Remarks before the Comptroller of the Currency Conference on "Foreign Banks in the United States: Economic, Supervisory, and Regulatory Issues," Washington, D.C., July 13, 1995.Bank supervision ; Banks and banking, Foreign - United States

William J. McDonough

English

Research Papers in Economics

FRBNY ECONOMIC POLICY REVIEW / OCTOBER 1995 1
Remarks on Economic, Supervisory, and 
Regulatory Issues Facing Foreign Banks 
Operating in the United States
William J. McDonough, President, Federal Reserve Bank of New York
linked closely to the overall economic performance of the
United States. As has been widely reported, the near-term
outlook for the U.S. economy is uncertain. Particularly in
this environment, it is essential that the Federal Reserve
pursue a disciplined monetary policy, one aimed at foster-
ing a sustained, noninflationary growth environment in
which the economy continues to shift from a higher to a
lower inflation climate. Only with price stability can pro-
ductivity, real income, and living standards achieve their
highest possible levels and thereby enable both households
and businesses to function as efficiently as possible. The
key, of course, is to instill a sense of confidence that infla-
tion is trending lower in the long term. It is the path that
in the long run creates the most hospitable environment
for businesses to grow and households to thrive.
Fostering such an environment remains the num-
ber one job of the Federal Reserve and is a key element in
maintaining the status of the United States as an attractive
market for domestic and foreign banks alike. Another very
important element contributing to an attractive climate for
banks in the United States—and especially for foreign
banks—is this country’s longstanding policy of providing
national treatment to foreign banks operating in the U.S.
markets.
The following remarks were given by Mr. McDonough before the
Comptroller of the Currency Conference on “Foreign Banks in the
United States: Economic, Supervisory, and Regulatory Issues” in
Washington, D.C., on July 13, 1995.
I am delighted to be here today to address this important
conference on economic, supervisory, and regulatory issues
facing foreign banks operating in the United States. I also
very much appreciate the efforts of my colleague Gene
Ludwig and his staff at the Office of the Comptroller of the
Currency in organizing these sessions. Foreign banks con-
tribute importantly to the depth and breadth of financial
markets throughout the United States, enhancing the
sophistication and flexibility of our markets. It is a special
pleasure for me to be here because so many of your institu-
tions are located in the Second District and have close
working relationships with us at the Federal Reserve Bank
of New York.
What I would like to do in my remarks to you this
morning is to stand back and take a look at the environ-
ment for foreign banks in the United States and comment
on some recent developments. I will also touch on some of
the challenges facing the banking industry.
I am very aware that the prospects for banks are
The views expressed in this article are those of the authors and do not necessarily reflect the position of the Federal
Reserve Bank of New York or the Federal Reserve System.
The Federal Reserve Bank of New York provides no warranty, express or implied, as to the accuracy, timeliness, com-
pleteness, merchantability, or fitness for any particular purpose of any information contained in documents produced
and provided by the Federal Reserve Bank of New York in any form or manner whatsoever.2F R B N Y  E CONOMIC POLICY REVIEW / OCTOBER 1995
What does national treatment do? Most funda-
mentally, national treatment accords foreign banking insti-
tutions the same rights and privileges as domestic
institutions in participating in our markets for financial
services. In practice, national treatment seeks to create a
level playing field for foreign and domestic banking insti-
tutions by giving them substantially equal access to benefit
from participating in our economy and by subjecting them
to substantially similar regulations and supervisory over-
sight. The national treatment policy followed by the
United States is premised on the belief that open and com-
petitive markets strengthen all market participants and
thereby provide both cost and quality benefits to the bank-
ing institutions themselves and their customers. Our
nation feels strongly that this is the right way to achieve
fairness in the financial marketplace for all competitors,
and U.S. political leaders recently have raised the issue of
reciprocity in the policy of national treatment by others.
The principle of national treatment in banking
was reflected in bilateral treaties and later in major bank-
ing legislation enacted in the United States. It was, for
example, embodied in the Foreign Bank Supervision
Enhancement Act of 1991, which was enacted to align
supervision and regulation of foreign banks in the United
States with that applied to U.S. institutions. The strength-
