View original document

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







2:00 P.M.

Mr. Chairman and members of the Committee, I appreciate the
opportunity to testify on the role of the Federal Deposit
Insurance Corporation (the "FDIC") in supervising a segment of
foreign bank operations in the United States, and, in particular,
the Daiwa Bank Trust Company ("Daiwa Trust"), the only insured
U.S. subsidiary of The Daiwa Bank, Limited ("Daiwa").


has evaluated the problems and trading losses of Daiwa Trust in
close cooperation with the New York State Banking Department
("NYSBD"), the state chartering authority.

In evaluating the

implications of a broader range of problems stemming from the
larger trading losses first reported at the New York branch of
Daiwa, the FDIC has also worked closely with the Federal Reserve
Bank of New York and the Board of Governors of the Federal
Reserve System ("Federal Reserve"), which has primary supervisory
authority, along with the NYSBD, over that branch.

The Federal

Reserve has umbrella supervisory authority over all foreign
banking operations in the United States.

Acting together, the

Federal Reserve, the NYSBD, and the FDIC concluded that the
conduct of Daiwa and Daiwa Trust with respect to the separate
losses in each institution stemming from unauthorized bond
trading activities and the response, given the continuing safety
and soundness concerns, of Daiwa and Daiwa Trust officials to
those losses and to internal control deficiencies identified at
Daiwa, was highly inappropriate and that the only suitable
response to that misconduct was to terminate Daiwa's privilege to
conduct banking business in the United States.


The problems at Daiwa's New York branch and Daiwa Trust were
of three types:

1) the unauthorized activities of traders, 2)

the significant deficiencies in internal controls for monitoring
compliance with laws and regulations and risks, and 2) the long­
term, conscious effort by senior managers to deceive regulators
concerning losses stemming from trading activities.

Simple fraud

was therefore compounded by collusion, which made the detection
of various fraudulent acts more difficult to discover.

On September 18, 1995, Daiwa reported a loss exceeding $1
billion as a result of trading activities conducted at its New
York branch from 1983 to September 1995.

These losses were not

reflected in the books and records of Daiwa or in its financial
statements, and their existence was concealed through
liquidations of securities held in Daiwa’s custody accounts and
falsification of its custody records.

Daiwa has indicated that, while its senior management
learned about the trading losses at the New York branch on July
24, 1995, the senior management of Daiwa and its New York branch
directed that those losses be concealed from U.S. bank regulatory
and law enforcement authorities as well as the public for almost
two months and also directed the continuation of transactions
designed to avoid the disclosure of Daiwa's losses.

In addition, the senior management of the New York branch of
Daiwa undertook a series of actions in 1992 and 1993 designed to
deceive bank examiners regarding Daiwa* s trading activities,
including providing written notice to the Federal Reserve that
actions had been taken to separate the custody and trading
functions at the branch, while continuing to operate without such
controls in place.

In early October, 1995, following the commencement of
governmental investigations and the issuance of joint cease and
desist orders into trading losses incurred by the Daiwa branch in
New York, Daiwa reported that Daiwa Trust incurred net losses of
approximately $97 million as a result of trading activities, at
least some of them unauthorized, during the approximate period of
1984 through 1987.

These trading losses: (1) were not reported

on its books and records? (2) were not reported on the financial
statements of Daiwa Trust; and (3) were concealed from federal
and state examiners and regulatory authorities through a series
of transactions with off-shore entities.

In addition, the senior

management of Daiwa and Daiwa Trust participated in the
falsification of records and concealment of those trading losses.

The FDIC* s deposit insurance funds will not suffer any loss
from the problems at Daiwa Trust.

As of September 30, 1995,

Daiwa Trust had total assets of $1.1 billion and held
approximately $134 million in insured deposits

only 18.3

percent of its total deposits.

Daiwa Trust's $97 million in

trading losses, at least some of which were the result of
unauthorized trading by Daiwa Trust employees, were absorbed by
Daiwa in connection with its transactions to conceal the losses.
Daiwa Trust is presently well capitalized, and all present
indications are that the value of its assets are more than
sufficient to satisfy all its liabilities, including its
liabilities to depositors.

