ANOTHER OPPORTUNITY ON GOVERNANCE OF FOREIGN BANKS

6:06 AM Dec 22, 1993

ANOTHER OPPORTUNITY ON GOVERNANCE OF FOREIGN BANKS
Geneva 22 Dec (Chakravarthi Raghavan) -- Developing countries under pressure from the US and EC to liberalize their financial services sectors and remove restrictions on entry of foreign banks should make such entry-authorization conditional on each foreign bank contracting to adhere strictly to Basle committee recommendations on bank ethics, and conditional on home countries commitment to exchange information to enable adequate host country supervision of bank affiliates.

These and other recommendations for better prudential supervision and strengthen developing country governance over transnational bank affiliates and preventing such affiliates from being vehicles of clandestine capital flight, tax evasion and other such activities is in a paper by David Felix in the third volume of the UNCTAD publication -- International Monetary and Financial issues for the 1990s.

Felix is Professor of Economics (Emeritus) at Washington University in St. Louis, USA.

The paper is part of research papers for the Group of 24 (developing country group in the IMF and World Bank) and was prepared in the context of what the G24 could do to lead developing countries out of their current "unproductive passivity" in the face of the negative consequences of the vastly increased financial mobility of the past two decades -- a matter of increasing concern even to the industrialized countries.

The paper argued -- but was virtually ignored by the G-24 -- that since developing countries are even more victimised by the adverse consequences of international financial mobility than the industrial countries,, they should be active participants in the ongoing collaborative efforts to reduce such negative aspects while preserving international capital mobility.

The paper was particularly critical of the IMF and the World Bank for their policy advices to developing countries -- for pursuing competitive laissez faire economy with capital accumulation, and benefits of flexible exchange rates and financial globalization to be garnered through liberalization -- even though the two institutions and their economists are aware that such policies are producing economic incoherence.

The IMF and the Bank, the paper notes, are now in fact supporting the efforts of the BIS (Bank of International Settlements) countries to strengthen their prudential supervision of banks and recently has been urging intensification of such efforts.

Some of the recommendations of the Felix paper have acquired a certain timeliness in terms of the Uruguay Round General Agreement on Trade in Services (GATS) and the intention to continue over the next 18-24 months the negotiations for financial services commitments.

On the financial services issue in the GATS, the US towards end of November had announced that it would provide on a most-favoured-nation basis only current market access for banking and financial services enterprises already having a presence in the US market, and that all other access, for new branches or expansion into new activities, would be on non-MFN and reciprocal basis.

A number of developing country negotiators threatened to withdraw their own liberalization offers, but the US brought pressure on their finance ministries in their capitals, to leave the offers on the table.

Ultimately, as a part of the many compromises that enabled the conclusion of the Round, further negotiations on financial services sector are to continue, with US maintaining its two-tier approach and MFN exemption for second tier operations, but suspending its use for first six months of entry into force of the GATS, and with all Parties having the option, after six months, to assess their own positions and take decisions -- whether the US would give up its MFN exemption or whether others would take a similar exemption.

The report of the Joint Parliamentary Committee in India on the stock-market scandal and its indictment of the foreign banks for their leading role have also highlighted the way transnational enterprises in host countries use their position to evade and break laws and regulations in the pursuit of their profits.

In this context, some of the recommendations in the Felix paper could be put in place by countries concerned as part of their domestic prudential regulation, while in others they might do well to put it as part of their scheduling commitments to ensure that the market openings would require industrialized-home countries of these TNC banking enterprises agreeing to act towards host-developing countries atleast on a par with what they are mutually committed to under the Basle Committee recommendations.

Felix has suggested that developing countries pressed by major industrial countries to remove restrictions on entry of transnational banks should insist that all such entries be conditional on each petitioning bank (seeking to open branch or establish itself) formally entering into a contract, with host country, to adhere faithfully to the Basle Committee's 1988 recommendations on bank ethics in all its host country activities.

The "contract", the Felix paper suggests, should also authorize that

* supervisory authorities of host developing country may apply penalties, including closure, for contract violations;

* the bank and/or is home country may appeal the penalties to the World Court, but must accept its judgement as final, and agree not to engage in any unilateral retaliation against the host country prior to or after the Court's ruling.

The Uruguay Round accord, and its provisions for a World Trade Organization and its Dispute Settlement Understanding, to the extent a host-country has made commitments (creating rights and obligations), would meet part of this in that the home country of the banking enterprise would be obliged to take up the issue as a dispute and abide by the WTO/DSU rulings.

But the contract such as in the Felix paper would also have the added effect of the bank concerned not trying to pressure the host country with unilateral retaliations.

Some of the foreign banks involved in the Indian stock-market scandal, according to Indian press reports (before the Parliamentary inquiry report was published Tuesday) had pressured the finance ministry into not taking actions lest banks act to inhibit or reverse the short-term flow of foreign deposits through the banks.

The Felix paper also suggests that in accordance with the Basle Committee's July 1992 recommendations on exchange of information between home and host bank supervisory authorities, the home country shall agree to make best effort responses to all requests for information about the activities of the TNC banks from the host developing country's supervisory authority that it deems needed for adequate supervision of the activities of the bank's local affiliate.

