Federal Supervision of the International Operations of Banks

Published by the Government Accountability Office on 1977-03-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                         DOCUMENT RESUME
00321   - [A10517931

[Federal Supervision of the International Operations of Banks].
March 24, 1977. 9 pp.
Testimcny before the Hceuse Committee on Banking, Currency and
Housing: Financial Institutions Supervision, Regulation and
Insurance Subcommittee; by Fred D. Layton, Director, Task Force
on Federal Supervision of Banks.
Issue Shea: Accounting and Financial Reporting (2800).
Contact: Office of the Comptroller General.
Budget Function: International Affairs: International Financial
    Prcgrams (155).
Organization Concerned: Federal Reserve System; Federa, Deposit
    Irsurance Corp.; Federal Reserve System: Board of Governors;
    Office of the Comptroller of the Currency.
Congressional Relevance: House Committee on Banking, Currency
    and Hou-;ing: Financial Institutions Superv!sion, Regulation
    and Insurance Subcommittee.

          Only about 130 of the 14,000 U.S. banks had overseas
branches and/or foreign subsidiaries at the end of 1975, and
most of these are either national banks supervised by the
Comptrcller of the Currency or State member banks supervised by
the Federal Reserve. GAO reviewed the bank examination reports
on 18 national banks and 12 State member banks having
substantial international operations. The mocst prevalent
problems in international operations found by examiners were: a
high percentage of classified assets; inadequate controls over
foreign exchange operations; and inadequate overall internal
controls. The Federal Reserve Board cf Governors and the
Ccuptrcllcr of the Currency need to use all available
information to develop and use a single approach for classifying
loans subject to "country risk." Procedures should be
implemented to examine (where permitted by the ccuntry involved)
major foreign branches and subsidiaries onsite. They should be
examined periodically and whenever adequate informaticn about
their activities is not available at the home office. The
Federal Peserve Board of Governors and the Ccapt.ccller of the
Currency should utilize each other's examiners tc cut expenses
for foreign examinations. Some clarifying legislation on the
interagency use of examiners might be necessary. (Author/QM)
                .-UIi    Sa-L57LES GD:-2LRAL ACCIt'UiY   G OFFCE
                              WASINlGTON, D. C.

                                                         FOR FELE:_E ON DIVVERY
                                                         Expected at 10:CO a.m. EST
                                                         Thursday,   arch 24, 1977

                                STAEMET OF
                              FDBa D. LAYTON
                        DLMEC0R, BAL.KG TASK FORCE
                     U.S.            ERESIT.ATIVES

i4. CEAPt4N:
    We are pleased to be here today to discuss further the GAO stc;udy
of Federal s-upervisicn of State and national banki            We ',_ll direct
our cornerts this morning specifically to supe:vision of nter.na ona!
operaticons cf banks by t.Z'Ccatroller of the Cur-ency, t-.he Federal
Reserve System and the Federal Deposit Lnsurance Ccrporaticn.
     As you know, our study was requested last year by several ocr.-
-gessioralcomr-mttees, includi;ng this one, and our report was submitted
by the Corptroller General to the Corsess on Jarnuary 31, 1977.
     ,Durng the period covered by our study,interrnatioraL           banking

operatcras increased substantialiy.          Assets held by foreign brnches

of Federal Reserve Member Balks increased from $61 b-illin at December 31,
1971, to $176 billion at December 31, 1975--a t.-eefolc increase.
     Foreign loans of dcmestic banks more tIhu doubled-from $27 billion
at the end.of 1971 to $60 billion at the er.d of 1975.

     Trbese assets are held by relatively small number of Oanks.       At the

end of' 1975, onl, about 130 of the 14,000 U.S. banks had overseas
branches and/or foreign subsidiaries. Foreign branches of the 20 largest
banks had al.ohs-   .2 percent of total foreign branch assets.

     Most of the barks involved in internatioral operations are either
national banks supervised by the Caoptroller of the Currency or State
member bancs supervised by the Federal Reserve.
Scope and Purpose of the GAO Review
in the z1ternaional Area
      Cur p,-rmary concern was in detenLrFnizg whether bank examirnaions of
internatilornal operatiorns were of sufficient scope to identify banks which
were likely to run into serious manageri-al or financial difficulties.
 MTerefore, our attention was directed towarzs the methodology used by
 the supervisory agencies for mcnitor-ng international operati.ons of U.S.
 banks.   In or study, we reviewed the examination reports on 18 national

 bunks and 12 State member banks   which had substantial international
      It is -iortzntthat your Subconsrittee understand our arrwngements
 with the three agencies for making this study.     A principal condition

 of the agreements was that we would not disclose any information about
 specific banks, bank officers, oz. customers. We also agreed that we would
 not examine any barks ourselves but would accept the facts found by the
 three agencies' examiners. We made no attempt to independently evaluate
 the :oundnes. of any of the banks in cur samples or to evaluate the
 cr-edit-worthiness of any of the bank customers.        We depended on the

 examiners' experience an identifying bank problems.
How do ExaMi-ners review .ntern.Aticrca~-!
?Feraior       of Eans?

