Although Congress has rejected the broad banking reform package proposed by the administration early this year, it enacted comparatively narrow legislation - the Federal Deposit Insurance Corporation Improvement Act of 1991 - on Nov. 27.

The act contains numerous provisions of particular interest to Japanese and other foreign commercial banking organizations that have representative offices, agencies, branches, commercial lending offices, or banking subsidiaries in the United States.

Although it is impossible to predict all the ways this act will affect foreign banks, some trends are visible. The BCCI and Banco Nationale scandals have motivated U.S. banking regulators, particularly the Federal Reserve Board, to increase general oversight of foreign banks and to become more inquisitive - if not, in fact, suspicious - about the activities and ownership structure of foreign banks.

For foreign banks, at least, the 1990s are likely to be an era of heightened and more intrusive regulation by U.S. banking regulators.

Many elements of the reform package that would have affected foreign banks in general, and Japanese banks in particular, have not been enacted into law. These include:

* Various provisions requiring foreign banks to roll up their branches in order to take advantage of new powers or to branch interstate.

* Termination of grandfathered securities affiliates.

* Elimination of the exemption from registration under the securities laws for securities issued by branches, the Fair Trade in Financial Services Act, and elimination of the bank exemption from the broker registration requirement of the securities laws.

Some of these proposals, however, are hardy Washington perennials. The fact that they have failed to pass during this congressional term is no assurance that they will not return during a future session.

In particular, the conferees agreed that the Fair Trade in Financial Services Act would be reconsidered during the next congressional session. Moreover, the requirement to conduct a study on the desirability of a general branch office roll-up will keep this idea on the legislative and regulatory agenda.

The improvement act contains numerous provisions inspired by the BCCI scandal and designed to heighten the oversight of foreign banks.

Capital Restoration

The act mandates adoption of a capital-restoration plan whenever an insured depositary institution becomes "undercapitalized." To be accepted by the regulators, this plan must be guaranteed by any "company having control" of the insured depository institution until such time as the insured institution has satisfied all applicable capital standards for four consecutive quarters.

The act limits the aggregate liability of the controlling company to the lesser of 5% of the depository institution's total assets at the time it became under capitalized or "the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards with respect to such institution as of the time the institution fails to comply with a plan under this subsection."

If the controlling company cannot or is unwilling to guarantee the capital-restoration plan, it may - among other things - apparently be required to divest itself of the insured bank or to forego paying dividends.

The controlling company capital restoration liability will concern foreign banks that intend to make either minority or controlling investments in United States bank holding companies. Certain investments, which are intended to be passive minority investments - from the perspective of the foreign bank - may be deemed to be "controlling" investments by the FDIC.

The Federal Reserve Board gives a broad meaning to the word "control." It may determine that a company controls a bank even in circumstances in which that company directly or indirectly owns or controls much less than 25% of the capital of that bank.

If the FDIC takes a position on the meaning of control as aggressive as that of the Federal Reserve Board, certain minority investments - particularly those that near 20% or involve board representation, could subject the foreign investor to controlling company capital restoration liability.

Accordingly, it may be sensible for a foreign investor contemplating a direct or indirect minority investment in a U.S. bank to explore with the FDIC the possibility of relief from such liability, even though the act does not give the FDIC any explicit authority to grant waivers.

With respect to majority investments or wholly owned United States banking subsidiaries, the controlling company capital restoration provision of this act changes what may be seen to be a business imperative to restore the capital of a banking subsidiary into a legal obligation. The foreign bank parent may find that the holding company capital restoration liability is a material contingent obligation requiring disclosure in prospectuses and listing applications.

Section 3 Applicability

Under current law, foreign banks that operate in the United States only through branches, agencies, or commercial lending companies are treated as if they were bank holding companies for purposes of restrictions on nonbanking activities contained in the Bank Holding Company Act of 1956. But they have heretofore been exempt from restrictions on acquisition of bank stock contained in the holding company act.

Under the improvement act, however, foreign banks that operate in the United States only through branches, agencies, or commercial lending companies are specifically made subject to the provisions of the holding company act governing the acquisition of bank stock.

