Foreign Trade and International Banking Institutions

SIC 6082

Industry report:

This category covers establishments of foreign trade companies operating in the United States under federal or state charter for the purpose of aiding or financing foreign trade. Also included in this industry are federal or state chartered banking institutions that only engage in banking outside of the United States.

Industry Snapshot

The nature of banking became increasingly international throughout the 2000s. According to the Institute of International Bankers, three of the factors contributing to this trend included the reliance of national economies on one another, the globalization of trade, and technological developments that enhanced communication and transportation.

In addition, while for much of the twentieth century the regulatory environment was aimed at restraining banking concentration and bank involvement in other financial activities, such restrictions gave way to more liberalized capital flows and a more relaxed attitude toward consolidation and foreign involvement in the 2000s, both by U.S. banks operating overseas and by foreign banks in the United States. This trend did not last, however, and, spurred by the global financial crisis of the late 2000s, foreign trade and international banking institutions faced increased regulation and tightened controls at the start of the 2010s.

Background and Development

In 1919, the U.S. government adopted a federal law called the Edge Act named for its sponsor, Republican Walter E. Edge of New Jersey. The Edge Act of 1919 allowed the Federal Reserve to charter foreign and domestic banks to permit them to participate in international trade finance and investment through what became known as Edge Act banks. These banks were allowed to expand their offices in more than one state without the usual nonbanking restrictions.

An Edge corporation offers foreign banks and their affiliates ways to expand operations in the United States without being subject to the nonbanking restrictions set by the Bank Holding Company Act of 1956. Edge banks can accept deposits and engage in a broad array of financial activities, without necessitating a foreign office to purchase international loans or process credit.

The late 1970s witnessed a great expansion of Eurobanks, which acquired an increased share of the U.S. banking market, generating heated political debate in the U.S. Congress. This dialogue resulted in the International Banking Act of 1978, implemented to equalize regulatory treatment of foreign and U.S. banks doing business in the United States. This act, along with revisions to Regulation K (International Banking Operations), gave foreign banks and affiliates the right to own a majority of shares in Edge corporations.

Prior to revisions to the Edge Act in 1984, the Fed used the "transaction-by-transaction" approach, which imposed fairly stringent constraints on the U.S. operations of the Edge banks. This approach required that all deposits to Edge corporations be related to international transactions and that all transactions with domestic residents be related to identifiable international transactions. With the debt crisis in the 1980s, combined with a flood of consolidations and bank mergers, many Edge banks disappeared.

In 1984, three major revisions were made. Two of the revisions expanded the U.S. activities of the Edge banks, while the third closed a loophole in the Edge banking statute that permitted three nonbanking firms to enter the Edge banking field.

The first revision expanded U.S. activities to provide full banking services--deposit-taking, lending, and other services--to any entity that engaged in international business. These companies included international airlines, shipping lines, and export-trading companies that were engaged exclusively in international activities and that were restricted to international business by their charters or licenses.

The second revision permitted an increase from $2 million to $15 million in the amount an Edge bank could invest or lend in permissible activities without prior approval from the Federal Reserve.

The third revision to Regulation K closed a loophole in the existing Edge banking laws, which allowed nonbank financial service companies to acquire the charters of existing Edge banks without the requirement of prior approval of the Federal Reserve. The new statute required any persons to give 60 days of notice before acquiring 25 percent or more of the voting shares of an Edge corporation. This regulation allowed the Fed to impose conditions necessary to prevent adverse effects such as conflicts of interest, undue concentration of resources, or unsound banking practices.

Although subject to capital restrictions and the limitations of the Edge Act, an Edge corporation could engage in contracts to finance activities involving projects performed substantially abroad, importing or exporting goods, assembly or repackaging of goods imported or exported, issuing long-term debt, and financing the costs of production of goods and services for export. In addition, the Edge corporation was involved in buying and selling spot and forward foreign exchange, issuing securities to finance foreign activities, guaranteeing debts of customers, acquiring participation in extensions of credit, and holding securities or buying and selling securities upon the order of the customer.