In response to the invitation from the Committee, this
testimony describes foreign bank organizations that operate in
our country and the FDIC's role in supervising them.


discusses the FDIC's recent actions against Daiwa Trust, in
cooperation with other bank regulators.

It presents a range of

supervisory issues raised by the experience with Daiwa and Daiwa

Finally, it discusses the FDIC* s continuing response to

those issues.


The Federal Reserve, the Comptroller of the Currency (OCC),
the Office of Thrift Supervision (OTS), the FDIC, and state bank
supervisory authorities have varying degrees of supervisory
authority for the United States operations of foreign banking

As Chart 1 and Table 1 summarize, there were 836

separately licensed foreign banking organizations operating in

the United States as of June 30, 1995.

As of that date, these

foreign banking organizations had total assets of about $1.1
trillion, of which 72.8 percent were in 689 uninsured foreign
banking organizations supervised by the Federal Reserve, the
applicable state licensing authorities, and, to a lesser extent,
the OCC.

Of the 836 total foreign banking organizations in the United
States, 18 percent are insured.

The FDIC has primary federal

supervisory responsibility over 12 percent of foreign banking
organizations in the Unites States, which include over 68 foreign
bank subsidiaries and 35 state-licensed branches.

As Chart 2

illustrates, the 103 foreign bank organizations, which the FDIC
supervises, had total assets of $109.6 billion as of June 30,
1995, or 10.2 percent of the total foreign banking assets in the
United States.

The FDIC shares supervisory responsibility for

these organizations with the applicable state authorities.


addition, the FDIC has a role in insuring the deposits of the
remaining 44 insured foreign banking organizations operating in
the United States, 36 banks and thrifts and 8 branches, which had
total assets of $182.7 billion, or 17 percent of total foreign
banking assets.

Of these 44 organizations, the OCC primarily

supervises 34, with total assets of $130.2 billion? the Federal
Reserve primarily supervises 8, with total assets of $42.1
billion? and the OTS primarily supervises 2 with total assets of
$10.4 billion.


As Chart 3 reflects, all FDIC-insured financial institutions
in the United States have estimated total insured deposits of
$2.6 trillion as of June 30, 1995.

Of this amount, an estimated

$117 billion, or 4.5% of total insured deposits, are held by
insured foreign banking organizations.

As such, the direct

potential risk to the FDIC insurance funds represented by all
foreign bank organizations operating in the United States is not


Daiwa operates two branches in New York City, which are
licensed to conduct business under New York state law.


branches do not have federal deposit insurance, and are subject
to supervision by the New York State Banking Department under
state law and the Federal Reserve under the International Banking
Act of 1978, as amended by the Foreign Bank Supervision
Enhancement Act of 1991.

Daiwa also operates five other branches, seven agency
offices, and 14 representative offices, none of which have
federal deposit insurance.

Each of these branches, agencies, and

offices are licensed to conduct business by the 11 states in
which they are located and are supervised by the individual
states respectively and the Federal Reserve.

In addition, Daiwa owns a U.S. state-chartered non-member
bank, Daiwa Trust, which has deposits insured by the FDIC.


FDIC shares supervisory responsibility over Daiwa Trust with the
state chartering authority, the NYSBD.

Because of Daiwa Trust's

foreign ownership, the Federal Reserve also has examination
authority over the bank.

As a result of separate but similar violations that took
place in one of Daiwa's New York branches and in, Daiwa Trust, the
banking agencies issued various orders on November 1, 1995,
terminating all operations of Daiwa and Daiwa Trust in the United

Daiwa and Daiwa Trust have consented to these orders.

First, the Federal Reserve, joined by the New York State Banking
Department, the California State Banking Department, the Illinois
Commissioner of Banks and Trust Companies, the Commonwealth of
Massachusetts Division of Banks, the Florida State Controller,
and the Georgia Department of Banking and Finance, issued a
consent order terminating Daiwa's uninsured branches, agencies,
and representative offices nationwide.

Second, the New York

State Banking Department entered a consent order terminating the
operations of Daiwa Trust.

The FDIC has joined in this

supervisory action by issuing a consent order terminating Daiwa
Trust's federal deposit insurance.

The FDIC's decision to terminate Daiwa Trust's insurance was
based upon recent information that Daiwa Trust, with the


assistance of Daiwa, concealed a pattern of unsafe and unsound
banking practices and violations of law over an extended period
of time dating back to 1983.

