NEW YORK - Increasingly burdensome regulations, taxes, and capital requirements are prompting many foreign banks to reconsider their operations in the United States, according to senior executives with Ernst & Young.

If such burdens increase and foreign banks cut back on their U.S. operations, capital flows to this country might be reduced, the executives also suggested.

"We're seeing a lot less expansion by foreign banks in this market," said Forrest "Bud" Ward, national director, financial services industries, at the New York-based accounting firm.

"One reason is regulatory, a second is capital requirements, and a third is taxes," Mr. Ward said.

"There's very clearly an added cost developing to doing business in the United States."

Discouraging Factors

Among the key issues now confronting foreign banks are:

* Expanded authority for U.S. regulators to examine a banks U.S. and worldwide operations.

* Reluctance to allow grandfathering of existing activities.

* Tougher demands for internal controls, written operating procedures, and new policies for managing credit exposure and interest rate risk.

* Less flexibility for regulators for interpreting legal requirements.

* Increased willingness by regulators to take legal action in the even of disagreements or noncompliance with regulations.

Mr. Ward attributed the increasing regulatory and tax burden to specific changes in legislation, such as Congressional approval of the Foreign Bank Supervision Enhancement Act, and to general measures intended to strengthen banks' capital and improve tax revenues.

However, he and other executives stressed that much of the legislation and the tax code has been designed for U.S. banks and does not take into account the fact that most foreign banks operate here through subsidiaries and have been running their operations according to home-country guidelines, not those of the United States.

Tough Capital Standards

In particular, they noted, U.S. guidelines requiring banks to have capital above the levels set by the Bank for International Settlements is making it more difficult for foreign banks to enter or expand in the United States.

The U.S. rules call for banks to have a total capital equal to 10% of risk-weighted assets in order to be considered well capitalized. That includes a ratio of 6% primary equity to risk-weighted assets.

The two U.S. minimum capital requirements compare with 8% and 4%, respectively, under international guidelines set by the Bank for International Settlements.

De Facto Barrier

"The U.S. first sought an international benchmark and then turned around and added higher capital standards in the 1991 banking act," noted James J. Fanning, a partner with the firm and specialist in international banking. 1 Executives with the firm added that although this does automatically exclude a foreign bank from entering the U.S. market, regulators have in practice declined to approve an application from a foreign bank if it fails to meet U.S. standards.1 One of the most difficult issues confronting foreign banks, the executives added, is how to comply with U.S. reporting requirements mandated under the 1991 banking act, which placed foreign banks under the supervision of the Federal Reserve Board.

Extra Costs

The net effect of the legislation, they said, has been to considerably step up exams of foreign banks and require them to have the same documentation and controls in place as U.S. banks.

"The legislation has added costs," the Ernst & Young official noted.

"Foreign banks have gone from a situation where they had a regulator familiar with their operations to one where they have regulator unfamiliar with their operations and with a different set of criteria," he added.

"The upside is that this gives foreign banks a mechanism to evaluate their operations as a cohesive unit," said Christopher Maher, manager in charge of regulatory consulting issues.

"The downside is that there is a long examination process and there are problems coordinating supervision and exams by the Fed and state banking authorities and Office of the Comptroller of the Currency."

Tax-Related Regulations

Executives stressed that alongside regulatory issues, tax-related rules are becoming increasingly burdensome for foreign banks and constraining their growth in the United States.

"The tax system is not favorable to unincorporated entities like foreign bank branches and is curtailing their ability to expand," said Jack Wilson, Ernst & Young's national director for tax service in the financial industry.

"When the cost gets to the point where the risk-reward ratio is not there, many are going to rethink the nature of their U.S. presence."

"In fact," he added, "there's a selective reconsideration already under way."

Ernst & Young executives declined to disclose the names of any foreign banks that are currently reassessing their presence here, but said foreign banks with U.S. retail operations have been especially hampered by new regulatory and tax codes.

Uncertainty over possible additional changes in regulatory and tax codes is also deterring foreign banks from seeking to expand here, they added.

"No sooner do foreign banks think they've understood everything then Congress goes ahead and changes the rules of the game," Mr. Ward said.

The international tax expert warned that foreign banks are worried not only about changes that might come in the future, but also about retroactive changes, such as elimination of foreign banks' grandfathered right to deduct interest expense on loans from their foreign parent company or borrowings that are guaranteed by the foreign parent, or trades done with a foreign parent to hedge a position with a third party.

"The people who are writing the regulations don't understand how banks do business internationally," Mr. Wilson said.

"Trying to apply U.S. tax concepts to foreign banks only creates an opportunity for an extreme lack of national treatment."

Danger Seen for U.S.

Current trends could put the United States at an economic disadvantage, Ernst & Young believes.

"It's logical that we will continue to see a contraction [in foreign banks activities], but if foreign banks are deterred from entering the United States, the retaliation will come from the market place," Mr. Ward said.

"Capital flows to where it can earn a return, not to where it will be lost."

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