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INI'ERNATIONAL BANKING AND THE FED An address· delivered by Robert P. Mayo, President of the Federal Reserve Bank of Chicago at the Annual Meeting of the Mid-Anerica Council on International Banking, June 30, 1978 It is, indeed, a great pleasure for rre to be here with you tonight. In rey professional career in the Midwest that spans sare fifteen years, I have been intimately involved-first as a banker, and for the past seven years as a public servant-in praroting the growth of international banking activities in the area. Therefore, I feel a great affinity with people who, like yourselves, have been an integral part of that rrovernent. Tonight, I would l.ike to share with you sore of r(¥ thought on ~C!]IUIIIMDI[ Ill ai •• in international banking in the United States in general, and in the Midwest in particular. Let ne, if I may, look at the overall picture first, and start out with some figures to place tlle banking trends in a perspective. At u. s. international the end of 1977 camercial banks of the ten major industrial countries had $657.3 billion in foreign loans and other claims outstanding, an increase of over $100 billion in a single year. The U.S. canrcercial banks have been in the forefront of this expansion. Their total claims on foreigners (including the claims booked through their foreign branches), rose fran $61 billion in 1970 to aoout $347 billion https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -2- at the end of 1977--a five-fold increase in seven years. We at the Federal Reserve have, of course, watched this develop:rent with great interest. Our response to it has been a prcxluct of two sets of considerations: On one hand, we have recognized that the trerrendous increase in the international activities of U.S. banks was a constructive response of these institutions to the rising need for credit globally. In part, this rising demand for credit was an extension of a long-tenn trend reflecting rising aspiration of peoples everywhere for improvements in their standard of livin,g. Investrt~.nt--and credit-have ah.,-ays beet---i an integral part of that process. But far IOC>re inp:>rtant in this surge in dew.and has been the "energy crisis" that surfaced in 1973~74~ The five-fold increase in the price of oil created trerrendous disequilibria in the world balance of payments. The huge bal- ance of payments surpluses accruing to the OPEC countries had their counterpart in large deficits by the oil-consuming nations. These deficits had to be financed. if the \\Orld were to survive the "energy shock. " The c.::ormercial banks around the vJOrld rose to the challenge of the petrcx:1ollar recycling." 11 In that sense, they have been perfonning a vital function of sustaining v.0rld's econanic activities.by helping to finance--directly or indirectly-the oil-related deficits sustained by virtually every nonoil producing nation in the world. As an institution charged by Congress with the responsibility of contributing to the econanic health of the country, we at the Fed responded. p:::>sitively: Fran this https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -3- perspective, the expansion of U.S. banks' activities abroad has been viewed by us at the Fed as highly beneficial. But there has been and.:her side to this coin: The tremen- dous expansion in the foreign lending has considerably altered the traditional loan/capital ratios of many participating banks, and opened the banks to new risks. As an institution charged with the responsibility of maintaining soLmdi viable banking industry in the United States, the Fed, obviously, reacted with concern. Of particular concern has been the dramatic increase in the debts of the developing countries. It has been estimated that the debt of soire 70 non-OP:EC devalopit7.g countries $160 billion at the end of last year. aT■Ow-it:.ed to s~.e Of that total, alnost a half--or sare $78 billion--was owed to private lenders, _pr~ily cannercial banks in the industrial oountries of the 'vJOrld--an increase of sare 150 percent since the end of 1973, following the oil crisis. Doubts emerged about the ability of ni.any of these countries to service the debt. There were fears of defaults, of "dam.no effects" that could severely undennine the active strucb.lre of world banking. The Federal Reserve, in cooperation with the central banks of other major countries, and with other u . s. bank regulatory agencies, took steps to guard,as much as possible against excesses in the international activities of the U.S. banks that could lead to such developnents. In 1976, the Board of Governors of the Federal Peserve System created a Car.mi.ttee on Foreign LeP..ding consisting of rranbers of the Boa.rd of Governors and of several pres- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -4- idents of individual Federal ReserVe banks, to study and appraise the situation, and to reccmnend appropriate measures if need be. The work of the camdttee has just been carpleted, and the Federal Reserve, together with the Carptroller of the Currency, and the FDIC, is n<:M in the process of implementing sane of the measures that appeared desirable .. One of the fiirst steps has been the effort to obtain, and to make available to the ccmnercial banks engaged in international activities, a better and nore corrprehensive data on international ba.."'1ldng \;"Orld-wida. We Ww""lted to provide the man.aga--nent of these banks with best available information so that they themselves are able to make rational decisions in respect to lending. _The fed has always strongly felt that the exercise of prudence in banking lies primarily with the management of individual banks. Thus the Systan's current efforts to assure the soundness of international banking activities derive, in the first instance, fran that premise. Going beyond this, the System is now in process of implerrenting a new supervisory, ba!l.k examination approach that would incorporate sane precautions against credit over exposure on part of individual banks in their foreign lending to individual countries. I will not go into details of this approach. It will be ccmnunicated to your banks in due course. What I wuuld like to anphasize, however, are some broad philosophical principles on which