The full significance of this provision will only become apparent with the passage of implementing regulations by the Federal Reserve Board. One certain result is that foreign banks will be required to obtain the Federal Reserve Board's approval before acquiring - directly or indirectly - more than 5% of the voting shares of any domestic bank or bank holding company.

To obtain approval, such foreign banks will be required to file applications with the Federal Reserve Board. These applications could take several months to process and would require foreign banks to divulge considerable information about worldwide operations.

In addition, the holding company act, as amended by the improvement act, would require two foreign banks, each of which has an office in the United States, to obtain the Federal Reserve Board's approval before merging in their home countries. It is entirely possible - but not certain - that the Fed would require something less than the full-blown application process in these circumstances.

The improvement act requires the Fed to disapprove any acquisition or merger if the foreign bank does not give adequate assurance that it will provide information on its operations and activities - and those of its affiliates - or is not subject to comprehensive supervision or regulation, on a consolidated basis, by the appropriate authorities in the foreign bank's home country. The act also places a similar requirement in the standards for approving an acquisition of a savings and loan under the Home Owners' Loan Act.

Deposit Limitations

The improvement act requires foreign banks that accept or maintain retail deposits of less than $100,000 to operate solely through an insured United States banking subsidiary. It remains unclear whether the regulators will continue to permit uninsured domestic branches to accept wholesale deposits of less than $100,000, as they are currently permitted to do. Branches that are currently insured are exempt from this limitation.

State Activities

The act prevents state branches and agencies from taking advantage of broader powers afforded under certain state laws. Beginning one year after enactment, a state branch or agency must limit its activities to those allowed to a federal branch.

Since, under current law, federal branches may engage only in activities permissible for a national bank, this provision would limit state branches and agencies to the activities of national banks.

However, a state branch or agency may engage in an activity not otherwise permissible for a national bank if the Federal Reserve Board determines that the activity is "consistent with sound banking practice" and, in the case of an insured branch, the FDIC determines that the activity would pose no significant risk to the insurance fund.

Foreign banks with state branches or agencies will be required to examine their operations for various activities that had previously been determined to be in conformity with state law. They will now be required to make sure that they were in conformity with the new requirement. In many cases, we predict that these will prove to be less flexible than state law.

In many cases, activities that have been or could be carried out consistent with state law will be precluded, either because it will not make economic sense to apply to the Federal Reserve Board or the FDIC for the relevant determination or because the Fed or the FDIC would decline to approve that activity - either for policy reasons or because of simple bureaucratic inertia.

Loans Secured by Stock

Under current law, domestic banks and their holding companies are required to report any loans to (or guarantees and letters of credit for the account of) a person or group of persons acting in concert that are secured by 25% or more of the shares of an insured bank. The Federal Reserve Board is likely to interpret this provision to also cover the stock of a bank holding company.

The improvement act requires foreign banks with United States branches, agencies, or commercial lending subsidiaries to report to the appropriate Federal banking agency any loans which, when aggregated, are secured by 25% or more of the stock of any United States bank.

For purposes of calculating whether 25% or more of the stock is secured by the loan, the foreign bank must include any stock held by it or by any affiliate. The act provides that the lender need not report the loan if the borrower discloses the amount borrowed to a federal banking agency, the borrower has been record owner of the stock for more than one year, or the stock used to secure the loan is of a newly chartered bank.

Representative Offices

Under current law, foreign banks may open a representative office, a state-supervised agency, a state-chartered branch, or a commercial lending company in the United States solely upon any necessary approval of the appropriate state regulator.

The improvement Act requires the Federal Reserve Board, in addition to the appropriate state regulator, to approve the opening of a representative office, a state-supervised agency, a state-chartered branch or a commercial lending company subsidiary in the United States.

In evaluating a foreign bank's application for approval, the Fed could consider whether:

* The foreign bank engages directly in banking outside of the United States.

* The foreign bank is subject to comprehensive supervision or regulation on a consolidated basis by the appropriate authorities in its home country.

* The home country regulator has approved the foreign bank's United States office.

* The financial and managerial resources of the foreign bank - including the competence, experience, and integrity of the bank's officers, directors and principal shareholders.

* There are adequate assurances with respect to the availability of information to the Federal Reserve Board.

