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December 6, 2000

Opportunities and Challenges for Financial Institutions in the US

Global Banking and Financial Policy Review

After a 20-year effort, financial modernisation legislation was finally enacted in the US with the passage of the Gramm-Leach-Bliley Act (the GLB Act) in late 1999. The legislation over-turned the prohibitions of the 1933 Glass-Steagall Act and other legislation separating banking, securities, and insurance activities. As a result of the legislation, the US is embarking on a period of unprecedented change and opportunity for domestic and international financial service providers. This article describes recent major changes, with a focus on international banks with operations in the US. Since the GLB ct was enacted and implementing regulations adopted by the Board of Governors of the Federal Reserve System (Federal Reserve Board), more than 330 organisations have taken advantage of the law's provisions and become Financial Holding Companies (FHCs). At least 20 of these new FHCs are non-US based banks. These are the first of many financial institutions that will be able to combine control of commercial banking, securities, and insurance companies in ways that had been prohibited since the 1930s. A FHC can engage in a variety of banking, securities, and insurance activities and any other activities that are considered "financial in nature or incidental to a financial activity." This is in contrast to the restrictions on a bank holding company or foreign bank operating in the US, which can engage only in banking activities and those activities determined to be closely related to banking - which includes limited securities activities, but not most insurance underwriting or agency activities. The Federal Reserve Board provides umbrella supervision of FHCs, and other functional regulators, such as the Securities and Exchange Commission and state insurance regulators, provide oversight of the individual affiliate companies engaged in securities and insurance activities. The Federal Reserve Board continues as the umbrella regulator of bank holding companies and foreign banks with operations in the US even if they do not elect to become FHCs. The GLB Act also permits eligible banks to establish "financial subsidiaries" to conduct a broader range of financial activities, although financial subsidiaries of a bank are prohibited from engaging in insurance underwriting, real estate investment and development, and, for five years, merchant banking activities. It is these new FHCs and financial subsidiaries that will reap the greatest rewards from the new financial reform legislation.
 
BECOMING A FINANCIAL HOLDING COMPANY
 
In order to become a FHC, a company must file a declaration with the Federal Reserve Board certifying that all of its bank subsidiaries are (i) "well capitalised"; (ii) "well managed"; and (iii) have a Community Reinvestment Act (CRA) rating of at least "satisfactory." For foreign banks or companies, the CRA standard is applied to any FDIC insured depository institutions controlled by the foreign bank or company, or any FDIC insured US branch of the foreign bank. In determining whether a foreign bank is well capitalised and well managed, the Federal Reserve Board applies standards comparable to those applied to domestic banks in the US. The Federal Reserve Board has stated that in regulating foreign organisations, it will give due regard to "national treatment" and equality of competitive opportunity. It may also take into account a foreign bank's composition of capital, accounting standards, long-term debt ratings, reliance on government support to meet capital requirements, the extent to which the foreign bank is subject to comprehensive consolidated supervision (CCS) by its home country supervisor as prescribed by the Basle Committee on Banking Supervision, and other factors that may affect analysis of capital and management. For those foreign banks from countries where the home country supervisor has adopted risk-based capital standards consistent with the Basle Accord, the well-capitalised requirement is satisfied by tier one and total risk-based capital ratios of 6% and 10%, respectively. If a foreign bank is from a country that has not adopted the Basle Accord, it must seek a prior determination from the Federal Reserve that it is well-capitalised in a manner comparable to the capital that would be required of a US banking organisation in order to become a FHC. As part of the capital test, the Federal Reserve Board also requires that a foreign bank have a tier one capital to total assets lever-age ratio of at least 3% in order to be treated as a FHC. Although this is lower than the 5% leverage ratio applied to US depository institutions, foreign banks have generally objected to any leverage test as Global Banking and Financial Policy Review 232.
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