ening of supervision and regulation of foreign banks in
1991 went hand in hand with comparable changes in legis-
lation affecting U.S. institutions. These changes were
reflected in the Federal Deposit Insurance Corporation
Improvement Act of 1991, as well as in the earlier Finan-
cial Institutions Reform, Recovery and Enforcement Act of
1989.
Under the terms of the Foreign Bank Supervision
Enhancement Act of 1991, before a foreign bank can estab-
lish a branch or agency in the United States, the Federal
Reserve Board must determine that the foreign bank is
subject to comprehensive consolidated supervision by its
home country supervisor. While I recognize that it is not
yet the norm worldwide, I am firmly convinced that com-
prehensive consolidated supervision is in the best interest
of all banks if the integrity of our financial markets is to be
preserved. Maverick institutions must be precluded from
avoiding accountability to an appropriate supervisory
authority.   The approval by the Basle Committee on Bank-
ing Supervision in 1992 of a statement on minimum stan-
dards endorsing comprehensive consolidated supervision of
banks worldwide provides an impetus for national regula-
tors to move supervisory regimes in this direction.
A recent legislative effort to improve the climate
for the banking industry in the United States is the Inter-
state Banking and Branching Efficiency Act of 1994. This
Act substantially removes a number of barriers to full
interstate branch banking for foreign as well as domestic
banks. Interstate branching will enhance the ability of
banks to diversify their balance sheets and thereby lessen
credit risk stemming from lending concentrations.
Under the Act, bank holding companies, includ-
ing foreign banks, will be able to acquire banks in another
state beginning one year after passage of the Act, that is, by
the end of September 1995. In addition, the Act allows
branching by merger across state lines beginning June 1,
1997, provided that a state does not enact legislation prior
Only with price stability can productivity, 
real income, and living standards achieve their 
highest possible levels and thereby enable both 
households and businesses to function as 
efficiently as possible.
I am firmly convinced that comprehensive 
consolidated supervision is in the best interest 
of all banks if the integrity of our financial 
markets is to be preserved.FRBNY ECONOMIC POLICY REVIEW / OCTOBER 1995 3
to this date to “opt out” of such branching arrangements.
There are also provisions allowing states to “opt in,” that
is, permit entry by merger or de novo branching before
June 1997. I applaud the demise of the outmoded restric-
tions on banks’ ability to do business across state lines and
believe it makes sense for all banks and their customers.
Another legislative initiative currently under dis-
cussion in the House of Representatives is the repeal of the
Glass-Steagall Act. As proposed in the Financial Services
Competitiveness Act of 1995, the repeal would, among
other things, enable both foreign and domestic banks to
expand their securities underwriting and dealing activities
through separately capitalized securities affiliates within a
“financial services holding company” structure. I not only
support the goals of this legislation but also feel its passage
is overdue.
Complementing these legislative initiatives are
efforts by federal bank supervisors to improve the supervi-
sory environment for foreign banks. These efforts are being
directed to streamlining the supervisory process through the
implementation of the “Enhanced Framework for Supervis-
ing the U.S. Operations of Foreign Banking Organizations,”
more commonly referred to as the FBO program.
This program, which is now being put into effect,
reflects a shift in emphasis in the supervision of foreign
bank activities in the United States. Previously, the
branches and agencies of foreign banks were reviewed more
as stand-alone entities. Now, a more comprehensive
approach emphasizes the role of these entities as integral
components of the foreign banks as a whole. I am aware of
concerns that this approach seems, to some observers, to
extend U.S. bank supervision outside of our country. In
reality, it does no such thing. Rather, it is an effort to place
the U.S. operations of foreign banks in an appropriate con-
text, using a systematic and consistent framework.
Consistent with this approach will be a series of
initiatives, including a new examination rating system for
U.S. branches and agencies of foreign banks, that several of
you may already have seen. Overall, the program focuses
more heavily than has been the case in the past on risk
management and internal control systems with respect to
both lending and capital market activities, similar to what
we’ve been doing increasingly in our examinations of U.S.
banking organizations.
In addition to providing U.S. bank supervisors
with a more logical approach to the supervision of foreign
bank activities, the new program should yield considerable
