SATISH M. KINI AND SIMON RASIN

Transcription

1 THE FEDERAL RESERVE DEPARTS FROM ITS USUAL STANDARDS TO APPROVE THE ESTABLISHMENT OF U.S. BRANCHES BY INDIAN AND CHINESE BANKS SATISH M. KINI AND SIMON RASIN The authors explain why banks in developing countries may benefit from recent actions of the Federal Reserve Board approving two applications by non-u.s. banks to establish branch offices in the United States without finding either bank subject to comprehensive and consolidated supervision in its home country. In the span of a mere few weeks, the Federal Reserve Board ( FRB ) took the unusual step of approving two applications by non-u.s. banks to establish branch offices in the United States without finding either bank subject to comprehensive and consolidated supervision ( CCS ) in its home country. Specifically, on October 19, 2007, the FRB approved the application of India s second largest bank, ICICI Bank Limited ( ICICI ), to establish its New York branch office and, on November 8, 2007, the FRB took the same approach with respect to the China Merchants Bank ( CMB ), the sixth largest bank in China. Mr. Kini and Mr. Rasin are members of the Financial Services Practice of Goodwin Procter LLP and counsel U.S. and non-u.s. banks and other financial institutions on U.S. banking and securities regulatory matters. The authors would like to thank Christopher A. DiTata, an associate in the Business Law Department, and Laura W. Dickson, a research librarian, at Goodwin Procter LLP for their assistance. 262

2 ESTABLISHMENT OF U.S. BRANCHES BY INDIAN AND CHINESE BANKS The FRB s actions are a noteworthy relaxation from the usual requirements of the International Bank Act of 1978 ( IBA ), which directs the FRB to make a finding of CCS before permitting a foreign bank to establish a branch in the United States. 1 The FRB s step may pave the way for other Indian, Chinese, and possibly other non-u.s. banks to enter the United States under the same relaxed standard. This article first reviews the IBA s standards for foreign banks wishing to establish a U.S. branch and explains why this standard was put into place by Congress. It then reviews the FRB s actions in the ICICI and CMB cases. Finally, this article looks at the possible reasons for and implications of the FRB s actions. THE IBA AND ITS CCS STANDARD As a general rule, the establishment by a non-u.s. bank of a branch in the United States must receive approval from the FRB. 2 To be approved, the application must meet the requirements set forth in the IBA, as amended by the Foreign Bank Supervision Enhancement Act of 1991 (the FBSEA ) and other laws, and as implemented by the FRB s Regulation K. 3 Under these requirements, the foreign bank must: (1) engage directly in the business of banking outside the United States; (2) provide the FRB with the information it needs to assess adequately the foreign bank s application to enter the United States; and (3) be subject to CCS in its home country. 4 In making the CCS determination, the FRB considers various factors. The FRB gives weight to whether the home country supervisor: (1) ensures that the foreign bank has adequate procedures for monitoring and controlling its worldwide activities; (2) obtains information on the condition of the foreign bank and its subsidiaries and operations outside the home country through regular examination and other reports; (3) obtains information on the dealings and relationship between the foreign bank and its home-country and foreign affiliates; (4) receives from the foreign banks financial reports that are consolidated on 263

3 BANKING LAW JOURNAL a worldwide basis; and (5) evaluates prudential standards, such as capital adequacy and risk exposure on a worldwide, consolidated basis. 5 The FRB has said that no one of these factors is essential and that other elements as well may inform the FRB s decision. 6 In sum, the CCS requirement will be met if the FRB determines that the home country supervisor receives sufficient information on the worldwide operations of the foreign bank to assess its overall financial condition and compliance with law and regulation. 7 In practice, the evaluation of whether a bank is subject to CCS by its home country regulator breaks into two separate questions. The first is whether the home country regulator has the processes, controls, and tools in place to regulate its banks in a manner that meets both the letter and the spirit of the IBA s CCS standard. The second question is whether the foreign bank is, in fact, subject to such supervision in its home country or whether it is for some reason exempt from such regulation in practice. 8 The requirement that the FRB approve a foreign bank s establishment of a U.S. branch and that the agency do so based on a finding of CCS in the bank s home country stemmed from two scandals that broke shortly before that requirement was enacted. One such scandal resulted from the criminality and regulatory evasions of a Middle-Eastern banking institution, chartered in Luxembourg the Bank of Credit and Commerce International ( BCCI ), which eventually collapsed. One of the main lessons learned from the BCCI disaster was that a lack of comprehensive, consolidated supervision of banking organizations made it easier for such organizations to engage in unsafe and illicit activities. A report by two U.S. Senators on BCCI s criminality argued that BCCI was, from its inception, designed to have a fractured corporate structure specifically for the purpose of evading supervisory efforts, and thereby more easily engage in illicit activities undetected. 9 Commentators suggest that this scandal contributed to the passage of the requirement for FRB approval. 10 The Banking, Finance and Urban Affairs Committee of the U.S. House of Representatives explicitly cited a second scandal, which implicated a large Italian bank named Banca Nazionale de Lavoro ( BNL ) in illegal loans to 264