the approach is based. It is not a mechanical approach that v.0uld.tell banks where to Lend and where https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -5- not to lend. It has been fully recognized. that the "country risk"encarpasses a whole spectrum of factors, eoonanic social, political, and legal that cannot be analyzec. and evaluated roochanically. While sate "objective criteria" such the oountry's current account imbalance, and the rate of its external debt acCUlllll.ation will be used to "screen out" countries for in-depth analysis, the final detennination of the "risk exposure" will be broadly based, and will include such factors as the degree of ooncentration, maturity structure--but above all other subjective criteria. Imking f:ruhl a broad per~-c-~va at ti.11e overall posture cf the Federal Reserve tONard the international activities of U.S. banks, one may cane to a oonclusion that the p::,sture ha§.. ~ one of being posed at the sharp edge between the efforts to prarote the growth of international banking on one hand, and on the other hand trying to rroderate it. But perhaps a very close look may suggest that the dichotany does not really exist; after all, a continued expansion of international banking can take place only if the excesses that may threaten to und.ermi.ne it in the longrun are guarded against. And that, I believe, is what the Fed has been trying to achieve in fanning its attitude and policies toward the international expansion of U.S. banks in general. In trying to sketch out for you sore of the issues relating to international banking, I have spoken, so far, as a member of the nation-wide Federal Reserve System. Let me nCM "switch the hats," don a hat of the president of a regional Federal Reserve https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -6- bank, and focus briefly on sane of the issues relating to international banking activities in the Seventh Federal Reserve district, and the Midwest in general. When I came to the .Midwest in 1962 I soon became aware of the glaring gap between, on one hand, the extensive international orientation of the business and agriculture in the Mid-West, and on the other hand, the still rather nodest and timid involvement of a great majority of the mid-western banks in international banking. For e.xarcple, in 1960, when the five Midwest states that canprise the Seventh Federal Reserve district were exporting over $3.0 billion L, rranuf~~ed goods (sane 21 percent of the national total) and alrrost $800 million (or some 17 percent of the total) in agricultural products-a total of almost $4 . . 0 billion of exports originating here--the exp::,rt financing bankerst acceptances--the major financial instrument traditionally used to finance exports--outstanding at all the district banks arrounted, at the beginning of that year to--would you believe it--$8.3 million! Indeed, the total claims on foreigners by all these banks amounted to $100 million at that time! By 1970, the situation improved sanewhat--but not dramatically. Export- financing acceptances were still only aoout $42 million even through the volume of exports originating here expanded to $8 1/2 billion. But the total claims on foreigners, including those booked fran by these established foreign branches of several district banks amountel to over $5 billion--a fifty-fold increase in just 10 years. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -7- What was particularly significant about this expansion that took place during the sixties was the fact that it took place under the severe limitations imposed on the international activities of the district banks by the Voluntary Foreign Credit Restraint pro- gram imposed in 1965 for purposes of shoring up the countcy's balance of paynents. Under that program-which many of you in this audience still painfully remember, I am sure--the nation's banks were confined in their foreign lending activities to the arrounts that were only a percentage of an early sixties base paricxl. The program was particularly painful for the district banks because it caught then L"1 an ~-pansionar,t phase of their international activities, and thus with a relatively small base. Irrleed, the total claims on foreigners booked at the head offices of...the_ district banks remained virtually frozen at around .p900 million level between 1964 and 1970; the expansion in foreign lending that I previously mEmtioned took place aJrnost exclusively at the foreign branches of these banks. Incidentally, this develop- rrent highlights what may be viewed as a "r:ositive" side of the program. The VFCR program, pain.&."7.11 as it was for the Midwest banks in restricting their head-office foreign activities, pro- vided an impetus for an expansion of the district banks' activities abroad. Many of the district's banks set up or expanded their foreign branches and subsidiaries so as to be able to meet the needs of their custaners for international banking services without the encumbrance of the program that made it difficult for them to meet these needs fran their head https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -8- offices. While in the early sixties, there were no foreign bran- ches of the district banks, by the end of 1977, the district banks were maintaining rrore than 70 banking facilities abroad. Finally, in 1973, a new dircension of international banking activities in the Midwest emerged. Foreign banks came to Chicago. Recognizing finally the long-standing importance of the Midwest as a heart-land of America's industrial, agricultural-and exportactivities, and recognizing the emerging importance of the Midwest as an international financial center, the foreign banks t(X)k advantage of the 1973 State Banking Law, and 31 of them opened their offices here in Chicago. The changes in the complexion of banking in the Seventh Federal Reserve district implicit in the figures that I just cited, brought with them new dirrensions to our functions at the Federal Reserve Bank of Chicago. Many of our traditional activities that we perfonn as a regional banking regulatory authority had to adjust to these profound changes: Our people in the Reserve Analysis Division of our Bank had to learn to cope with the intricacies of assessing the legal reserve requirements of EtJ.rodollar transactions of our member banks; our Bank Examination people had to learn to evaluate banks' international assets that were unfamilia~--to them; our Statistical Section had to learn to decifer statistical reports on our banks' activities in places that they never heard of; and I could go on, citing examples of the adjustments we had to make in our responding to the developnents in international ban.1<ing in the district. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis But in a way, these responses, important as they have been -9- in our overall operation, have been only a small part of the pro- found changes that have taken place at the Federal Reserve Bank of Chicago. Our We have not only responded. We had to becane initiators. initiative has evolved essentially on two planes: One was "internal" to the Federal Reserve System as a whole, the other was "external" as it has related to our manber banks. On t.."1e internal plane, our efforts can i;.ierhaps best be characterized as efforts to decentralize System's regulatory policy making processes as they relate to international banking. For many years, when U.S. international banking was concentrated a.lnost exclusively on the Eastern Seabcard, regulations afftCe/;'t;f ~~ -inter- national activities of U.S. banks were initiated and pranulgated, quite logically, by the Federal Reserve District1 in that---region •As the U.S. international banking began to nove to the :Midwest, we at the Federal Reserve Bank of Chicago felt that we must share in the internal processes by which regulations affecting international activities of U.S. banks are developed and prarulgated--so that the peculiarities of operations of banks in our district in their awn I international activities may eventually be given recognition in structuring the regulation. For example, we worked hard for the rocxiification of the Voluntary Foreign Credit Restraint program that caught our banks at the initial stages of their international expansion)and thus with a very small base to work £ran in their international lending. We fought for, and invariably obtained repre- sentation on various special System's canrnittees, both on the staff level and at the principal level, dealing with various aspects of https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -10- U.S. international banking. For example, we at the Federal Reserve . .~ 4 d.<:.t l , v Ban.1<. of Chicago were represented on the System's Task Force on (./4-~ -f . L t ' ~ '1t-L-c/ a,,-/- ~ Foreign Operations of U.S. Banks in 1972) I, and sane members of rqy s taff were members of the System s Comrru.ttee on Foreign Banks RegI • t> a.-£,,C- -CG. , • a,,,~~ ti /2 / ~ 4 ,t_ ,._ ~ ~ ~ eut,'4L,.t"., ulation that examined the operations of foreign banks in the United States and drafted the legislative proposal nCM before Congress; I 1 and members of~ staff have been members of the System's Steering Ccmnittee on Foreign Lending that, am:>ng other things, is nCM in the process of drafting examination standards for the international operations of U.S. banks. These are just few examples of our efforts within the Federal Reserve System where we have tried to project the international orientation of our banks into the overall policy making processes. On what I have referred to earlier as the 11 external 11 plane our activity relating to the international orientation of our district has also been quite extensive. Just to- rrention a few of these, back in the early 1970, we launched the publication of a weekly "International Letter" to provide comprehensive, concise sun:mary of t significant inter.national econanic developrents to the general public so as to increase their awareness of irnfx:>rtant issues in the international financial area . We have devoted a considerable arrount of resources in exploring the ·possibility of changes in the international payrca1ts-clearing procedures with the ultimate objective being the breaking up of the virtual "rronopoly" of New York City in these transactions due to · the peculiarities of the Clearing House settlements procedures. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis We have been, and we are working J -11- hard in the area of bankers' acceptances. This area has been viewed \Its by;.as being of particular importance because it touches rrost inti- mately on that bothersane "gap" I mentioned earlier, a gap between the international orientation of business, ccncterce and agriculture in our district on one hand/and the supporting financial activities of our banks. We published several articles on bankers acceptances designed to familiarize the general public with that instrument; we have been supportive of efforts to provide for better and rcore easy rna.rketing of bankers' acceptances of the district banks--including the exploration of the possibilities of establishing a market in bankers ' acceptances in Qricago--so as to make the usage of that instrument IIDre attractive to the Midwest banks; we are currently involved in restructuring our internal procedures in handling questions und interpretation of regulations dealing with bankers acceptances. We are 'WOrking ta.,.,ard a goal of creating a System-- wide infonnation clearing system whereby interpretation of regulations on bankers' acceptances rendered, say, by the r~ew York Fed to one of its banks will be made available to all banks, including those in our district. I We expect that this will eliminate the situations we encountered in the past where banks in sane regions of the country were issuing eligible bankers acceptances in financing transactions that banks •in other regions of the country believed would be ineligible, and thus excluded themselves from such financing. (/I Well, I supfX)se I could go on--but you, I am sure, are to resune this evenings activities. by noil anxious So let me close my remakrs by surnmarizing--and enphasizing --the underlying philosophy of all those https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis -12- things I talked about tonight: efforts to ~~d I want you to Jmav that in your international banking activities in the Midwest 1 you have friends at the Federal Reserve Bank of Chicago. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis
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