Melanie L. Fein
¡¾Abstract¡¿ The legal regime governing banks in the United States is notoriously byzantine. In order to compete successfully in the U.S. banking markets, Chinese banks must navigate a complex maze of regulatory chutes and ladders. Ms. Fein¡¯s article offers an overview of the extensive regulatory and supervisory requirements those Chinese banks seeking to operate in the United States may encounter.
Only a handful of Chinese banks currently maintain offices in the United States. As Chinese banks grow and expand, however, the number of Chinese banks with a U.S. presence is likely to increase. The United States has long provided an open financial marketplace for foreign financial institutions, and Chinese banks will find a highly competitive and dynamic banking market in the United States.
In order to compete successfully in the U.S. banking markets, however, foreign banks must navigate a complex maze of regulatory chutes and ladders. While U.S. domestic banks are accustomed to operating under the convoluted and somewhat archaic American bank regulatory framework, foreign banks generally find it chaotic and bewildering. Any Chinese bank contemplating a move into the U.S. market must have a good understanding of U.S. banking laws and the U.S. bank regulatory system before opening an office in the United States¡ªeven a representative office. ¡¡¡¡
The U.S. banking system is the product of more than 100 years of regulatory history during which laws were enacted at different times to address different regulatory needs as our financial system evolved and matured. Along with the multitude of laws came a multitude of regulatory agencies created by the federal and state governments to implement and enforce the laws. At the federal level, banks are regulated by the following agencies:
In addition to these federal banking agencies, U.S. banking organizations are subject to regulation under laws implemented by other agencies, such as the Securities and Exchange Commission, Federal Trade Commission, Commodity Futures Trading Commission, and other federal agencies. Moreover, each of the 50 states has its own banking laws and regulatory authorities. The ¡°dual banking system¡± in the United States¡ªunder which the chartering and supervision of banks occurs at both the federal and state levels¡ªis confusing not only to outsiders attempting to understand the American banking system, but to many American banks as well.
While the agencies governing banks in the U.S. have separate and distinct regulatory missions, their regulatory jurisdictions often overlap and banking institutions in the United States must answer to a host of regulators implementing a plethora of laws and regulations.
The U.S. Comptroller of the Currency last fall delivered a major address to an audience at the People¡¯s Bank of China in Beijing in which he attempted to explain the complexity and rationale underlying the multi-faceted U.S. bank supervisory framework. In commenting on the number of different regulators, the Comptroller noted that competition among regulators has resulted in a strong bank regulatory system:
¡°Competition can be as productive in the public sector as in the private. In the case of bank supervision, the assumption has been that the agencies would each do their jobs better with bureaucratic competitors in the mix, challenging them to excel. . . .The relationships that exist among U.S. supervisors validate the concept that lies at the heart of our structure¡ªthat competition among regulatory agencies can enhance the quality of supervision and help prevent it from becoming unduly burdensome for financial institutions.¡±
The United States maintains a policy of ¡°national treatment¡± toward foreign banks. Under this policy, foreign banks are entitled to do business on the same terms as domestic banks, but also must abide by the same regulatory requirements that apply to domestic banks. Because of differences in the way some foreign banks are structured and regulated, U.S. banking standards sometimes are applied differently to accommodate foreign banking structures.
Foreign banks are permitted to operate in the United States through a variety of formats, including branch offices, subsidiary banks, agencies, commercial lending companies, and representative offices. Only subsidiary banks and branch offices may take deposits. Strict regulations govern the operations of these entities, and a foreign bank must meet certain approval standards before establishing a U.S. presence.
The Foreign Bank Supervision Enhancement Act of 1991 (¡°FBSEA¡±) significantly increased federal regulation of the U.S. operations of foreign banks and imposed new penalties for failure to comply with U.S. banking regulations. The Act grew out of weaknesses in the regulation of foreign banks highlighted by, among other things, the collapse of the Bank of Credit and Commerce (¡°BCCI¡±), a Middle Eastern bank chartered in Luxembourg with U.S. and worldwide operations.
