Alfred Lewis School of Management, Binghamton University, New York, USA

I . Introduction

The increasing presence of foreign banks in the commercial banking sector in the US is to a great extent the result of the size of the US economy, its diversified money and capital markets, and a desire on the part of foreign banks to expand financial services to subsidiaries located in the US (Hultman, 1986). In addition to the attractive US market, foreign banks also have to establish a presence in order to protect their domestic markets by establishing operations where their principal accounts are located, thereby preventing foreign competitors from gaining access to those accounts. The EC union of 1992 is expected to lower barriers to interstate financial services between member- states and as such, the immediate concern is being focused on the reactions of financial institutions to the opportunities and threats

The European Community and the implications for United States banking industry

he purpose of this paper is to T examine the ramifications of the EC union on the US banking industry both in the US domestic environment and in the EC market. In the context of regulatory changes being imposed by the US government, the competitive posture of US banks is discussed. The future environment of the industry is also addressed in relation to the increasingly global nature of the industry.

of the financial unification (Golembe and Holland, 1990). The EC, with a combined population of over 320 million and with a GDP of over $4 trillion, is the largest industrialized market in the world. Further- more, political-economic developments in the European Free Trade Association (EFTA) and the former Council for Mutual Economic Cooperation (COMECON) countries can be expected to lead to significant increases in the potential size of the EC market (Lewis, 1991).

II. US domestic banking environment

The environment of the banking industry in the US is defined by three major pieces of legislation. They are namely the McFadden Act of 1927, the Glass-Steagall Act of 1933

234 A. Lewis

US banks must also compete with non-banking

institutions

and the Bank Holding Company Act of 1956. These acts restrict US banks from engaging in activities such as underwriting, securities, investment banking and insurance as well as geographical limitations. In addition, reserve requirements are relatively high for US banks when compared with the rate foreign banking institutions have to maintain in their respective home countries. Unlike European banking institutions that are full service banks, US banks not only have to compete with each other but must also compete with non-banking institutions commonly referred to as non-bank banks.

FOREIGN BANKS + US BANKS C NON-BANK BANKS =Elm Figure 1. Competitive forces in US banking industry.

The non-bank banks are institutions that provide banking services but are not subject to the regulatory constraints to which banks have to operate within, they include finance subsidiaries of major corporations, insurance companies, brokerage institutions etc. A rep- resentation of the US banks’ environment is presented in Figure 1 . This competitive environment is further complicated by the increasing presence of foreign banking institutions in the US. Table 1 presents a breakdown of the market structure of the

Table 1 . Market share of financial intermediaries.

Institution 1960 1989

Commercial banks 34.2% 26.6% Insurance companies 21.8 14.5 Other depository institutions 17.0 14.1 Pension/retirement funds 8.8 15.6 Mutual and money market funds 2.6 8.1 Agencies and mortgage pools 1.7 10.8 Other 11.6 10.4

Source: Compiled from Federal Reserve Publications

Financial Services Industry (FSI) in the US. US banks’ share of the financial market has dropped from 34.2% in 1960 to less than 27% in 1989.

The result of the discontinuous environ- ment in which US banks have to operate has been blamed for the number of bank failures as well as inappropriate strategic response to the industry competitive environment by banks’ top management. Table 2 presents a time-line of bank failures in the US.

Table 2. Number of bank failures in the US (1982-1990).

1982 1983 1984 1985 1986 1987 1988 1989 1990

42 48 79 116 138 184 200 206 168

Source: FDIC Annual Reports.

III. European banking presence in the US

The fragmented nature of the US banking industry is a competitive disadvantage to US banks. The fragmentation denotes the separ- ation of commercial, investment, insurance and securities segments of the industry. The structure of the banking industry in the EC is concentrated- for example, Britain is dominated by four banks, France and Germany by three respectively, in contrast to over 10,000 banks in the US. The limitations of

The fragmented nature of the US banking industry is

a competitive disad van tage

the regulatory framework in the US prevent US banks from achieving economies of scale and economies of scope. The larger banks out of the 10,000 in the US tend to be regional and furthermore do not really engage in international banking activities. As of 1988, foreign banking institutions were responsible for over 28% of the wholesale

Journal of Strategic Change, August 199.3

EC and US banking 235

banking activity in the US. For the purpose of this study ‘foreign banks’ is composed of a variety of institutional structures hence a breakdown is provided in Appendix A. This penetration of the US banking activity by foreign banks exceeds the levels experienced in industries such as primary metals, elec- tronics, and the transportation sector (Baer, 1991). Foreign banks also service customers from offshore offices and as such are not subject to the regulatory restrictions imposed on US banks. Furthermore, foreign banks tend to be more cost competitive by exploiting more efficient operations abroad in order to lower their margins in dealing with customers in the US. The ever increasing US trade deficits has resulted in increases of US$ reserves by trading partners. This in return has led to an increase in the number of foreign banks in the US from 334 in 1979 to

Foreign banks have been able to acquire US

banking institutions at relatively low cost

674 in 1988 (Damanpour, 1991). Another result of the US trade deficit is the weakening of the dollar relative to other major currencies whereby foreign banks have been able to acquire US banking institutions at relatively low cost. It is estimated by the Federal Reserve that foreign banks now own over 21.5% of all banking assets in the US. In addition, the regulatory framework of the banking industry in the US contributes to the increasing presence of foreign competition. Whereas US banks are restricted in terms of the three acts mentioned earlier, foreign banks since the 1970s were able to offer banking services and conduct activities state lines. In addition, they were able to acquire domestic banking institutions in the US which was denied to domestic institutions. They were also not subject to the reserve requirement imposed on US banks. This enabled the foreign banks to realize a

reduction in cost of funds of about 0.5% (Damanpour, 1991, p. 46). In an effort to correct this imbalance the International Banking Act of 1978 was enacted.

IV. Contributions of foreign banks to US banking

Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System made the following remarks before the Committee on Banking Finance and Urban Affairs, US House of Representative, on June 11, 1991. ‘The liquidity and depth of the U.S. banking environment have, to a great extent, been made possible by the participation of foreign banks. The active presence of foreign banks in this country has helped to assure the continued importance of the United States in international financial markets and has con- tributed to the growth of banking, including international banking’. Henry C. Wallich of the Federal Reserve Board believes that foreign banks have had a good effect. His reasons are as follows: ‘In the domestic sphere they

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have introduced innovations and have increased competition, have introduced new pricing techniques, such as LIBOR, have contributed to the capitalization of served US banks by providing for the flow of home-office capital into . . . bank deposits in the US and the US balance of payment capital account, have tried to create stronger dollar base for their own international operations, and have helped to solidify the inter- national role of the dollar as well as enhanced the American banking market as the world financial centre, thus contributing to the general betterment of the US economy, and finally with respect to acquisition of problem banks, foreign banks have helped to resolve problems created by the US law which prohibits interstate mergers and acquisitions within individual states’ (Damanpour, 1986).

Journal of Strategic Change, August 1993

23 6 A. Lewis

There are those who are concerned that foreign

banking is harmful to the American economy

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In terna tional ban king is limited to a small

percentage of most banks’ business

On the other side of the issue, there are those who are concerned that foreign banking is harmful to the American economy and specifically American banking. Their concerns are as follows:

0 Grandfathering gives some foreign banks unfair advantages with respect to American banks and other foreign banks that entered the US after the IBA.

0 Foreign banks operating in the US benefit by more liberal bank legislation.

0 Foreign banks may be less responsive to the community needs.

0 Foreign banks have bought large US banks.

The first two are indeed valid in terms of an equitable competitive environment. However, the Federal Reserve Board disputes the third point because the majority of foreign banking activity is concentrated in the wholesale segment of the industry, and furthermore it was found that foreign banks have proven to be consumer oriented and usually infuse substantial investments into the acquired banks.

V. US banking international banking operations

US banks range in size and function from the small town bank to the multi-regional multi- function super banks. International banking, defined as banking activities that cross national borders, is limited to a small percentage of most banks’ business. For a typical regional bank, international assets average less than 5 % of the bank’s total assets. Four out of the roughly 10,000 US banks account for approximately 50% of all

international assets. Ten banks account for little more than 80%. Frequently mentioned financial institutions that are participating in international banking are Citibank, J. P. Morgan, and Chase Manhattan. Lester Thurow foresees a dismal future for American banking, and particularly for American banking abroad. Specifically, he cited the low savings rate in the US and as a result US banks have to borrow wholesale on the inter- national market in order to fund their retail lending operations. US banks are thus unable to compete with their European counterparts who are able to borrow at relatively inexpensive rates due to the high level of savings by Europeans. He further states that ‘Because of all our banking laws, we don’t have national banking in the United States. We moved to international banking without developing national banks’ (Deutsch, 199 1).

Although US banks may operate Inter- national Banking Facilities (IBFs) and Edge Act Corporations which do not require a physical presence outside the US, very few banks have used these regulatory allowances to increase their participation in international banking.

VI. European community domestic banking environment

The environment of the banking industry in the EC market is being shaped by the adoption of the Second Banking Directive which is proposed to be implemented on January 1, 1993. Table 3 provides a description of the elements contained in the Second Directive. There is general consensus that the Second Banking Directive of the EC will act as a catalyst in the reform of global banking operations. The originally proposed

Journal of Strategic Change, August 1993

EC and US banking 23 7

Table 3. Scope of EC second banking directive.