4 ESTABLISHMENT OF U.S. BRANCHES BY INDIAN AND CHINESE BANKS Iraq, as a reason to consolidate regulation of foreign bank branches under the FRB. The Committee stated that new legislation was necessary because the FRB s ability to examine BNL was hampered by fragmented supervisory responsibilities. 11 A LIMITED EXCEPTION TO THE CCS STANDARD In 1996, Congress amended the IBA to allow the FRB to approve a U.S. branch application by foreign bank, even when the FRB does not find that the bank is subject to CCS by its home country regulator. The FRB has authority to take such action, provided that the FRB finds that the Bank s home country regulator is actively working toward meeting the CCS standard. 12 Congress gave the FRB such authority to encourage further progress towards comprehensive consolidated supervision by countries that do not currently accord such supervision. 13 In deciding whether to exercise this discretion, the FRB must take into account whether the bank is adequately combating money laundering. This consideration, importantly, differs from the other CCS factors, which focus on the capabilities and authority of the foreign bank s supervisor. 14 In addition, the FRB may consider whether the foreign bank s home country supervisor is developing a legal regime to address money laundering or is participating in multinational efforts to combat money laundering. 15 The FRB has on only rare occasion used this CCS exception to approve a foreign bank s establishment of a U.S. branch. For example, in 1997, the FRB used the exception to allow the Housing & Commercial Bank ( HCB ) of South Korea to establish a New York branch. The FRB had, prior to 1997, found that Korean authorities met the CCS requirements. According to its order, the FRB could no longer make this finding given then-present difficulties in the Korean financial system and evident gaps in the supervisory regime. The FRB pointed out that Korean authorities recognized the weaknesses and were taking legislative and regulatory steps to remedy them. As a result, the FRB took the view that Korea was actively working to establish CCS for the bank and approved its branch application. 16 On another occasion, the FRB thought it appropriate to use the CCS exception to allow an Egyptian bank to establish a U.S. branch. In so doing, 265

5 BANKING LAW JOURNAL the FRB did not specify what elements of Egypt s regulatory scheme did not meet the CCS standard but granted the approval based on the actively working exception. 17 The FRB used the CCS exception yet again to allow a Hong Kong bank, which was ultimately controlled by a state entity of the People s Republic of China ( PRC ), to establish U.S. branches. The FRB found that although the Hong Kong authorities met CCS requirements, they lacked regulatory authority over the Hong Kong bank s PRC parent. The FRB relied on the actively working exception to approve the application, this time finding that the Hong Kong authorities were cooperating with the PRC authorities to establish arrangements for the consolidated supervision of the bank. 18 THE FRB S ACTIONS IN THE ICICI AND CMB CASES In its two recent cases, the FRB approved the applications of ICICI and CMB using the actively working exception to the IBA s CCS standard. The FRB s orders issued merely weeks apart are highly parallel. The ICICI order was issued first, as noted above, on October 19, The Indian bank had applied to establish a branch in New York, which according to the FRB, would provide wholesale banking services to U.S. subsidiaries of Indian firms. The FRB s order to CMB was issued shortly thereafter; CMB also sought to establish a New York branch to engage in wholesale deposit taking, lending, trade finance and other banking activities. The FRB concluded that the Reserve Bank of India ( RBI ), the principal supervisor for ICICI and its non-indian subsidiaries and affiliates, is actively working to establish arrangements for the consolidated supervision of ICICI. In reaching this view, the FRB noted, among other things, that the RBI: has authority to license banks and regulate their activities both domestically and abroad; supervises and regulates institutions through onsite and off-site monitoring; periodically audits Indian banks foreign operations; and is authorized to request and receive information from Indian banks and their subsidiaries and affiliates as well as penalize such institutions for failure to comply accurately with information requests. The FRB also indicated that ICICI is required to be audited annually, which audit covers financial statement, asset quality, internal controls, and money laundering 266

