Foreign banks seen to pick trading for growth in their U.S. operations.

NEW YORK - Foreign banks in the United States will continue to expand selectively over the next few years despite the restraints imposed on their expansion by tough banking and tax legislation, according to a senior executive with KPMG Peat Marwick.

Stephen M. Brecher, partner at KPMG Peat Marwick in charge of international bank practice and national director of technical tax services for international banking, said much of the expansion will focus on trading operations and activities like private banking rather than foreign banks' old mainstay, commercial lending.

"There is a significant trend to trading activity as opposed to lending activity," Mr. Brecher said in a recent interview.

"There's still substantial lending by foreign banks, but the growth of trading activity has been explosive.

"It's been one of the most significant developments over the last few years."

Greater Controls

The executive noted that growth in trading operations among foreign banks in the United States has produced a commensurate demand for increased controls over credit and market risk.

It also has raised conflicts between tax authorities in the United States and other countries over what income should be booked where.

"Which locations do you allocate the profits to if you have a global book that passes around the world every 24 hours?" Mr. Brecher asked.

"Clearly, as your business grows, you face major taxation issues on cross-border trans-actions."

The accounting expert suggested that advanced pricing agreements, under which banks and the Internal Revenue Service agree in advance on a portion of earnings that will be allocated to the United States are probably among the better solutions.

"If you take foreign currency options as an example and you have a truly global book, it's virtually impossible to determine the appropriate points of profit and loss," Mr. Brecher said.

"This process [advanced pricing agreements] at least allow a taxpayer to allocate on an economically logical basis profit or loss to the United States."

Notwithstanding taxation and other issues affecting trading operations, Mr. Brecher said trading is slated to expand.

"Trading among foreign banks in the United States will continue to grow because it is an important activity that has the potential for substantial profits," he said.

"Trading will grow even if it does entail tax uncertainties."

Toward Clarification

In fact, a number of the tax uncertainties are already being reduced.

In particular, Mr. Brecher said, temporary and proposed regulations that the IRS issued on Oct. 18 reversing its previous position will substantially alleviate questions over how to characterize hedge transactions.

To benefit from the new regulations, banks and other corporations must identify hedging transactions on their books and records and specify both the hedging position and the item, items, or aggregate risk that is being hedged.

Hedging transactions entered into on or after Jan. 1 must be identified on the day entered into, while transactions entered into prior to Jan. 1 and remaining in existence on March 31, must so be identified by March 31.

"To the extent to which foreign banks hedge interest rate and foreign exchange risk, they can be quite certain of receiving ordinary income treatment, something which until now has remained a major thorn in their side when conducting trading operations," he said.

Mr. Brecher noted that the expansion in trading and other internationally related operations has led to a growing movement toward internationalization of banking standards.

Of these, he pointed out, the most significant so far has been the international agreement under the Bank of International Settlements to set up common minimum capital standards worldwide.

Nonetheless, Mr. Brecher expressed some doubts as to how far the internationalization of capital and accounting standards will go over the next few years.

"There have been efforts for years to get some standardization of accounting practices, but these have moved slowly because of the business or legal constraints or the different regulatory environment in each country," the executive said.

"Achieving international standards is definitely an objective, but it remains subject to being derailed locally," he added.

Local Interpretation

Even common international capital standards, he noted, are still subject to different interpretations locally and individual countries can choose to include types of capital.

The executive, however, conceded that different regulatory systems in different countries are posing an increasing problem for foreign banks operating in the United states.

In particular, he noted, the U.S. operations of banks which have merged with insurance companies in other countries are running into problems in the United States because such mergers are barred under U.S. law.

"On the market side, you clearly have an expansion in the scope of activity by financial institutions within the legal framework, such as mergers between banks and insurance companies.

"Expansion of activities across segment lines is one of the major issues at foreign financial institutions in the 1990s and even more in the future."

Bleak Outlook

Although fairly optimistic about possibilities for progress on tax-related issues that pose a problem for foreign banks, Mr. Brecher said he was pessimistic about any immediate changes in U.S. legislation that could facilitate foreign banks' operations in the United States.

"U.S. regulations are clearly an obstacle to trends that are developing elsewhere," Mr. Brecher said.

"And I don't see the Clinton administration feeling any strong pressure to change that environment."

"If nothing does change," he added, "you may well have foreign banks relinquishing their U.S. banking licenses."

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER