WASHINGTON - The unfolding scandal at Daiwa Bank Ltd. may force the Federal Reserve Board to take the unprecedented step of revoking the Japanese institution's New York branch license, banking attorneys say.
"It is entirely possible if the Fed thinks it was misled that it would take that kind of stringent action," said one attorney. Others agreed.
In 1991, the Fed acquired the power to yank the license of a foreign branch if it breaks U.S. laws, but it has never done so.
To be sure, the Fed has other options. It could fine Daiwa or temporarily suspend its right to operate a branch in this country. But the attorneys said they expect the Fed to take a harder line.
"In cases that have generated widespread public interest, they have been very vigorous in pursuing the wrongdoers," said the first attorney.
The Fed may "want to make a very clear example out of them to get the attention of the rest of the foreign bank community," a second lawyer asserted.
A third banking attorney said that the fact that the Fed got its license-revocation power in 1991 "as an explicit grant of authority" makes license termination more likely.
The lawyers, who said they feared their practices would be damaged if their names were used, also said they expect the Fed will crack down on yet other foreign banks.
Fed officials wouldn't comment on their enforcement plans. And a New York-based spokesman for Daiwa would not comment beyond saying the bank is cooperating with investigations by the Fed and law enforcement officials.
Pulling Daiwa's license could be the surest way for the Fed to restore its reputation as a capable foreign bank regulator - a question the central bank thought it had put behind it after the Bank of Credit and Commerce International debacle in the early 1990s.
The Daiwa case, however, has rekindled the debate. Senate Banking Committee Chairman Alfonse D'Amato and Fed Chairman Alan Greenspan discussed the need for changes in foreign bank supervision during an Oct. 19 phone conversation and again Oct. 20 at a meeting of the Italian- American Foundation.
Daiwa could lose its license not because bond trader Toshihide Iguchi's allegedly covered up $1.1 billion in trading losses, the attorneys said.
Rather, Daiwa is in deep trouble because it appears to have lied to the Fed in 1993 about separating its front- and back-office activities. Recent reports indicate the bank never imposed those Fed-mandated controls. Also, top bankers in Japan allegedly ordered Mr. Iguchi in July to continue to cover up his losses while they determined how to handle the crisis. But then they feigned ignorance when the story first broke.
"For that reason, I'd be very surprised if they don't come down very hard on Daiwa," the second attorney said. This is the stuff for which I think a license termination would be appropriate."
The lawyers cited another reason why the Fed may revoke Daiwa's branch license. Daiwa, like all foreign branches, has a dual allegiance to the Fed and its home-country's regulator.
The bank chose to notify the Japanese Ministry of Finance six weeks before the Federal Reserve Bank of New York was notified.
"If they don't come down on them hard, then the thinking will be that they are tolerating this kind of behavior," the second attorney said.
The Daiwa development "is going to force the regulators to redouble their efforts to extract a pound of flesh from these people and not give them any special considerations," said a fourth attorney, who also requested anonymity.
While observers expect a powerful Fed response, they also said the central bank was caught in an impossible situation.
"Bank supervision is not built on the theory you are dealing with criminals," said Michael Bradfield, a former Fed general counsel and now a partner here at Jones, Day, Reavis & Pogue.
Examiners are trained to detect potential risks to the bank's health, whether they are loan problems or management practices. That is exactly what the Fed did here, Mr. Bradfield said.
Some observers, however, said the public has a right to expect more from examiners.
Paul Pilecki, a partner at Shaw, Pittman, Potts & Trowbridge in Washington, agreed examiners can't detect every crime. But when they do identify a problem - as happened here - they must make sure it is corrected.
"What is surprising to me is that they did not go back and verify that the change had been made," he said. "That is the customary step."
New York Fed spokesman Peter Bakstansky refused to comment on this criticism.