1. 2 .

3. 4. 5.

6. 7.

8.

9. 10. 11. 12. 13.

Deposit-taking and other forms of borrowing Lending (consumer credit, mortgages, factoring, trade financing Financial leasing Money transmission services Issuing and administering means of payment (credit cards, travellers cheques and bankers drafts Guarantees and commitments Trading for own account or for the account of the customers in:

a. Money market instruments (checks, bills,

b. Foreign exchange c. Financial futures and options d. Exchange and interest rate instruments e. Securities

Participation in share issues and the provision of services related to such issues Money broking Portfolio management and advice Safekeeping of securities Credit reference services Safe custody

CDs)

Source: Second banking directive, EC.

EC banking framework would have denied US banks wishing to operate in the 12-member group certain rights if the strict reciprocity rule had been applied. The Second Directive however is based on the concept of National Treatment whereby foreign banks subsidiaries are treated just like domestic EC banks. The exception will be cases of countries that do not allow EC banks to compete equally with domestic banks; in such cases the EC will treat banks from these countries based on reciprocity concept.

VII. Conclusion and implications

The implementation of the EC second directive will increase pressure on foreign governments to reform their banking systems. In particular Article 65 of Japan, the Glass- Steagall and the McFadden Acts in the US. Attempts were made to repeal the limitations of the Glass-Steagall Act in the US in late 1991, however, the terms of the bill also stipulated increased supervision of bank activities. The US banking lobby defeated the

bill as drafted, hence, it is likely that attempts will be made in the future to develop a compromise proposal that will on one hand,

. make US banking industry more competitive with the foreign competition, and on the other hand, satisfy the oversight wishes of the US government.

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The US banking environment remains the

most regulated of the G- 7 countries

The US banking environment remains the most regulated of the G-7 countries while Japan has the most attractive environment due to favourable regulatory framework (Dugger, 1991). It is thus very important for the US to modernize the regulatory environ- ment in which banks have to operate.

Finally, the equalization of rules of the game will further increase the level of globalization of the financial services industry, but in particular it will enable US banks to be potentially more competitive in terms of foreign banking institutions.

Appendix A Agency

According to the International Banking Act of 1978, an agency is ‘any office or any place of business of a foreign bank located in any state of the United States or District of Columbia at which credit balances are maintained, checks are paid, or money is lent, but at which deposits may not be accepted from a citizen or resident of the United States’.

Branch

A branch is defined as ‘any office or any place of business of a foreign bank located in any state of the United States or District of Columbia that may accept domestic deposits

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238 A. Lewis

that are incidental to, or for the purpose of, carrying out transactions in foreign countries’.

Edge Act Corporation

An Edge Act Corporation is a ‘nationally chartered organization set up to engage in international banking and investment, under the rules established in the 1919 Edge Act’, as listed in the International Banking Act of 1978. An Edge Act can ‘make loans, accept deposits, and provide a wide range of banking services, but all of these must be directly related to foreign or international transactions’.

Investment company

An investment company, as established under Article XI1 New York State banking law, is similar to state charted banks, except for the three following major differences: (1) ‘An investment company is not subject to the 10% lending limitation, while a commercial bank cannot lend any one person an amount greater than 10% of its capital stock, surplus, and undivided profits; (2) an investment company has no restriction on investing in stocks of corporations, while banks cannot acquire the stock of any corporation; and (3) an investment company cannot accept deposits, but can only maintain credit balances incidental to the conduct of its lawful business’.

Subsidiary

‘A subsidiary bank is legally separate from the parent bank. It has a full range of banking powers and is subject to the same restrictions as US domestic banks’.

International Banking Facilities (IBF)

IBFs are involved in money market trans- actions and may offer daily time deposits to non-bank residents.

Definitions as described by American Banker, Feb. 1990.

References

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Damanpour, F. (1986). A survey of market structure and activities of foreign banking in the U.S., Columbia Journal of World Business, Winter, pp. 35-45.

Damanpour, F. (1991). The Evolution of Foreign Banking Institutions in the United States: Developments in International Finance, Greenwood Press, Inc., Westport, CT .

Deutsch, Barry (1991). A conversation with Lester Throw, a walk on the dark side, Bank Marketing, September, pp. 16-20.

Dugger, R. (1990/1991). International banking competitiveness, Secondary Mortgage Markets, Winter, pp. 20-23.

Golembe, H. C. and Holland, D. S. (1990). Banking and Securities, Europe 1992, Ed. Hufbauer, H. C., The Brookings Institute, Washington, pp. 65-109.

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Lewis, A. 0. (1991). International banking in the European Community, Proceedings of the Fourth International Conference, Eastern Academy of Management, June 9- 13, 199 1, France.

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