An Edge possessed certain limited powers as a corporation. It had the power to maintain its corporate existence for 20 years, to sue and be sued, to make contracts, to appoint officers and employees, to elect directors, and to adopt by-laws. The banking powers of an Edge corporation with a final permit included borrowing and lending money, issuing letters of credit, and effecting transactions in coin, bullion, exchange, and securities.

U.S. banks, which are bound by law to focus foreign investment only in other banks, are able, by investing in Edge corporations, to spread their portfolios into just about any foreign company. By 1998, about 70 percent of U.S. banking assets of foreign subsidiaries was channeled through Edge corporations.

While restrictions from interstate banking diminished substantially, the benefits for foreign activities remained attractive to some firms. In 1998, there were still more than 30 Edge branches, concentrated primarily in New York and Miami, Florida, with assets of $18 billion. However, by the mid-2000s, only three Edge branches (all located in Miami) remained, with assets of $4.34 billion. Of these three, Spain-based Banco Santander International dominated, with $4.18 billion in assets, followed by the relatively minor presence of a Columbia-based and a German-based bank.

International banking facilities (IBFs), a legal classification created in 1981, differed from Edge corporations in that they had no separate organizational identity but constituted separate accounts established by host banks, including both U.S. banks and U.S. branches of foreign banks. IBFs were compelled by law to limit their activities to international transactions that demonstrably did not directly affect U.S. markets. Such facilities offered several incentives, such as the exemption from reserve requirements and, in some states, favorable tax status. In 1998, such facilities possessed $46 billion in assets for U.S. banks and $169 billion for U.S. branches of foreign banks.

The passage in 1999 of the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act, paved the way for new conglomerations of financial services formerly prohibited by the Glass-Steagall Act of 1933. Among other provisions, the Financial Services Modernization Act allowed for the creation of financial holding companies (FHCs), by which banks might combine diverse financial operations, such as insurance firms, brokerages, securities underwriters, travel agencies, and others within one establishment. It thus opened the door, for instance, to mergers between U.S. insurers and foreign banking operations as well as between foreign and domestic banking concerns, without necessitating the divestiture of one party's operations by the merged company. For a foreign banking firm operating in the United States to establish a FHC, the Federal Reserve had to bestow a sound rating on the firm's capitalization and management based on an evaluation of accounting and lending practices, the nature of the firm's capital exposure, and its reliance on federal support to meet capital standards, among other considerations.

The further deregulation of the U.S. financial sector at the end of the 1990s spurred the increased centralization of foreign firms' U.S. banking operations. While relaxed restrictions on interstate banking led to substantially increased merger and consolidation activity among U.S. banks, foreign banks likewise recognized the need for greater efficiency and centralization in order to compete with U.S. players. Fuji Bank Ltd. and Sanwa Bank Ltd. closed down many of their U.S. branches in order to shore up and expand the operations of regional headquarters. Meanwhile, some U.S. states, such as Delaware, went to great lengths to attract foreign banks through the relaxation of tax laws. In 1999, Delaware Governor Tom Carper signed into law the Foreign Banking Amendments, which allowed foreign banking concerns to establish Delaware as their home state, thereby allowing them to maintain branches with full banking capabilities equal to those of out-of-state U.S. banks.

Total U.S. banking assets of foreign banks increased sharply from $27 billion in 1972 to $1.55 trillion in 2004. The combined U.S. banking and nonbanking assets of international banks totaled more than $3 trillion. European banks held 80 percent of this total, while Asia accounted for 10 percent. South America, Central America, and North America were responsible for the remaining 10 percent. International banks spent roughly $20 billion per year on their U.S. operations; roughly half of this total was spent on employee compensation.

Several regulatory matters affected international trade financing during the first half of the 2000s. In June 2004, the Basel Committee on Bank Supervision approved a revised Basel II, the result of five years of negotiations. Under Basel II, international rules for determining minimum capital requirements for globally active banks became more complex. Whereas many countries will implement Basel II across the board, in the United States, only the largest (approximately 10) banking institutions were required to comply, although several others complied voluntarily.

The USA Patriot Act served as a deterrent to foreign banking interests. In an effort to stop money laundering in the post-9/11 era, the Patriot Act required that all parties associated with privately owned banks, especially foreign banks, be clearly identified. The object was to flush out foreign "shell banks" used to funnel terrorist funding, which had no physical presence within the country.

In addition, Section 402 of the Sarbanes-Oxley Act, which restricted foreign banks from providing loans to bank directors and officers, had been troublesome to foreign bankers in the United States. However, in April 2004, the Securities and Exchange Commission released a new rule that exempted some qualifying foreign banks from this restriction.

The bundling and selling of investment packages that included subprime mortgages in the early and mid-2000s contributed to the financial meltdown that occurred later in the decade. According to the FDIC, 25 banks failed in 2008--a figure that jumped to 140 in 2009 and had reached 132 for the year by October 2010. By comparison, two and three banks failed in 2003 and 2004, respectively.

Some of the banks that did survive incurred huge losses--Citigroup, for example, reported in 2007 that it would write off up to $11 billion worth of subprime mortgage-related securities. In response, banks started to restrict lending, which in turn made fewer funds available to the American consumer and contributed to the economic recession of the late 2000s.

In 2008, the U.S. government passed the Emergency Economic Stabilization Act of 2008, also referred to as the bailout of the U.S. financial services industry. Another attempt to promote economic recovery came in 2009 from the U.S. Treasury Department with the implementation of the Financial Stability Plan.

Meanwhile, the number of foreign institutions in the United States declined. In December 2006, foreign banking organizations operated or controlled 188 branches, 133 agencies, 62 U.S. commercial banks, and 8 Edge or agreement corporations. Foreign banking institutions held about $216 billion in commercial and industrial loans, roughly 18 percent of the total in the United States.

Assets held by branches and agencies of foreign banks in the United States reached $2.5 trillion in 2007. Their share of U.S. banking assets had risen since 2003 to a historical high of 24.1 percent in the first quarter of 2007, well above the previous peak of 22.6 percent in 1991. Market shares of loans and deposits rose to $885 billion, 14.9 percent of all loans at the beginning of 2007. Foreign banks also remained active in business lending. The share of deposits for foreign banking organizations was 27.6 percent in 2007.

Current Conditions

In 2010 foreign banking institutions held more than $1.53 trillion in assets, or 25 percent of all commercial banking assets in the United States, according to figures from the Federal Reserve. The foreign banking industry was affected by the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed into law on July 21, 2010. The Dodd-Frank Act proposed massive changes to financial regulation in the United States; for instance, foreign banks were subject to higher capital requirements and new business conduct standards, among other changes. The "most sweeping rewrite of Wall Street rules since the Great Depression," according to one bank regulator, gave the Commodity Futures Trading Commission the power to regulate foreign companies with derivatives businesses in the U.S. U.S. branches and agencies of foreign banks with total assets of $250 million or less were deemed eligible for an 18-month examination cycle if they met certain qualifying criteria.

Industry Leaders

Leading foreign banks holding companies operating in the United States in the early 2010s included HSBC Holdings PLC (London), Royal Bank of Scotland Group (Edinburgh), Barclays PLC (London), BNP Paribas (Paris), Deutsche Bank (Frankfurt), ABN Amro (Amsterdam), and Bank of Montreal.

Of all the foreign banks, Canada, France, and the United Kingdom had the largest number of bank offices in the United States. The U.S. cities with the greatest numbers of foreign bank offices were New York, Los Angeles, Chicago, Miami, and San Francisco.

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