6 ESTABLISHMENT OF U.S. BRANCHES BY INDIAN AND CHINESE BANKS procedures, and which audit is submitted to the RBI. 19 The FRB s ICICI order also discussed at length the steps that the Indian government has taken to enhance its domestic money laundering regime and noted India s participation in international efforts to combat money laundering and terrorist financing. In addition, the FRB cited favorably ICICI s efforts to combat money laundering and other illicit activities, noting that the bank has gone beyond the requirements of the RBI and has put in place enterprise-wide, risk-based anti-money laundering and other controls consistent with Financial Action Task Force recommendations. The FRB s CMB order made many of the same findings with respect to the Chinese regulatory scheme that the FRB made with respect to the RBI. To begin with, the FRB noted that the China Banking Regulatory Commission ( CBRC ), the principal supervisor of CMB, was established in 2003 to enhance the supervision of Chinese banks. 20 According to the FRB, the CBRC supervises and regulates Chinese banks like CMB, including their subsidiaries and overseas operations, through on-site examinations and offsite monitoring. The former covers such major areas of operation as corporate governance, capital adequacy, asset structure and quality, compliance, and others. The latter covers, as well, asset quality, capital adequacy, liquidity, corporate governance, affiliate transactions, and internal controls. According to the FRB, CMB is subject to annual audit, by an accounting firm approved by the PBOC. In addition, the CBRC may order a special audit of banks under its supervision at any time. 21 The CBRC also has authority to obtain information from Chinese banks, to penalize banks for failures to comply, and to sanction banks and bank officers for violations of applicable laws and regulations. With respect to anti-money laundering, the FRB noted that the PBOC is the principal regulator of CMB for money laundering compliance; the PBOC supervises and regulates CMB through both on-site and off-site examinations and monitoring. In addition, Chinese laws have evolved on money laundering matters, according to the FRB. The FRB order cited the Chinese government s efforts to establish a regulatory infrastructure to assist in money laundering controls. 267

7 BANKING LAW JOURNAL POSSIBLE REASONS FOR AND IMPLICATIONS OF FRB S ACTIONS Given the above precedent of using the actively working exception to a CCS finding so rarely, it is striking that the FRB now has used the exception twice in very rapid succession. The FRB gave no reason why it chose to do so, but there has been speculation regarding several possible explanations: First, it is quite possible that the FRB wanted to acknowledge and encourage regulatory reforms in India and China precisely the purpose of the actively working exception to CCS. Indeed, there is no sign that the FRB acted precipitously; to the contrary, ICICI reportedly waited three years to obtain the FRB s approval for its branch application during which time, as cited by the FRB s order, Indian regulators have made significant strides in improving their regulation and supervision of their banks. 22 To this end, Indian officials reportedly needed to provide the FRB with assurances on India s anti-money laundering regime to secure the ICICI approval. 23 Second, the FRB s action may have been motivated by an attempt to encourage further expansion of bilateral relationships between the United States and each of India and China and further integration of both developing countries in the globalized economy. For example, the FRB s ICICI order was released just days before U.S. Treasury Secretary Paulson made a much-publicized trip to India to encourage India s economic liberalization and the expansion of its trade and other links to the United States. 24 Public accounts indicate resistance at various levels in the Indian government to such U.S. overtures while the U.S. government continued to bar Indian banks from branching in the United States. 25 Third, the FRB s actions may have been designed to encourage reciprocal opening of Indian and Chinese markets to U.S. banks. Indeed, U.S. banks have long sought to expand in both markets, which they consider to be ripe for further development and growth for retail and commercial banking products. Their entry into both key markets has been restricted for, among other reasons, the lack of reciprocity with respect to U.S. banking markets. For example, Chinese regulators reportedly have resisted allowing U.S. and other foreign banks to take larger stakes in China s domestic financial institutions, citing as a roadblock the FRB s refusal to permit Chinese 268