The FBSEA significantly enhanced the supervisory role of the Federal Reserve Board over foreign banks operating in the United States. As a result of FBSEA, all U.S. branches, agencies and representative offices of foreign banks must be approved by the Board, in addition to the relevant chartering authority. FBSEA gave the Board supervisory powers to require information from foreign banks and to terminate their U.S. banking operations for failure to comply with U.S. banking laws. ¡¡¡¡
FBSEA established a new standard that must be met by foreign banks operating in the United States. The new ¡°comprehensive consolidated supervision¡± or ¡°CCS¡± standard, requires the Board to make the following determinations before approving an application by a foreign bank to establish or acquire a branch, agency or commercial lending company in the United States:
In acting on applications in accordance with this standard, the Board is authorized to take into account the following factors:
FBSEA provides that the Board, in acting on an application, shall not make the size of a foreign bank the sole determinant factor and may take into account the needs of the community as well as the length of operation of the foreign bank and its relative size in its home country.
A foreign bank that fails to meet the CCS standard may be required to terminate its U.S. operations or be subjected to supervisory restrictions. The Board has noted that the failure of a foreign bank to meet the CCS standard may have implications for other banks with the same home country supervisor. ¡¡
Many foreign banks¡ªparticularly those located in countries with developing banking systems¡ªcannot meet the comprehensive consolidated supervision standard and thus are not permitted to establish branches, agencies or commercial lending companies here. Such banks nevertheless may establish representative offices in the United States. To date, a number of Chinese banks have established representative offices, including Agricultural Bank of China, Industrial and Commercial Bank of China, and China Merchants Bank.
A ¡°representative office¡± is defined as an office of a foreign bank in United States other than a branch, agency, or commercial lending company and is permitted to engage in the following activities:
As a result of FBSEA, a foreign bank may not establish a representative office without prior Federal Reserve Board approval. In acting on an application to establish a representative office, the Board is required to ¡°take into account¡± the standards required for a foreign bank to establish a branch or agency¡ªnamely the comprehensive supervision standard and the willingness of the bank to provide information to the Board. This lesser standard applies because representative offices do not conduct banking business in the United States and thus pose less risk than do branches and agencies.
Prior to the 2001, the Board used two different standards in approving applications by foreign banks to establish representative offices. The Board approved representative offices with full powers based on a finding that the home country supervisors exercise a ¡°significant¡± degree of supervision over the bank. In such cases, the Board considered ¡°the extent to which there is a regular review of a substantial portion of the bank¡¯s operations by the home country supervisor through examination, review of external audits, or a comparable method, submission of periodic reports relating to financial performance, and assurance that the bank itself has a system of internal monitoring and control that enables bank management to administer properly the bank¡¯s operations.¡± The Board also relied on the home country supervisor¡¯s indication that it did not object to the establishment of the representative office.
In other cases involving representative offices of foreign banks in countries without ¡°significant¡± supervision, the Board approved representative offices based on a finding that the foreign bank was subject to a supervisory framework consistent with approval of the application, taking into account limitations on the activities of the representative office and the operating record of the bank. In such cases, the activities of the representative office were limited to traditional representative office functions such as gathering information, soliciting non-retail business, or general promotional activities, or the number of employees was limited. The Board stated that, in assessing whether a particular foreign bank would be eligible for this relaxed standard, the home country supervisor would be expected to be in the process of implementing a system of supervision that would meet the ¡°significant¡± supervision standard.