Daiwa Trust was legally obligated

to report losses from trading activities as well as any
unauthorized trading to the New York State Banking Department and
the FDIC.

Instead, with the participation and planning of senior

management in both Daiwa Trust and Daiwa, these losses were
concealed and shifted to off-shore entities in the Cayman

The pattern of conduct evidenced by this concealment,
coupled with the fact that Daiwa Trust’s parent, Daiwa, again
engaged in concealment of significant trading losses from
unauthorized trading activities in its New York branch of $1.1
billion, gave the FDIC strong reason to believe that unsafe and
unsound conditions would continue.

In view of the continuing

pattern of misrepresentation to bank regulatory authorities, the
failure to comply with applicable regulatory reporting
requirements, the severe credibility problems of Daiwa
management, and the inability to rely on any assurances from
Daiwa Trust that the unsafe and unsound banking practices would
be corrected, the FDIC was left with no other course but to
terminate Daiwa Trust's deposit insurance.

Under the terms of the New York State Banking Department and
FDIC orders, Daiwa Trust has agreed to terminate its operations

by February 2, 1996, subject to extension by the regulators, to
permit an orderly termination of its banking business.


Trust may terminate its operations by selling its business,
including deposits, to another banking institution, or by
liquidating itself and arranging to pay off its liabilities

The termination process for Daiwa Trust is being

carried out under the supervision of the New York State Banking
Department and the FDIC.


From October 1984 to January of 1994, Daiwa Trust was
examined ten times? four times independently by the FDIC, five
times independently by the New York State Banking Department, and
once concurrently by both agencies.

Criticisms related to

inadequate policies and controls were made at each of these

These included criticisms on several examinations

of management's failure to adhere to an adequate vacation policy,
which provides that bank officers and employees be absent from
their duties for an uninterrupted two-week period.

Such a policy

has historically been strongly encouraged, as a primary internal
control mechanism to prevent improper activities.


activities usually require the constant presence of the
perpetrator in order to manipulate records and otherwise prevent

The failure to adhere to a consistent vacation policy

could have led to an initial break-down in checks and balances


within Daiwa Trust, thereby facilitating the origination of the

Although the FDIC has no supervisory authority

over Daiwa's New York branch, it appears that the same kinds of
internal control deficiencies are relevant to its significant

Further, Daiwa Trust also had annual external audits
performed by independent public accountants, including the period
from 1983 to 1987, when the trading losses occurred.

During the

same period, Daiwa Trust maintained an Examining Committee, which
was responsible for the review of internal/external audit

There is no indication at this time that the

improprieties at Daiwa Trust surfaced in those audits.

The FDIC has instituted a comprehensive analysis of all of
the facts related to Daiwa Trust's losses between 1983 and 1987
and the responses of Daiwa and Daiwa Trust, as well as of the
FDIC's supervision of Daiwa Trust.

In addition to analyzing the

supervisory records of the FDIC and the NYSBD, interviewing the
examiners, and reviewing all other relevant materials, the FDIC
and New York State Banking Department are currently conducting
examinations of Daiwa Trust.

At the direction of the Federal

Reserve, the New York State Banking Department, and the FDIC, an
outside accounting firm has been retained to perform a
comprehensive review of Daiwa's improper activities, including
the $1.1 billion in trading losses at Daiwa's New York branch and


the $97 million net trading loss at Daiwa Trust and managements'
responses to both.

The three bank regulatory agencies have committed to the
U.S. Attorney's office that we will conduct our comprehensive
examinations pursuant to written protocols in a manner that will
not impede its ongoing criminal investigations and prosecutions.
We have sought to cooperate fully with the criminal
investigations, and as a result, our examinations have been
slowed somewhat.

These examinations will determine the specific

facts surrounding the improprieties, including the action that
management took to hide them.

As the FDIC conducts its examination, the key issues are the
extent to which Daiwa Trust's problems are the result of: (1) a
breakdown in internal controls, (2) fraudulent conduct designed
to defeat those controls or (3) both.

