
sell life insurance.
This has been done,
however, under
statutes that allow the Federal Reserve to consider fully the
effect on banks and the banking system, taking into account
factors not applicable to the BESA.
A radical change in the
authority to conduct activities overseas, such as the proposals
would provide,
question
of
should be dealt with straightforwardly as a
new
products
and
services
for
banking
-11-
organizations.
The Board strongly supports authorization of
some new products and services for bank holding companies but
believes that they should be granted in a direct fashion, and
not through trade legislation, especially where there would be
no benefit to U.S. exports generally.
Although these proposals would shift the emphasis of
the original statute from export promotion to promotion of
international trade per se by permitting bank holding companies
to engage in general trading activities without regard to
promoting U.S. exports, this is of course a matter for Congress
to decide.
The Board’s regulations requiring a predominance of
exports are, however,
fully. consistent with the intent of
Congress at the time of passage of the BESA.
With respect to the ability of a bank to finance its
affiliated export trading company, the BESA subjects a bank’s
extension of credit to an affiliated export trading company to
the provisions of section 23A.
As you
know,
section 23A
requires collateralization for any extension of credit by a
bank to an affiliate, usually in an amount that exceeds the
face amount of the extension of credit.
appropriate in order
This is entirely
to protect the bank.
However,
in
recognition of the need for a bank-affiliated export trading
company to secure funding for its trading in goods, the Board
has provided a reasonable exception by waiving the excess
collateral requirement for loans by a bank to its affiliated
-12export trading company.
The regulations require instead that
the bank take a security interest in goods or the proceeds from
the sale of goods that are subject to a contract of sale.
This
measure enables an export trading company to obtain financing
for the activity for which financing is most needed but the
exception does not subject the bank to undue risk.
This
liberalization
of
section 23A’s
collateral
requirements is the type of carefully crafted exception to the
provisions of section 23A that we believe is most appropriate
in this context.
It is tailored to the needs of an export
trading company but ensures that the assets of the bank will
not be jeopardized.
*
■ The Board also expects a
bank-affiliated export
trading company to be capitalized adequately to support its
operations.
There is no regulatory requirement, however, for a
certain capital level.
Each case is evaluated based on its own
facts.
Some of the proposed amendments to the BESA that
relate to section 23A and to capital
substantial supervisory concerns.
requirements
raise
The proposals would expand
the ability of a bank-affiliated export trading company to take
on the equity risk of foreign subsidiaries, clearly increasing
the risk to which the export trading company is subject.
At
the same time, the proposals would reduce the safeguards for
the affiliated bank, by exempting all transactions from the
collateral requirements of section 23A and by permitting an
export trading company to be less than adequately capitalized.
-13-
These
changes
would
seem
to
be
especially
inappropriate at this time when there is a consensus that bank
affiliates should
be
subject
to market
An
discipline.
affiliate should not be able to use a bank’s resources — and
the federal guarantee for those resources — except to the
extent permitted by the provisions of section 23A.
Board has consistently stated,
As the
if a bank-affiliated export
trading company is creditworthy, it can obtain credit in the
market even from a non-affiliate.
If an export trading company
is not creditworthy, an affiliated bank should not be placed at
risk by being able to lend without collateral.
Moreover, a
total elimination of section 23A collateral requirements is
directly contrary to the approach taken
in other
recent
legislative proposals, which would actually strengthen the
protection available to the bank.
As I
have previously stated, the Board has been
willing to be flexible in its approach to section 23A as it
applies to loans to bank-affiliated export trading companies
but only where the bank will not be adversely affected.
We
cannot support any proposal that would permit a nonbank
affiliate to drain the resources of the bank in pursuit of its
business.
With
respect
to
capitalization,
some
of
the
legislative proposals would permit an export trading company to
operate with a capital to assets ratio of 4 percent.
That
ratio would be low for most trading companies; such ratios are
-14typically at
least
25 percent for trading companies not
The proposed ratio is even lower than
affiliated with banks.
the capital required of a bank.
We see no justification for
reducing the Board's ability to require that a bank holding
company subsidiary be adequately capitalized in relation to its
business.
Having said this, it should be noted that where the
proposed activities of a bank-affiliated export trading company
have risk characteristics similar to those of a bank, the Board
has determined that the export trading company may maintain a
capital ratio equivalent to that required of a bank.
Such a proposal permitting a low capital to assets
ratio would also be contrary to prudent supervisory policies as
reflected in recent efforts, including those of the Congress in
passing the International Lending Supervision Act of 1983, to
increase
capital
international
of
banking
activities.
bank-affiliated export
organizations
Moreover,
it
involved
would
trading companies from
in
remove
the market
restrictions imposed on other companies not affiliated with
banks,
thereby encouraging
increased risk-taking with its
concomitant risk to the banking organization.
It should be
kept in mind that a bank can be harmed not only by direct
interaction with an affiliate but also by a weakening of the
bank holding company's ability to serve as a source of strength
to its subsidiary banks.
In addition to the supervisory questions raised by
these proposals on section 23A and capital
adequacy,
the
-15-
proposals raise a serious issue of competitive equity.
These
proposals place bank-affiliated export trading companies in a
favored position over all other competitors by removing them
from the effects of market discipline.
A bank-affiliated
export trading company would have a ready source of financing,
even if the company is not creditworthy, and could undertake a
higher volume of activities because of its low capitalization.
This situation would be entirely inconsistent with the concept
of a level playing field.
In light of these factors, the Board must oppose any
proposals that would increase the risk to the bank from the
operation of the .affiliated export trading company.
Such
export trading companies should be permitted to operate with
sufficient flexibility to allow them to succeed but within
appropriate constraints on their
ability
to
harm
their
affiliated banks. . We believe that the current statutory and
regulatory framework achieves these goals.
The recent past did
not provide circumstances for the best test of the current
framework.
Changing economic conditions should make it easier
for these export trading companies to operate more successfully
in the next few years.
While we believe that the foregoing is a realistic
assessment of both the current law and the proposals that have
been introduced into the Congress, the Federal Reserve is, as
always, willing to work with the
Congress
in developing
-16-
necessary legislative reforms.
We urge you, however, to keep
in mind that some of the proposals raise serious supervisory
concerns.
Others are aimed at changing
bank-affiliated
export
trading
the purposes
of
companies from an export
orientation to encouraging trade outside the United States or
even U.S. imports.
In the final analysis, of course, the goals
for any new legislation are established by the Congress, and
the Board always endeavors to adopt implementing regulations
that reflect those goals.
Thank you very much.
@FedFRASER