         Both the Comptroller of the Currency anr   the Federal. Reserve System
                                                      way.        Both perform
approach interational examinations in much the samre
                                                                   s are per-
international examinations in two phases. Sane
                                                    "l_-v's phase includes
 formed at the bank's mran office in t.he U.S.
                                                    and reviewi.g foreign
evaluating large international extensions of credit
                                                    examrinations rel'Y
exchange activities of the main office. The credit
                                               mirn office with duplicate
heavily on the overseas branches providing the
                                                        car. be made in con-
    credit files on overseas loans. These examinations
                                                      they may be done
    junction with the regular domestic examination or
                                                      operations and thus
    separately. A few banks have decentralized their
                                                           b-Ics overseas
    the regulator rust make the c-edit examinations at the
    regioral centers.

         Tie other phase of inrernational examInatic are on-site exam.nations

                                                      of examining smaller ex-
    conducted at the foreign branc~hes. they consist
                                                           exchange activities
    tenslons of credit by the branches, examining foreign
                                                          foreign branch
    of the branches, evaluating main office control over
                                                         examinations occur
    activities, arn cfhecking internal operations. These
                                                         the main office.
    much less frequently than the regular examination at

           Because of theiw- special risk, the foreign exchange
    of   the banks were of major concern to the examiners. The
                                                                 may be
    are concerned that the volume of foreign exchange activities
                                                        risk in foreign
    excessive or that the bank has taken an unwarranted
    exchange trns,i Aons.

How are Eainr.ers .Ttained to Maike
In.ternational2 Exo.
     The agencies provide thei- examiners ^who make irternaticral ex-
anminations with special training in foreign exchange transactions ard
in e.aluatirg foreign creditLs      T.e Federal Deposit Insurance Corporation
does not offer specialized international training; officials said that

most of the banks supervised by the Corporation tend to be small and are
therefore unlikely to be engaged in internatioral bankring.       M.e Corpora-

tion used the Cormptroller of the Cu-ren:y training program to provide
international training when needed.
     Bank examiners we questioned generally thought the internal
courses provided were usefulv;; however, some did say more training in
fcreign exchange t-=usactiors would be halpful.       We received responses

from 1,500 banks to a questiornaire on various aspects of banrik supervision.
Eighty-nine per-ent of the barks responrding thought the exaniners' under-
standirn   of Interrztiornal operations was adequate or more than adequate.
What Problems did the Examiners Find
in the Inter.atiornl Area?
      The exam-nation reports for the 30 banks included in our study
showed that the most prevalen, problems in internatiornal operations fourd
by examiners were:    (1)a high pemcentage of classified assets, (2) inade-
quate controls over fcreier exchang operations, and (3) inadequate overall
 intern-l controls.

     The most recent examiL-ation reports available for these banks at
the time of our study showed that the 30 banks had outstanding loans to
foreign Goverrnernts, businesses and individuals totaling $80.5 billion.
The examiners had classified 3.7 percent of these loans as substandard,
four-tenths of 1 percent e       toubtful, arnd or..-tenth of 1 percent as loss.

                                         of   e-i
What Problers did GAO Find in the
;Way t.e Supervisory .AenciesIbo-niored
Foreign Operations of Banks?
     In our study we found that the F .deral Reserve and the Ccrmtroller
took different approaches to evaluating loans to foreign governments,
businesses and irndividuals.   These different approaches caused some

bank loans to be classified differently than other bank's loarns to the
sanme country or foreign business. Even within the Federal Reserve
System, two approaches were taken to evaluating loans subject to country
     The term "country risk" is used to describe the special risk
involved when loans are ma
                        rmce    n different currencies because the borrower
must repay the loan in the currency borrowed. The borrower's ability
to obtain appropriate currency may be affected by the political and
economic stability of the bor-ower's country.
        At the New York Federal Reserve Bark, a committee of senior examiners
evaluated country risks and assfgend a general classification to loans
made to borrowers in some of those countries.      All loans to those countries

and their businesses were class-ffied the same unless the borrower's
ability to obtain the repayment currency was indepenwentr    of the country's

 stability or the loan ms made in the local currency. Ifthe loan was made
 in the local currency, it was Judged according to the borrower's financial

        Except for the New York Federal Reserve Bank which used this
c-mlttee approach, the other Federal Reserve Banks evaluated foreign
loans individually.     This approach led to inconsistent classifications

                        ____       -5-
      '.-   Federal    .eee
                         sa   S.ys-en. rFr ex-!le, a !car. to one country

was classified by San Francisco exazminers, wrhile emtiners from
Now York, P..hiladelphi, ard Rich.nd did not classify loans to the same
country.    SLnilarly, exaniners fr-o       Boston, Chicago aend Sa Francisco

criticized loans to another country but the New York examiners did not.
The basic problem here was that examiners were'evaluating the loans
based on their individual knowledge of the country.
     _he Conptroller of the Currency has also used a committee approach
since 1S74 fcr evaluatirng cour;try risk. Each quarter ernior interna-
tional exm.iners ret to evaluate the risk involved in loans to certain
ccun.rles and t - assigĀ± class2ficat-toss to thocse loans. The examiners

classify t.hose lcns if repayment appears to be as much deperdent on the
br.r-ower' s ablJity to obtain the approcriate repayre.nt currency as on
the borrower's finsncial condition. Class4icaticns arrived at by the
co=--itt-ee a-e tenr   used for   all   lons to those countries.