8 ESTABLISHMENT OF U.S. BRANCHES BY INDIAN AND CHINESE BANKS banks full entry in the United States. 26 Whatever the ultimate reasons for the FRB s actions, it appears that other banks will benefit from the recent actions. Indeed, press accounts at the time of this writing indicate that other banks from China and India have pending applications with the FRB to establish branches in the United States. Moreover, other developing countries whose banks currently cannot enter the U.S. market also may take heart from the FRB s actions, which may ultimately pave the way for them also to gain branching approval in the United States. NOTES 1 Non-U.S. banks may establish representative offices in the United States with FRB approval, which approval may be granted without a CCS finding by the FRB. 12 C.F.R (d)(2). Representative offices may engage only in representational and administrative functions such as business solicitation, research, and back office and liaison functions in connection with the banking activities of the foreign bank. See id (d)(1). 2 See 12 U.S.C. 3105(d). Additional branches in the home state of the foreign bank may be opened without prior approval, but the FRB must be notified. See 12 C.F.R (a)(2)(i)(a). 3 See 12 U.S.C. 3105; 12 C.F.R The FRB may also consider other factors enumerated in the IBA. See 12 U.S.C. 3105(d)(3). 5 See 12 C.F.R (c)(1)(ii). For example, the FRB found a Portuguese bank to be subject to CCS by the Bank of Portugal, the bank s home supervisor. The FRB made this finding because the Bank of Portugal (1) required the submission of a semiannual consolidated financial statement and additional informal monthly submissions regarding the bank s condition; (2) conducted on-site inspections; (3) reviewed risk concentration, risk management, credit quality, credit approval systems, internal audit procedures, accounting control, and capital ratios; (4) received an annual report on the bank s global internal control systems; (5) monitored large single counterparty exposures of the bank; and (6) required independent audits of the bank. See Caixa Geral de Depósitos S.A., 85 Fed. Res. Bull. 774 (1999). 6 See Caixa Geral de Depósitos S.A., 85 Fed. Res. Bull. at 775 n C.F.R (c)(1)(ii). 8 See e.g., Caixa Geral de Depósitos S.A., 85 Fed. Res. Bull. at 775. The FRB s order 269

9 BANKING LAW JOURNAL first recites the various methods the Bank of Portugal uses to regulate banks, as summarized in Note 5, supra. Before beginning its analysis, the Board noted that Caixa Geral de Depósitos S.A is one of the institutions subject to the supervision described in the order. 9 See Sens. John Kerry & Hank Brown, The BCCI Affair: A Report to the Committee on Foreign Relations, (avail. at 10 Regulation of Foreign Banks 11 (Michael Gruson & Ralph Reisner eds., LexisNexis 4th Ed. 2003). 11 See H.R. Rep. No , at 106 (1991). 12 See U.S.C. 3105(d)(6)(A). 13 See S. Rep. No , at 26 (1995). The Committee Report states that this purpose is offset by the need to strike an appropriate balance between preserving prudently firm statutory standards and correcting unwarranted barriers to entry in the current approval process. 14 See U.S.C. 3105(d)(6)(B). 15 See id. 16 See Housing & Commercial Bank, 83 Fed. Res. Bull. 935 (1997). A few years later, the FRB used this same actively working exception to allow another South Korean bank to branch into the United States. See Kookmin Bank, 2000 WL (F.R.B.) (Feb. 11, 2000). 17 See National Bank of Egypt, 86 Fed. Res. Bull. 334 (2000). 18 See CITIC Ka Wah Bank Limited, 89 Fed. Res. Bull. 443 (2003). 19 The FRB also noted with approval the fact that ICICI has issued American Depositary Shares on the New York Stock Exchange and, thus, files financial reports with the U.S. Securities and Exchange Commission that also are subject to external audits. 20 The FRB s order stated that, prior to the CBRC s establishment, the People s Bank of China ( PBOC ) had authority with respect to bank supervision. Today, the CBRC has primary responsibility as a banking supervisor. The PBOC serves as central bank and primary supervisor for anti-money laundering matters. 21 The FRB also noted that CMB is listed on the Shanghai and Hong Kong stock exchanges, which listings require CMB to have external audits conducted under international standards. 22 See John Elliot, Riding the Elephant, Fortune.com (Oct. 22, 2007) (avail. at 23 See US may remove entry bar for Indian Banks, Rediff India Abroad (Mar. 7, 2007) (interview with Indian Ministry of Finance official) (avail. at 24 See Remarks by Treas. Sec y Henry M. Paulson, Jr., The United States as a 270

10 ESTABLISHMENT OF U.S. BRANCHES BY INDIAN AND CHINESE BANKS Partner in India s Continued Growth at the U.S.-India Forum in Mumbai, India (Oct. 29, 2007) (avail. at gov/press/releases/htp648.htm). 25 See, e.g., Harley Davidson entry in India linked to Indian banks in US (Feb. 25, 2006) (avail. at 26 See Vincent Ryan, China Merchant Bank Vaults into U.S., CFO.com (Nov. 12, 2007) (avail. at 271