INTERNATIONAL BANK SUPERVISION HAS LONG WAY TO GO

Geneva 16 Sep (Chakravarthi Raghavan) -- Despite the 'real progress' made since the mid-1970s under the auspices of the Basle committee on supervision of the international private banks, "there remains a long way to go before such a system of supervision is in place", according to the UN Conference on Trade and Development.

In its just published Trade and Development Report, 1992, the UNCTAD secretariat has underscored the connection between effectiveness of bank supervision and the prudential side of policies of countries towards right of establishment for foreign private banks and the framework for global financial liberalisation (pushed in the Uruguay).

The negotiations on financial services in the Uruguay Round have been concerned with the opening up of national banking markets to international competition and the harmonisation of national regulatory regimes to prevent them from being a source of unfair advantage in competition.

Until initiatives for international banking supervision have become comprehensive and are genuinely effective in practice, there would be continued reluctance on the part of many countries to accept substantial restraints on policy autonomy over right to refuse market access on prudential grounds, UNCTAD says, in a comment on the efforts in the Uruguay Round to liberalise financial services and secure curbs on national regulations.

While the Uruguay Round effort is a multilateral exercise, and theoretically gives a voice to all the participating countries, the question of prudential supervision, an important concomitant of the liberalization drive, is dealt with still only in a small group of countries, whose functioning and the negotiations among them is even less transparent than the GATT and Uruguay Round negotiations.

The UNCTAD report has sought to throw some light on the prudential regulations side, though giving some good marks for the Basle Committee and the bank regulators - a view that the numerous victims of the BCCI would find it difficult to agree with, particularly in the light of the information unravelling in courts and elsewhere about the extent to which some of the major countries and their banking regulators and/or other parts of the governments of these countries, as well as auditors, were aware of the problems and suspicions of fraud in the operations of the BCCI but kept quiet for various other reasons, including the use of the BCCI by intelligence agencies for their own purposes.

The Indian stock-exchange scam scandal, involving several Indian and leading foreign banks, have also raised other questions, including how far the parental authorities who would frown on dubious transactions in violation of strict banking regulations tolerate or keep quiet over similar activities abroad, and its implications for liberalisation of banking and financial services.

The 1975 Basle Concordat was put in place for delineating distribution of supervisory responsibilities for foreign banks - distinguishing between branches which were integral parts of the foreign parent bank, subsidiaries which are legally independent and incorporated in the host country (but controlled by one foreign bank) and joint ventures which are incorporated in the host country as legally independent entities but controlled by two or more parent institutions.

The Basle Committee itself was set up as a response to the 1974 failures of the Bankhaus I.D.Herstatt and the Franklin National Bank.

The 1975 Concordat acknowledged (though it did not act) the gaps in supervision because of structure of the international banking system of some entities (which may be banks in the parent but not host country or lack of supervision in the host country) as also need for exchange of information between supervisory authorities.

This last faced, and still faces, impediments because of the banking secrecy laws of host countries.

The limitations of the 1975 concordat soon became evident, and the concerns about its weakness was given a further fillip following the collapse of Banco Ambrosiano in the summer of 1982, when the Italian authorities protected the interests of Italian depositors by transferring the bank's business to a new Italian entity, while disclaiming responsibility for the obligations of its Luxembourg subsidiary and the Latin American subsidiaries.

The revised Basle Concordat of May 1983, UNCTAD says, tried to meet the perceived weaknesses, and the problems posed by divergent supervisory standards and complex structures of many international banking groups.

The 1983 Concordat, like its 1975 predecessor, sought to underline the importance of exchange of information between national banking supervisors and need for speedy communication between host and parent authorities of information concerning serious problems in any part of a banking group.

This led to further work and the 1990 supplement on information flows between supervisors and recommendations on the relations between prudential considerations and grant of market access.

This last, gave special attention to situations where the host or parent authority are dissatisfied about the way the supervisory responsibilities are being discharged in practice. Where an entity requesting banking licence is either not subject to prudential supervision in a parent country or is a joint venture with no clear parental authority, the host country is advised to give market access only if it is able to exercise a parental role and check with the home country authorities about any objections relating to the entity.

The 1983 Concordat and supplement also recognized impediments posed to coordinated banking supervision by secrecy laws and urged review and amendment of these laws subject to strict safeguards that information disclosed is used only for purpose of prudential supervision in host country. It also dealt with the issue of external auditing, and called ideally both parent and foreign entity being audited by same firm or the auditor of the parent having access to audit papers of the foreign entity.

On the issue of quality of auditors, the supplement expressed a preference for internationally qualified firms with experience of banking audit in the country of the banking entity.