      A'though the New York Federal Reserve Bank and the Comptroller have
 both used ccnr.lttee approach. for evaluating country risk, they have
 often a-rrived a2 different assessments of loans to the same country.
 sn July 1976, for exarple, the New Y':rk Fed's cormmittee and the Comptroller's
 ccrittee each developed ratLngs for loals to foreign countries. The

 CoT;roller' s ccomittee concluded that certain loars to several countries
 should be classified as substandard; the New York Federal Reserve Bank
 assign.ed the substandard classification to loans of only one oft'

    Usigr t-ree cbuntry risk evaiu2aticn rethcds -has resulted in.

different treatment of the barns th    the Federal Reserve and the

Ccptrolllr supervise.   rvther, the =ethcd used by the Federa- ?F.eerve

Banks depends on individual examiners keeping abreast of economic
ccr.ditions in many countries and being able to Judge loa-ns .nr.any

countries. We believe that a team of experts who evaluate econcrmic
conditions in each courtry should produce r.ore accurate -adconsistent
results thsn n=uerous irdividuals who evaluate corditions on a case-by-
case basis.
     Iherefore we recomr..ended that the Federal Reserve Board of
Governors and the Cciptroller of the Currency, usirg all :avalable
information, develop and use a single approach for classijying loans
subject to this country risk. In corr.enting on our report the agencies
pointed out some special problems involving country risk evaluaticn,
but they agreed that a uniform approach is desirable.
Are Examirations Made of
~Foreig  Branches and Subsidiaries?
     Federal Reserve end Ccmptroller examriners usually evaluates foreign
 loans from information at the hore off-ce of the parent banks. Both
 agencies required that banks maintain adequate records at the head office
 for the examiners to appraise the risk ard exposure of the bank through
 their foreign operations.
      In our review of the 30 banks with significant internatioral
 operations, we noted that two State member banks were experiencing scme
 problems which were related to foreign subsidiaies of the banks. Both
 banks' forcign activities had been examined by the Federal Reserve at

                                   -   -
the home office; however, the examiners had stid the mnfcr=.ation
available was inadequate. The subsidiaries were not examined onsite
until after the banks had begun experiencing problems.
    We believe that these subsidiaries should have been examined
onsite as soon as possible, once the hoce office files were found
inadequate. Early onsite examinations of the subsidiaries might have
disclosed their problems before parent banks were injured.
     We recommended that the Federal Reserve Board of Governors and
the Conptroller off the Currency implernent procedures to examine (where
permitted by the country involved) n2jor foreign branches arnd subsi-
diaries onsite-periodicaily and whenever adequate ieforrma';ion about
their activities is not available at the hcme office.

    . According to the Federal Reserve, it began in the fail of 1976 to
nake onsite exar,mnatiors of foreign branches of State member
banks where it had previously used irfornation at the head office or
f-=om nspectioLns rade by State examiners.   According to the Federal

Reserve a numrber of foreign subsidiaries were directly examined for the
 first time with the agreement of the host goverrnent.
     The OCC advised us that examinations to determine the cuality of
the bark's operations are made onsite overseas when necessary. According
to the OCC, their examiners made on-site examinations during 1976 at 141
 overseas branches and subsidiaries of 25 banks located in 37 countries.

     Mhe Ccotsrol'er of .e Cu-rency hs a Londcr.                4
                                                      off'ce 'J.:-.   is i4..

charge of exar_.-ng branches and subsidiaries   'L   Europe.   Th.e Cc.-t-'ler
also uses staffs frtm its 14 recr.s to :rdce onsite
                                                 i ex-._i-ato.ns of

foreisn branches and subsid'Jaries.
     The Federal Reserve has internatioral examlner staffs in New York,
Chicago, and San Francisco.
     We recommnr.ded that the Federal Reserre Board of Governors and th=
Comptroller of thle Currency utilize each other's excaminers to cut ex-
penses .when conducting examinations in foreign countries.
     Th.e Corptroller agreed that interagency use of examiners when
concdlctirg xadriations in foreigi countries would be bereficial but
that some clarifying legislation might be necessary.      Wle would be glad
co work A:ith the C=nmittee on any legislation needed to clarify the
authority for intear2gency use of exa1T1ners.
     That concludes our statement, Mr. Chairman. We would be happy to
answer any questiorns you may have.