Every bank in the United States, whether foreign or
domestic, is required to maintain a system of internal controls
adequate to the level of risk raised by the institution's

A sound system of internal controls includes an

organization plan that segregates functional responsibilities

This separation includes such fundamental

controls as limitations regarding levels of authority for making
and approving lending, investment, trading activities,


segregation of duties, rotation of personnel, effective policies
on hiring and training personnel, vacation policies and
provisions for the protection of physical assets.

It also

includes a system of authorizations and recording procedures that
assures reasonable control of assets, liabilities, income and
expenses —

in other words, an effective recordkeeping system

capable of generating a wide variety of internal management

Finally, the system must include an effective audit


Internal controls aimed specifically at, among other things,
protecting institutions from unauthorized trading by their
employees would include such things as segregation of duties
between traders and personnel performing trade-related accounting
and disbursement functions? procedures under which trade
confirmations are sent and recorded independently of the trading
operation; information on charges and authorizations? and
procedures for revaluing trading positions.

Internal controls

should also include documentation of review and approval of all
trading limits, procedures to ensure prompt identification and
reporting of trading limit violations, and daily reconciliation
of individual dealer positions with bank positions.

Internal control systems are reviewed as a part of the bank
examination process.

Bank examinations, however, are not

designed to identify fraud that is intent on thwarting internal

controls and the examination process.

Rather, bank examinations

are designed to evaluate the overall financial condition of the
bank and the adequacy of management.

Examinations are conducted

to gauge the safety and soundness of an institution, to ascertain
the risks it poses to the insurance funds, and to protect

Like a medical examination, a bank examination is a

disciplined look for discernible warning signs.

The examination

is based on the books and records of the bank, statements made to
the examiner by institution officials, and information obtained
from other reliable sources.

Where the warning signs are

actively concealed, serious problems are less likely to be

Unless examiners find evidence of specific deficiencies, the
evaluation of internal controls is done as part of an overall
evaluation of the bank's systems.

In assessing the adequacy of a

system of internal controls, examiners perform a series of
examination procedures designed to identify control weaknesses.
If deficiencies are identified, more intensive tests are done.
Therefore, examiners treat internal controls in the same way they
approach the entire examination process —

the scope of various

examination activities is expanded in response to the "red flags"
they find.

If a bank’s management is covertly misleading

examiners and the bank’s systems are evaluated as adequate, fraud
may remain undetected, at least for a time.

Examinations are sometimes confused with external audits.
External audits are conducted by an independent public accounting
firm retained by an institution to verify the numbers used in the
institution's financial statements and accounting records.


addition, an audit is designed to provide a more extensive
evaluation of a bank's internal controls than typically occurs
during a regulatory examination.

External audits, for example,

may review and directly confirm transactions to determine whether
bank employees are complying with the system of internal

External audits, therefore, may have a somewhat

greater tendency to detect fraudulent activity.

It is still

possible, however, for bank insiders to conceal deliberately
improper transactions.

Even a complete and comprehensive audit

may not expose effective deceptive practices.

Constraints of time and resources do not permit a complete
and comprehensive audit during bank examinations nor would the
benefits derived from such audits warrant the increased
regulatory burden of imposing such comprehensive reviews on
healthy, well-managed institutions.

Nevertheless, when examiners

determine there is a need, because of a warning signal or
otherwise, they expand examinations to include the use of more
audit techniques and procedures.

Further, the FDIC encourages every insured depository
institution to undergo external audits.

Moreover, since 1993,

insured institutions with total assets of $500 million or more
have been required by regulation to obtain an annual independent
audit; to report annually on management's responsibilities for
preparing financial statements and maintaining an internal
control structure? and to assess and report on the effectiveness
of the institution's internal control structure.


institution's independent public accountant is also required to
attest to, and to report separately on, management's statement of
responsibilities for preparing the institution’s_annual financial
statements, for establishing and maintaining an adequate internal
control structure and procedures for financial reporting, and for
complying with laws and regulations relating to safety and
soundness, as well as management’s assessment of the
effectiveness of such internal control structure and compliance
with such laws and regulations.

The audit and report are filed

with, and reviewed by, the institution's primary federal
regulator, appropriate state bank supervisors, and the FDIC.
These audit requirements apply to 4 of the 43 insured U.S.
branches of foreign banks, and to 43 of the 104 U.S. institutions
which are subsidiaries of foreign banks.

