Fallout from Daiwa May Put Squeeze on Foreign Banks in U.S.

WASHINGTON - The regulatory backlash from the Daiwa Bank debacle may force some foreign banks to shut down their U.S. branches, according to consultants and lawyers.

Regulators are considering adding internal and external audit requirements, increasing on-site inspections, and enhancing their reviews of securities trading activities.

These measures would increase the cost of business for many foreign bank branches, said Karen Shaw Petrou, president of the industry consulting firm ISD/Shaw Inc. Many smaller foreign bank branches, which essentially act more as concierge offices than banks, would not be able to afford the increases, she said.

"Those will close," she predicted.

Some bigger banks, however, are still beefing up their presence here. The $527 billion-asset Sumitomo Bank of Osaka, Japan, for instance, asked the Fed on Dec. 13 for permission to acquire Daiwa's U.S. operations, which federal regulators ordered shut by Jan. 31.

But smaller branches may not be able to absorb the additional costs, according to analysts and consultants. The increased regulatory costs would be the second major hit on the books of Japanese bank branches here, said Eugene Sherman, an analyst with M.A. Shapiro & Co. The financial markets already force these branches to pay higher rates for dollars because Japan has such a shaky banking system, he said.

"Cost factors may force them to scale back," agreed Bert Ely, a consultant based in Alexandria, Va.

Foreign banks operate 567 branches and offices in the United States, controlling 21% of U.S. banking industry assets. Though exact figures were not available, Federal Reserve Board data indicate that approximately 10% of the foreign bank branches here control less than $10 million in assets each.

Mr. Ely said he suspects that many of these small foreign bank branches suffer from the same weak internal controls that brought down Daiwa. Federal and state regulators ordered Daiwa to close its U.S. branch in November after the bank admitted it failed to promptly inform the Fed that illegal trades had led to more than $1.1 billion in losses.

Those disclosures, and the fact that the trader supervised himself, prompted two congressional hearings and pledges from regulators to increase supervision of foreign bank branches.

Still, analysts said, the closings will not occur overnight.

"The Japanese, as a business practice, have been willing to incur costs to establish a presence in the market and to maintain share," Mr. Sherman said. "So simply incurring a premium and paying for examination costs would not necessarily lead to prompt closings."

Steven M. Lucas, a partner at Winston & Strawn who represents foreign banks, agreed. "You may see individual institutions" shutting down, he said. "But it won't be a stampede."

New York is such an important market that many foreign banks will swallow a loss to maintain a presence, he said.

Cynthia Glassman, a consultant with Furash & Co., said small offices with strong internal controls won't be that costly to maintain.

"If an office isn't doing much, there isn't a lot to audit," Ms. Glassman said. "How expensive can it be?"

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