benefits to foreign banks. Most notably, foreign banks
should, over time, see a significant reduction in the burden
and duplication of supervisory efforts, as well as an
improvement in examination efficiency and focus.
Another positive development aimed at enhancing
the attractiveness of the United States to foreign banks is
the Federal Reserve’s program, initiated in March 1993, to
streamline the procedures foreign banks must follow when
making application to establish a presence in the United
States under the Foreign Bank Supervision Enhancement
Act of 1991. Under these procedures, the processing of
applications has been expedited and the burden on appli-
cants reduced. Some of the key measures adopted, for
example, facilitate the process of checking on the back-
grounds of shareholders and key personnel, conducting
concurrent reviews of applications by staff in Washington
and at the Reserve Banks, and jointly identifying deficien-
cies in the application and promptly communicating these
to the foreign bank. I’m well aware that there still is room
for further improvement in reducing bottlenecks that have
delayed applications. I can assure you that we are commit-
ted to continued progress and are working on achieving
further efficiencies in an area that has been difficult for all
of us.
Finally, I think it is worthwhile to note that the
banking climate in the United States has benefited greatly
from extensive communications between the supervisory
I applaud the demise of the outmoded 
restrictions on banks’ ability to do business 
across state lines and believe it makes sense 
for all banks and their customers.4F R B N Y  E CONOMIC POLICY REVIEW / OCTOBER 1995
and legislative authorities. The Federal Reserve attaches
great importance to working closely with other bank
supervisors and legislators to craft policies and laws that we
believe will foster competition and increase flexibility in
the provision of financial services. At the same time, we are
intent on preserving our unyielding commitment to the
safety and soundness of the banking system. Continued
cooperation in pursuit of these common goals should help
ensure that the United States remains an attractive bank-
ing environment for foreign and domestic banks well into
the twenty-first century.
While there is much cause for satisfaction with
many of the measures already put in place, the future is not
without considerable challenge. One of the most important
challenges banks and supervisors face is to guard against a
significant weakening in credit standards. In the aftermath
of the 1990-91 stringency in credit, it was not surpris-
ing—and even desirable—to see some easing in credit
standards. Of late, however, it appears that increased com-
petition among lenders for middle-market and large corpo-
rate business has produced a narrowing of margins and
additional relaxation in lending terms. Because experience
has shown that easing of standards can be and often is over-
done, it is incumbent on lenders and supervisors to ensure
that future credit quality problems are avoided.
A second challenge banks and supervisors face is to
continue their efforts to encourage the development of
sound risk management practices in this period of rapid
financial innovation. There can be no doubt that the better
an individual institution’s risk management system is, the
more efficiently it can deploy its capital.
We at the Federal Reserve Bank of New York have
long encouraged innovation in financial instruments and
financial markets. Innovation increases competition,
improves market efficiency, and expands the variety of
products that can better serve customer needs. But with
innovation come increased responsibility and the need for
each financial institution, regardless of size, to engage in
prudent risk management practices to ensure that its activ-
ities remain consistent with its constantly evolving risk
profile.
Based on our experience, we believe that a success-
ful risk management system should satisfy—at the least—
four basic principles:
• First, it should be subject to active oversight by
the board of directors and senior management of
the financial institution.
• Second, it should embody well-conceived risk
identification measurement and reporting systems.
• Third, it should include comprehensive internal
controls emphasizing the clear separation of
duties.
• And, fourth, it should incorporate a well-defined
structure of limits on risk taking.
A review of some recent, well-publicized problem cases
clearly indicates that in each case there was a significant
failure in the design or implementation of one or more of
these basic principles.
I am pleased to note, however, that there seems to
be a consensus building in support of these basic principles
among a large group of internationally active banks, securi-
ties firms, end users, and their various supervisors. Last
year, both the Basle Committee on Banking Supervision
and the International Organization of Securities Commis-