The paper suggested that the G-24 should urge the Basle Committee extend its 1988 and 1992 recommendations:

* to cover tax fraud;

* to cover the activities of existing as well as new cross-border operations of transnational banks;

* to expand the committee to include representatives of regional developing country groupings -- such as South-East Asia, the New Zealand and Australia group and the Commission of Supervisory Authorities of Latin America and the Caribbean.

The Basle Committee comprises Central Bank authorities of Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom and the USA.

According to an article in 1993 UNCTAD Review by Andrew Cornford (an UNCTAD economist specializing on banking and financial services), the Basle Committee's July 1992 statement and recommendations, which came in the aftermath of the BCCI scandal, is centred around four principles :

Firstly, all international banks or banking groups should be adequately supervised on a consolidated basis by a parent-country authority.

Secondly, the creation of a cross-border banking establishment should receive the prior consent of both the host-country supervisory authority and the bank's and (if different) the banking group's parent-country supervisory authority.

In other words, the grant of market access to a foreign bank by a host-country authority should be conditional on the consent of all appropriate parent-country authorities, while permission for overseas expansion should be given by the parent-country authority to a bank in its jurisdiction only if it has been assured of the consent of the host-country authority.

Thirdly, supervisory authorities should have the right to gather information from the cross-border banking establishments of the banks or banking groups of which they are parent-country supervisors.

Thus, consent to cross-border establishment is to be conditional on the existence of an understanding between parent- and host-country supervisors concerning access to information required for effective supervision by the parent-country authority.

Fourthly, if a host-country determines that any of the three standards specified is not being satisfactorily met, then it may impose restrictive measures designed to satisfy its prudential concerns, including the prohibition of the creation of banking establishment.

The inquiry into the BCCI affair in the UK (and the role of the Bank of England as well as the BCCI auditors, Price Waterhouse) brought out the deficiencies, if not negligence, and failures of both the Bank of England in exercising its supervisory powers in the interests of the public, as well as that of the auditors -- whose information about fraudulent state of affairs at the BCCI were not known to many host-countries where the BCCI was operating.

Both making auditors of the branches, and the chief auditors of the parent company, statutorily responsible (under civil and criminal penalties) for reporting infringements of regulations of host-country could be part of prudential regulations and help police evasions.

In the 1970s, when the Citibank (figuring in the Indian stock-market scam) was circumventing tax and currency laws of other countries in Europe and elsewhere, the Swiss National Bank (Central Bank) was able to catch its violations of the regulations on net open positions in foreign exchanges of banks operating in Switzerland only because auditors of banks in Switzerland have a statutory obligation to report such infractions to the National Bank.

The Citibank and its offshore banking operations and evasion of host country tax and currency laws has been fully documented in an appendix in Richard Dale's "The Regulation of International Banking" (City Bank's "Rinky Dink Deals: A case study in regulatory arbitrage") as well as in Robert Hutchison (1986) "Off the Books: Citibank and the World's biggest money game".

The Basle Committee's statements on Banking Supervision are recommendations to member countries and not legally binding.

Bur by using Art VII of the GATS, and particularly paras two and three, like-minded countries, Cornford says in the UNCTAD Review article, could reach agreements, under the auspices of the Basle Committee or otherwise, concerning prudential regulation or control of money-laundering, with effects on the GATS 'trade in banking services'.

But even without it, Parties to the GATS could stipulate, in their schedules of commitments, conditions based on prudential regulations and, so long as they are not 'discriminatory' but require actions by the banks and enterprises seeking 'commercial presence' or 'establishment' and even by the host-countries, they might be able to deal with problems of capital flight, money laundering etc.

While even individual big countries, whose markets are sought, could act on their own, collective agreements of a group of countries would strengthen their hands even more.

Developing countries, the Felix paper argues, could also use bilateral tax treaties for tax information to deal with such problems.

Since 1988, the US has been promoting bilateral agreements for exchange of tax information to assure accurate determination and collection of taxes, to prevent tax fraud and develop sources of information on tax matters.

Under such agreements, tax enforcement authorities of two countries are obligated to fully comply with each other's requests for information concerning assets and earnings owned within one country's borders that are subject to tax by the other.

The US-Peru agreement and its provisions, for example, makes clear that obligation to provide information goes beyond information available on files, and includes performing additional searches and hearings, in which agents of the requesting government may participate.

Requests for such information also take precedence over prevailing confidentiality laws and practices of banks and other fiduciary institutions and agents.

Even without a request, tax authorities are enjoined to be a "whistle-blower" -- forwarding any information which has come to its attention and likely to be relevant for the determination, assessment, and collection of tax, recovery and enforcement of tax claims, as well as investigation or prosecution of tax crimes or crimes involving tax administration of the partner country.

The US has been pushing such agreements as part of its drive against drug offenders.

But developing countries, Felix suggests, could use such provisions to curb tax evasion through capital flight. It would also deter security houses, international law firms as well as banks operating in a signatory developing countries, which are also active in setting up offshore shell companies and trusts for clients from that country, from continuing such activity because of increased risk of exposure and penalty.

Signatory developing countries could also insist on its partners from issuing securities, such as bearer bonds, that invite capital flight for tax evasion.