As of June 30, 1995,

these 47 covered institutions had aggregate total assets of
$274.4 billion, and accounted for 93.9% of all insured foreign
banking organizations in the United States.

These requirements

do not apply to the uninsured offices of foreign banks in the
United States.



Given the Daiwa experience as well as other recent wellpublicized trading improprieties, the FDIC is revisiting its
examination methodologies, particularly in the trading area for
foreign and domestic institutions over which the FDIC has
supervisory responsibility.

Specifically, we are looking into

whether we should develop examination procedures that require
greater use of audit procedures in order to obtain external
confirmations of a sampling of trading activity during our
examinations of active trading departments.

Such an enhancement

of examination procedures would require the use of additional
resources, would add to examination time and would increase the
level of regulatory burden on institutions, so we are weighing
this course of action very carefully.

In any event, the FDIC will expand its review of internal
and external audit workpapers, particularly in regard to direct
confirmations of trading activities.

We will tailor our

examinations of controls in a bank* s trading department to take
into account any deficiencies we find during these reviews of

These reviews assist in examination planning, by

potentially streamlining the onsite examination process, and by
emphasizing any areas of regulatory concern.

Examiners have been

previously directed to emphasize the review of auditor work
papers for institutions that have exhibited internal control

problems, significant derivatives activities, and a history of
unusual accounting practices.

Going forward, the FDIC will

emphasize that such workpaper reviews should also be conducted
with regard to insured institutions having substantial exposure
to higher risk activities, such as trading activities.


deficiencies identified during such reviews, coupled with the
adequacy of management's actions to redress them, will then
largely determine the extent of follow—up audit procedures to be
conducted by examiners at the next examination.

Further, we are focusing more on internal controls in our
training and guidance of examiners.

Had present pre-examination

planning activities been in use during the mid-1980s, when Daiwa
Trust's losses occurred, more attention would have been given to
the trading activities of Daiwa Trust during the examination.


particular, we now review comparative call report information for
significant changes between financial reporting periods.


were sizeable increases in holdings of U.S. Treasury bonds
between March and June, 1987, in Daiwa Trust when bank management
booked the securities that covered previously unbooked positions.
Current pre-examination planning techniques might have noted such
an increase, triggering expanded attention to the transactions
and their consistency with Daiwa Trust's investment policies,
asset and liability management policies, and overall business


In particular, we will clarify guidance to our examiners
regarding potential auditing procedures to be conducted by
examiners to review riskier activities, such as trading.


w i n include, but not be limited to, the tracing of trades from
inception through final processing to determine that appropriate
separation of duties are in place? a review of the audit
department* s procedures for confirming all trading instruments
held at other institutions in safekeeping accounts? and ensuring
that all traders are operating within established daily and
intra-day limits.

As part of an on-going effort to improve supervision at the
FDIC, this summer, before learning of Daiwa Trust's problems, we
initiated a project to determine the best methodologies and
infrastructure for the FDIC's supervision of international
banking activities conducted by federally insured institutions.

This project is focused both on the U.S. operations of
foreign organizations, primarily U.S. subsidiary banks and
insured domestic branches of foreign banks, and the international
operations of U.S. banks.

We are evaluating the

comprehensiveness of the FDIC's international supervisory
capabilities, comparing and contrasting these processes with
those in place at the Federal Reserve and the OCC.


project team will soon make recommendations to the Director of
the Division of Supervision on whether and to what extent the

FDIC should revise its processes and infrastructure to supervise
more effectively and cohesively international banking activities
by federally insured institutions.

As part of this effort, we will establish a separate unit
within the FDIC with expertise in international banking.

Such a

unit will devote its attention to international banking matters,
and will communicate closely with similar units of the Federal
Reserve, the OCC, and the state banking departments.

Foreign bank organizations operate in the United States in
various organizational forms, both insured and uninsured, across
multiple regulatory and geographic boundaries.

To enhance and

coordinate supervision of foreign banking organizations, the FDIC
is participating in the interagency Enhanced Framework for
Supervising the U.S. Operations of Foreign Banking Organizations.
The federal and state regulatory authorities formally presented
the specifics of this program to the foreign banking community in
late 1994, and the interagency program is anticipated to be
initiated by early 1996.

The program promises to enhance

significantly U.S. supervision of foreign banking organizations.