Thought the report is silent on this, as brought out in the case of the BCCI and the role of the auditors, the fact of Price Waterhouse being an internationally qualified auditors of repute, and the fact that they shared after a while their information and suspicions with the Bank of England, did not result in the host countries becoming aware of the problems connected with BCCI. The Basle Concordat and supplement placed no reciprocal obligations on the parent authority to the host country authorities.

The report however says: "It would be optimistic to expect that, in the face of the possibilities for concealment furnished by financial innovation and by complex corporate structures spanning several countries, deliberate fraud by upper management of international banks can be rendered invariably susceptible to speedy discovery."

The report also analyses the Basle committee's efforts in dealing with the growing banking risks due to the competition among banks and use of a variety of financial instruments and off-balance- sheet exposures (including futures and options in an increasing number of currencies and interest rates), as also the new requirements for adequate capital standards, the problems created by money laundering and the attempts to address them.

"As in other areas...banking secrecy and customer confidentiality are potential impediments to the achievement of (the Basle Committee's) objectives," says the UNCTAD report. The Basle committee's recommendations were endorsed by the task force of the Group of 15 on money laundering, set up after the G7 1989 Summit declaration, urging banks to notify law enforcement agencies of suspicious activities by customers.

"Implementation of the recommendations would require changes in the laws concerning banking secrecy in many countries," UNCTAD comments.

Independently, the parental authorities were also given the responsibility of preventing banks in their jurisdiction from undertaking unsuitable expansion abroad.

The Report has also examined the evolution of international bank supervision through the functioning of the Basle Committee (comprising Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, the United Kingdom and the United States) from the 1975 concordat through its various changes in reaction to the Banco Ambrosiano affair of 1982 to the latest BCCI (Bank of Credit and Commerce International) scandal of 1991.

The report also examines the relations of the Basle Committee with other supervisory groups elsewhere (Offshore group, Latin America and Caribbean, the EC supervisors and the SEANZA forum).

On the BCCI case, the report points to the acquisition by BCCI of the First American Bankshares as illustrative of how opportunities for concealment furnished by a global banking network can be used to evade a country's banking laws and frustrate regulatory oversight, and information available to other authorities were concealed from the US Federal Reserve. The Luxembourg authorities had not been prepared to exercise supervision on a consolidated basis on the BCCI and the Bank of England had been unwilling to become the BCCI's principal supervisor. While ultimately, in 1988, a college of eight regulators were set up, "it does not seem to have provided the required control over BCCI owing to the dilution of supervisory responsibilities."

Underlining the wide range of subjects needed to be covered by a supervisory regime for international banking as well as difficulties of applying such a regime requiring 'non-routine' coordination by national supervisors, UNCTAD says that while the Basle Committee process might seem exceedingly slow, "such slowness is inevitable owing to the technical complexity of the Committee's work and the divergences among national systems of regulation and supervision."

The unfinished agenda of an effective system of international governance and supervision of banking, the Report says, is already long and could be expected to expand in response to continuing innovation in financial techniques and development of information technology.

These include: implications for banking supervision of the BCCI affair and regulation of, and improvements in internal controls of banks over trading risks and the scope and harmonization of national instruments for deposit insurance and assignment of rights and responsibilities in the case of failures of international banks. In view of the disparity in national arrangements for deposit insurance, initiatives for global harmonization would be unrealistic.

The report notes that scrutiny of quality of supervision in the parent's country is a normal part of the procedures followed by many countries in granting applications of foreign banks for market access, with some countries insisting on the parent authorities accepting the principles of the 1983 Concordat as a condition for grant of such access. Under the US laws (1991 Comprehensive deposit insurance reform and taxpayer protection act), uniform minimum standards for foreign banks entry and access has been set, and among the conditions for grant of entry and expansion are requirement that the foreign bank is subjected to consolidated supervision in its home country and furnishes information to the Federal Reserve required to ensure its compliance with US laws.

The report also points that insistence on stringent prudential standards in policies towards entry of foreign banks is in full accord with the 1983 Concordat and its supplement which support the adoption of a negative position by host authorities towards approval of operations on their territories by foreign banks judged to be inadequately supervised by parent countries.

This, the report, has important implications for any framework for global financial liberalisation.

"Until the initiatives of the Basle Committee and of other bodies to strengthen the supervision of international banks have become comprehensive in scope and are perceived to be genuinely effective in practice, continued reluctance can be expected on the part of many countries to accept substantial restraints on their policy autonomy regarding the right to refuse market access on prudential grounds," the report concludes.