* The foreign bank and its affiliates are in compliance with United States laws.

The act specifically authorizes the Federal Reserve Board to "impose such conditions" on its approval as it deems necessary. Although it is difficult to predict what types of conditions the Fed will impose, such conditions are virtually certain to be onerous from the point of view of foreign banks. And they are likely to be more onerous than those heretofore imposed by the states.

The authority to require adequate assurances with respect to information provides the Federal Reserve Board with virtually unlimited discretion to extract worldwide information from foreign banks with only a minimal presence in the United States. Although it is dificult to predict how the Fed will exercise this new power, there is a significant possibility that, following BCCI, the Fed staff will be quite aggressive in the type and breadth of information it requests from foreign banks.

Termination Authority

Under current law, federal banking agencies have no power to terminate the license of a representative office, an state-supervised agency, a state-chartered branch, or a commercial lending company subsidiary of a foreign bank.

The improvement act authorizes the Federal Reserve Board to close a representative office, an agency, a state branch, or a commercial lending company subsidiary, if there is reason to believe that the foreign bank - or any of its affiliates - has violated U.S. law or engaged in an unsafe or unsound banking practice.

Closing would be triggered if, as a result of these acts, continued operation of the representative office, agency, branch, or commercial lending company subsidiary would be inconsistent with the improvement act, the holding company act, or the Federal Deposit Insurance Act.

The Federal Reserve Board may, if it determines that expeditious action is necessary to protect the public interest, close a foreign bank's representative office, agency, branch, or commercial lending subsidiary without a hearing.

Under the improvement act, the Federal Reserve Board may recommend to the Comptroller of the Currency that a federal branch or agency be terminated if the Fed "has reasonable cause to believe that such foreign bank or any affiliate of such foreign bank has engaged in conduct" for which the Fed could terminate the activities of a state branch or agency.

The act requires the Comptroller, when considering an application to open a federal branch or agency, to consider any conditions that the Fed has imposed on the opening of state-supervised agencies or branches. It is unclear from the text of the act whether the conditions referred to are intended to be regulations of general applicability or any conditions that the Fed may have imposed on the particular foreign bank applying to open a federal branch or agency.

Finally, the act requires the Comptroller to afford the Fed with the opportunity to comment on any application by a foreign bank to open an additional federal branch or agency.

Examination Authority

Under current law, the Federal Reserve Board is required "insofar as possible" to use the examinations of the Comptroller, the FDIC, or the appropriate state regulator when supervising and examining a foreign bank's branches, agencies, or commercial lending subsidiaries. The 1991 improvement act authorizes the Fed to examine such offices, but directs it to coordinate its examinations with the Comptroller, the FDIC, and the appropriate state regulator.

The improvement act also extends the Fed's examination power to representative offices, state-supervised agencies, state-chartered branches, and subsidiaries of a foreign bank. Each branch of agency of a foreign bank will, under the act, be subject to an on-site examination at least every 12 months.

Subpoena Power

The act allows appropriate federal banking agencies, during the course of applications, investigations, or examinations under the International Banking Act, to administer oaths; take depositions; and issue, revoke, quash, or modify subpoenas. Failure to obey a subpoena from a federal banking agency would be subject to criminal penalty.

In general, these provisions bring the federal banking agencies' subpoena authority - applicable to foreign banks that are not bank holding companies - in line with the subopoena authority applicable to domestic banks and bank holding companies.

Home-Country Sharing

Federal banking agencies now have authority to disclose information, obtained in the course of exercising supervisory authority, to foreign bank regulatory or supervisory authorities - if the relevant federal banking agency determines that such disclosure is appropriate and will not prejudice the interests of the United States.

Before disclosing any such information to a foreign counterpart, the relevant federal banking agency is required to obtain the foreign authority's agreement to keep such information confidential "to the extent possible under applicable law."

Increased Civil Penalties

The improvement act increases the civil penalties for violations of the International Banking Act. Any foreign bank or any officer of a foreign bank that participates in any violation of the International Banking Act may be fined up to $25,000 a day.