Under the program, the FDIC, the OCC, and the relevant state
supervisor for a particular foreign banking organization will
provide the Federal Reserve with proposed annual examination
schedules for integration with those of the Federal Reserve



Generally, foreign banking organizations with multiple

U.S. operations will often have all the operations examined using
the same financial statement date.

After examination plans are

developed, exchanged and coordinated among the examining
agencies, the Federal Reserve will prepare a comprehensive
examination plan for each foreign banking organization.


Federal Reserve will coordinate the sharing of information
through the examinations of all foreign banking organizations
with multi-state operations.

The Federal Reserve will also

conduct an annual "Summary of Condition" assessment of the
combined U.S. operations of each foreign banking organization.
Such assessment will be furnished to the chief executive officer
at the foreign banking organization's head office, and the
appropriate Federal and state authorities.

In addition, for each foreign banking organization,
supervisory "strength-of-support assessments" will be developed
annually through a process involving all U.S. supervisors that
have licensing, chartering, or examining authority over a foreign
banking organization's U.S. operations.

These assessments, which

will be for internal agency supervisory purposes, will analyze
the ability of the foreign banking organization to meet its U.S.
obligations, as well as any factors which raise questions about
the ability of the foreign banking organization to maintain
adequate internal controls and compliance procedures at its



The ability of any bank, including foreign banks, to operate
in the United States is a privilege.

This privilege carries with

it the necessity for accurate records and financial reporting on
an institution's operations, activities, and transactions;
adequate internal controls for assessing risks and compliance
with laws and regulations; as well as the utmost credibility in
the institution's management.
the case of Daiwa.

These necessities were missing in

A failure to comply with reporting

requirements, inadequate internal controls, a continuing pattern
of misrepresentation to regulatory authorities, deliberate
concealment of material events, and the potential for the
continuation of unsafe and unsound practices left U.S. regulators
with no choice but to terminate the operations of Daiwa Bank in
this country.

Foreign banks must meet the same supervisory and

regulatory standards applicable to domestic U.S. banks.
approach we take in examinations today —
the 1980s —


had it been in place in

would have made it more likely that we would have

found problems at Daiwa Trust closer to the time when they
occurred, but fraud is difficult to detect.

The FDIC, along with other federal and state bank
supervisory and law enforcement authorities, is continuing to
investigate in detail what went wrong at Daiwa and why.


is evaluating whether its examination procedures applicable to


internal and risk controls for trading activities for foreign and
domestic institutions over which the FDIC has supervisory
responsibility should be enhanced.

What we have learned from the

Daiwa and Daiwa Trust experience is already being incorporated
into revisions to our supervisory and examination processes.


addition, even before Daiwa Trust's problems came to light, the
FDIC had instituted a comprehensive review of its supervisory
role with respect to foreign banks.

Moreover, the FDIC will

continue to work on an interagency basis to implement a
comprehensive approach to ensuring effective supervision of
foreign bank operations in the United States.

Finally, the FDIC,

which is a member of the Basle Bank Supervisors Committee, will
continue to work with the Committee to ensure greater
international cooperation and coordination in the supervision of
multinational banking organizations.

C h art 1


C h art 1

Total U.S. Assets of Insured and Uninsured
Foreign Banking Organizations (FBO)

Total Assets of $1.1 Triliion
As Of June 30,1995

Chart 2

Total U.S. Assets of Foreign Banking
Organizations - By Federal Supervisor

Total Assets of $1.1 Trillion
As of June 30,1995

Source: Federal Reserve

so u rce: Federal Reserve

Chart 3

Estimated Insured Deposits of Foreign Banking Organizations
Compared To All FDIC Insured Deposits
Total Estimated Insured Deposits of $2.6 Trillion (as of June 30,1995)

Domestic Insured

95. 5%
FBO Insured

4 . 5%

Source: FDIC

Table 1

As of June 30,1995

FDIC Insured Institutions
FDIC Insured Branches
FDIC Insured Banks and Thrifts
Total FDIC Insured Institutions

______ 104


Uninsured Institutions
Uninsured Branches
All Other
Representative Offices
Total Uninsured Institutions

1 3 9 ____ 0.()

Total Foreign Bank Organizations



Source: Federal Reserve