The German government proposed legislation earlier this year that would impose a reciprocity requirement on foreign banks.

Ironically, the legislation is intended to implement the Second Banking Directive of the European Community, even though it constitutes a substantial deviation from the community's decision in 1989 to accept a national-treatment standard.

The legislation is now in final form and will become effective Jan. 1. These comments are based on the last version to receive public review.

A Positive Approach

The rules give foreign banks from outside the community branching rights equivalent to those permitted for European banks in Germany.

This is a very positive step because it would mean that a foreign bank from a country outside the community could operate a branch in Germany without having to capitalize the branch separately.

In addition, regulation of the branches of a foreign bank, in keeping with European standards, is left to the home country. Yet the branches of U.S. banks in Germany are regulated by German and U.S. agencies.

With respect to Germany, such regulation includes, for example, large credit limits based upon the separate capital of a foreign bank's branch and a complex set of regulations that foreign banks find onerous.

Unfortunately, however, the reciprocity requirement, strictly applied, could prevent U.S. banks from enjoying the benefits of the new legislation.

Agreements Required

The legislation amends the German Banking Act by adding a new section 53c that requires a bilateral agreement between Germany and any country outside the European Community whose banks seek to enjoy "complete or partial" community-like branching rights.

The bilateral agreement must meet three requirements:

* Foreign banks from outside the community must be subject to banking supervision in their home country equivalent to German supervision.

* German banks must enjoy rights "on the basis of reciprocity" in the home country of the foreign bank that are equivalent to the branching rights under German law.

The supervisory authorities in the home country of the non-European Community bank must be prepared to cooperate with the German Banking Supervisory Office "in accordance with the principles" of the Second Banking Directive.

The German secretary of finance has the authority under the legislation to issue implementing regulations.

The first and third requirements are not likely to present problems for U.S. banks. As to reciprocity, there are a number of issues.

German banks currently enjoy substantial branching rights in the United States. As with domestic banks, however, those rights are limited by restrictions on interstate branching. Foreign banks have branches in the important commercial centers but cannot establish new branches outside their U.S. home states.

Moreover, U.S. regulators impose other requirements on the branches of foreign banks that are not imposed in Germany.

More U.S. Regulation

Even more fundamentally, U.S. regulators have increased the level of regulation of foreign banks, including their branches, in the past year following enactment of the Foreign Bank Supervision Enhancement Act.

Also with respect to this principle, the branches of foreign banks in the United States are subject to single-borrower lending limits, albeit on the basis of their worldwide capital. But the European Community requires that large exposures be regulated by the home country.

Finally, some U.S. states do not permit foreign bank branches at all. Thus, strict application of a reciprocity standard, even if limited to branching by German banks in the United States, could present serious questions for U.S. banks seeking the new German branching rights.

A national-treatment standard would not pose the same problem because German and other foreign banks are essentially treated the same as U.S. banks in this country.

Europe adopted a national-treatment standard in the Second Banking Directive in 1989, with respect to the subsidiaries of foreign banks chartered in the community's countries. Community officials are on record as having said that the United States offers national treatment to the community's banks.

This policy judgment has been made by the community even though it has lobbied for changes in U.S. laws that limit foreign bank activities in the United States, including interstate branching and securities dealings.

An even greater problem is that the reciprocity test in the German legislation is vaguely worded and could be read to require reciprocity for the full range of banking powers granted to universal banks in Germany.

Tougher Situation

In that case, U.S. banks would have a much bigger problem meeting the reciprocity standard because of the limited securities and other powers enjoyed by banks in the United States and because of prohibitions or limitations in some states on the entry and powers of foreign banks.

The German legislation looks like a deviation from the European Community's decision to accept national treatment as sufficient to grant communitywide banking powers to subsidiaries of banks from outside the European Community.

The law seems to have been developed without sufficient thought about its possible serious consequences.

The problems can be rectified easily, however, through the way the legislation is implemented. Indeed, the German banking law has contained a reciprocity requirement for years that has not been enforced.

There is still time for foreign banks active in Germany and U.S. government officials to ask the German government to respect to the European policy of national treatment.

German enforcement of a pure reciprocity standard would be a precedent for other countries to impose restrictions on cross-border financial-services activities. That development would poorly serve customers, banks, and the liquidity of international financial markets.

Therefore, the German government should be encouraged to implement the reciprocity provision by employing a national treatment standard, essentially as the European Community has done. This approach would cause the fewest problems for foreign banks and would be the most consistent with international practice.

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