sions (IOSCO) issued papers addressing the need for sound
practices regarding the risk management of derivatives
activities. In March 1995, a private sector group represent-
ing the six largest securities firms in the United States
issued a paper indicating their voluntary adherence to sim-
ilar practices. In addition, the Group of Thirty has put
forth two surveys and sets of recommendations on this
issue. And, from the supervisory side, examiner guidance
manuals on this subject have also been issued by the federal
banking regulators. But support for these principles, how-
There can be no doubt that the better an 
individual institution’s risk management 
system is, the more efficiently it can deploy 
its capital.FRBNY ECONOMIC POLICY REVIEW / OCTOBER 1995 5
ever gratifying, does not mean that our jobs are over. Inno-
vation is an ongoing process and management procedures,
as well as supervisory practices, must continually adapt.
A third challenge for banks and supervisors has to
do with what I would call internal culture issues. These
issues involve the role of senior management and boards of
directors in the risk management process. Most of the well-
publicized problems of the recent past have also reflected
shortcomings in internal management processes.
Experience to date makes it all too clear that the
active involvement of a financial institution’s board of
directors and senior management is absolutely critical to
their ability to articulate and promote the requisite risk
management culture within their organizations. They
must be knowledgeable about the financial products their
institution is offering and the risks it is taking if they are
to give definition to the organization’s tolerance for risk
and provide leadership in its implementation.
Innovative financial instruments often are
extremely complex and can embody a variety of nontradi-
tional risks. Therefore, no financial institution should be
engaging in activities its senior management does not ade-
quately understand and its board of directors cannot over-
see. This need for understanding the products and their risk
must extend to operating staff, auditors, and controllers.
Furthermore, senior management and boards of
directors must foster an environment of open communica-
tion at all levels of the organization. Such a dialogue is the
foundation of effective management supervision. A well-
informed management that encourages this communica-
tion will be in a better position to assess the contents of
daily internal monitoring reports and respond promptly
and appropriately to prevent a problem from emerging.
Honesty is another aspect of this internal culture.
The financial services business is traditionally one in which
integrity is essential. The most effective managers are
explicit about their commitment to fair business practice
and arm’s-length dealing in rules of conduct for employees,
and encourage the prompt communication of problems to
higher levels of management. This is more relevant today
than ever before. Competition is fierce. Markets can move
quickly; huge volumes can be traded in minutes, if not sec-
onds, and end users have a wide choice of alternative insti-
tutions with which to do business. In this environment,
integrity is indispensable if institutions are to attract cli-
ents and retain their loyalty over the long run.
Finally, financial institutions must maintain open
lines of communication with their supervisors. Even in the
best-managed institutions, something can go awry. The
cumulative experience of the industry is that the sooner a
problem is addressed, the better the chances of limiting its
financial and reputational impact. If a problem occurs, the
supervisors must be kept informed—not in order to micro-
manage the problem, but to be able to play a constructive
role in its resolution. The questions supervisors ask will
reflect their experience and their awareness of the potential
success or pitfalls of different strategies.
In sum, the environment for the banking industry
today is as vibrant as it has ever been. The range of oppor-
tunities for financial institutions to prosper and grow has
never been greater, as technology continues to shrink the
world, integrate markets, and open new avenues of poten-
tial profitability. In this environment, the real challenge
confronting both banks and their supervisors is to balance
the risks with the rewards. To do so requires commitment
and vigilance on all our parts—supervisors and super-
vised—to an ongoing process of dialogue, accountability,
and cooperation.
No financial institution should be engaging 
in activities its senior management does not 
adequately understand and its board of 
directors cannot oversee.

Remarks on economic, supervisory, and regulatory issues facing foreign banks operating in the United States

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Remarks on economic, supervisory, and regulatory issues facing foreign banks operating in the United States

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