In 2001, the Board adopted a single ¡°flexible¡± approval standard for approving representative offices in order to minimize confusion in light of the generally minimal risk posed by such offices. Under the amended approval standard, the Board generally will approve a representative office if the applicant foreign bank is subject to a home country supervisory framework that is ¡°consistent with the activities of¡± the proposed representative office, taking into account the nature of the activities and the operating record of the applicant. ¡¡¡¡
The Federal Reserve Board has approved applications for representative offices by at least three Chinese Banks, most recently China Merchants Bank whose application was approved on October 22, 2002. In acting on these applications, the Board has noted that the Banks are subject to a ¡°significant¡± degree of supervision by the People¡¯s Bank of China. The Board stated: ¡°The People¡¯s Bank of China (¡°PBOC¡±) is the licensing, regulatory, and supervisory authority for banks and all other financial institutions in China, and, as such, is the home country supervisor of Bank. The PBOC has pursued a program of reforms intended to enhance bank supervision, strengthen management of banks, reduce accumulation of nonperforming loans, further tighten risk management, and promote use of international accounting standards. The PBOC authorizes the establishment of offices of banks outside China, regulates these offices, and has taken steps to implement annual on-site examinations of all foreign offices of Chinese banks.¡±
The Board particularly noted that the People¡¯s Bank of China has taken actions to guard against money laundering, which is a major supervisory concern of U.S. regulators: ¡°Money laundering is a criminal offense in China and banks are required to establish internal policies and procedures for the detection and prevention of money laundering. PBOC regulations require banks to adopt know-your-customer policies, report suspicious transactions, and maintain an effective recordkeeping system. Additionally, the PBOC has established an Anti-Money Laundering Office, which is responsible for coordinating the anti-money laundering efforts of banks and law enforcement. This office may also coordinate and communicate with foreign agencies established to prevent money laundering.¡±
Chinese banks must expect to encounter significant regulatory challenges when they operate in the United States. American banks routinely complain about the heavy compliance burden imposed by U.S. banking regulators, and Chinese banks also must anticipate the need to devote substantial resources to complying with U.S. banking laws and regulations.
The lack of a strong compliance program can result in severe supervisory consequences. In 1995, for example, federal banking regulators terminated the U.S. banking activities of the Daiwa Bank of Japan and expelled the bank from the United States as a result of major trading losses at the bank¡¯s New York branch office which were initially concealed from regulators.
Just last year, the Comptroller of the Currency, acting simultaneously with the People¡¯s Bank of China, assessed $10 million in civil money penalties and took other enforcement action against the Bank of China for alleged misconduct. The misconduct, which resulted in significant losses to the Bank¡¯s U.S. branch offices, included showing preferential treatment to certain customers who had personal relationships with management, large exposures to a single borrower, the facilitation of a fraudulent letter of credit scheme, a loan fraud scheme, unauthorized release of collateral and concealment of that action, and other suspicious activity and potential fraud. Among other things, the OCC removed officers of the branch who were suspected of misconduct and required the branch to implement action plans to correct misconduct, guard against fraud, provide for adequate customer due diligence using an independent third party to verify compliance, cease doing business with 34 specific individuals and companies and affiliated entities, and strengthen its risk management division.
The joint supervisory and enforcement actions taken by the Comptroller of the Currency and the People¡¯s Bank of China reflected close cooperation between U.S. and Chinese regulatory authorities. The Comptroller issued a statement complimenting the People¡¯s Bank of China for the excellent work of its staff and thanking them for their cooperation in the investigation that led to the supervisory measures. The People¡¯s Bank of China issued a similar statement and stated, ¡°The People¡¯s Bank of China remains committed to further strengthening of supervision so as to facilitate the healthy development of the Chinese banking industry.¡± ¡¡¡¡
The United States offers a competitive but highly regulated environment for Chinese banks wanting to conduct banking operations in the United States. Chinese banks, like other foreign banks, need to be aware of the extensive regulatory and supervisory requirements imposed on banking institutions in the United States. The U.S. banking system is complex, and foreign banks, like domestic banks, are expected to assume a heavy compliance burden.
 These include Bank of China, China International Trade and Investment Corporation, Agricultural Bank of China, China Construction Bank, Industrial and Commercial Bank of China, and China Merchants Bank.
 Remarks by John D. Hawke, Jr., Comptroller of the Currency, at a Session on Banking Supervision with the People¡¯s Bank of China, Beijing, China, October 14, 2002. See Office of the Comptroller of the Currency News Release 2002-80.
 Korea First Bank, 79 Fed. Res. Bull. 1064, 1065 (1993).
 See Promstroybank of Russia, 82 Fed. Res. Bull. 599 (1996).
 China Merchants Bank, 88 Federal Reserve Bulletin 503 (2002). See also Agricultural Bank of China, 83 Federal Reserve Bulletin 617 (1997); Industrial and Commercial Bank of China, 83 Federal Reserve Bulletin 212 (1997).
 Office of the Comptroller of the Currency New Release 2002-07.
 Statements of Comptroller of the Currency John D. Hawke, Jr. and the People¡¯s Bank of China, January 18, 2002.
Author: Visiting Lecturer, Yale Law School