The improvement act creates three tiers of civil penalties for failure to file reports or for filing false or misleading reports with the Federal Reserve Board or the Comptroller. Under the first tier, a foreign bank may be fined up to $2,000 a day for a late report or unintentional error in a report.

Under the second tier, a foreign bank may be fined up to $20,000 a day for late, false, or misleading reports. Under the third tier, a foreign bank may be fined up to $1,000,000 a day, or 1% of its total assets (whichever is less), for purposeful or reckless errors in any report.

Criminal Penalty

Furthermore, the Federal Reserve Board may assess those civil penalties against a director or officer of a foreign bank up to six years after that person leaves the bank. In general, these provisions bring the civil penalties applicable to foreign banks which are not bank holding companies in line with the civil penalties applicable to bank holding companies.

The improvement act imposes a criminal penalty on any foreign bank officer who - with the intent to deceive, to gain financially, or ot cause financial gain or loss to any person - knowingly violates any provision of the International Banking Act or any regulation or order issued by the Federal Reserve Board.

A person convicted under this provision may be imprisoned up to five years and fined up to $1 million for each day that the violation continues - or both. Like the subpoena authority and the civil penalties, this provision generally brings the criminal penalties applicable to foreign banks that are not bank holding companies in line with the criminal penalties applicable to bank holding companies.

Capital Equivalence

Within six months, the Federal Reserve Board and the Secretary of the Treasury must submit to the House and Senate banking committees a study analyzing the capital standards of the Basel Accord and establishing guidelines for determining whether a foreign bank's capital is equivalent to the capital standards imposed on U.S. banks.

Within one year, the Treasury, the Federal Reserve Board, the Comptroller, and the FDIC must also report to the House and Senate banking committees on whether foreign banks should be required to conduct banking operations in the United States through subsidiaries. The effect of this requirement is to keep both concepts - capital equivalency and a general branch office roll-up - on the legislative and regulatory agenda.

Consumer Provisions

One provision added to the Foreign Banks Supervision Enhancement Act during the closing moments of the conference subjects foreign banks that are not bank holding companies to numerous consumer protection statutes. In very general terms, it appears that such foreign banks will be subject to the Home Mortgage Disclosure Act, the Truth in Lending Act, the Fair Credit Reporting Act, the Equal Credit opportunity Act, the Fair Debt Collections Act, the Electronic Funds Transfer Act, and the Expedited Funds Availability Act.

These consumer provisions should primarily affect the branches and agencies of foreign banks that deal with retail consumers. A U.S. banking subsidiary of a foreign bank is already subject to these provisions.

Finally, branches and agencies of foreign banks have been made subject to the provisions of the Federal Trade Commission Act that protect consumers against unfair and deceptive practices. Henceforth, the consumer affairs division of the Comptroller will respond to consumer complaints about federal branches and agencies. The consumer affairs division of the Federal Reserve Board will respond to consumer complaints about state branches, agencies, and commercial lending organizations; a similar division at the FDIC will deal with consumer complaints about insured branches.

During the next few months, federal banking agencies can be expected to promulgate regulations interpreting and applying these provisions.

As mentioned above, it is not possible to foresee all of the ways this new legislation will be applied. but it is clear that foreign banks should expected greater scrutiny than has been the case in the past.

EDWARD J. KELLY III

Member Davis Polk & Wardwell Washington, D.C.

Edward J. Kelly III is an attorney who advises clients in the areas of bank regulation, bank mergers and acquisitions, bank securities offerings, and legislative and other policy developments affecting banks.

Mr. Kelly joined Davis Polk & Wardwell in 1983 and was named a partner in 1988. He was law clerk to Associate Supreme Court Justice William J. Brennan Jr. In 1982-83, prior to his admission to the District of Columbia Bar in 1984.

He earned his bachelor's degree in English from Princeton University in 1975 and his law degree from the University of Virginia in 1981.

Mr. Kelly's most recent publication was a memorandum, "Early Intervention," reprinted in the Congressional Record on Sept. 25, 1990. In 1987 he made a statement to the Senate Banking Committee on reform of the Glass-Steagall Act on behalf of J.P. Morgan & Co.

Also in September 1990, Mr. Kelly served as a member of the Financial Services Volunteer Corps mission to Hungary.

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