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International banks (banks chartered by, and with head offices in, countries other than the U.S.) operate in New York through various entities including U.S. branches and agencies, which are referred to here generally as branches unless otherwise indicated. These branches and agencies can be licensed either by the Office of the Comptroller of the Currency (OCC) or the Banking Department of the State of New York (banking department). Other states have licensing arrangements similar to New York. Through the licensing process, New York-licensed branches are required to pledge certain assets (asset pledge requirement) with designated U.S. custodian banks, and OCC licensed branches are required to make certain security deposits (capital equivalency deposits) in a similar manner. This article will discuss these requirements, including their provisions, background and impact and efforts currently under way to reduce their burden and costs. STATUTORY AND REGULATORY PROVISIONS The New York provisions are included in �202-b (1) of the New York Banking Law (banking law) which authorizes the pledge but does not require any specific arrangement or amount, which are left up to the Superintendent of Banks (superintendent) and incorporated in Part 322 of the superintendent’s regulations. These require a pledge of assets equal to the greater of: five percent of a branch’s third-party (i.e., generally excludes affiliate’s) liabilities excluding international banking facility (IBF) liabilities; one percent of total liabilities including IBF liabilities; and $1 million. Liabilities relating to repurchase transactions may be deducted when calculating the asset pledge amount. In general, only highly liquid assets are eligible to be pledged. The OCC requirements are specifically (i.e., as to both arrangement and amount) contained in the International Banking Act of 1978 (IBA), which prescribes a 5 percent minimum requirement. Other states have different requirements ranging from 3 percent in Connecticut to no specified amount in Illinois (although the banking commissioner retains the authority to require a pledge of assets by individual banks on a case by case basis as warranted by the circumstances). BACKGROUND AND INTENT Since the branches of international banks operating here are not separately capitalized entities but rather extensions of the parent bank, there really is no “capital” directly present here to help secure the deposit and other branch obligations. As originally envisioned, these “asset pledge/capital equivalency” requirements (security requirements) were intended to provide a pool of assets that would be readily available for distribution to uninsured depositors in the event of a branch’s liquidation. The principal focus was on protection of uninsured retail depositors. In New York, for example, prior to 1993 these depositors enjoyed a statutory preference to the proceeds of the asset pledge account. Enactment of the Foreign Bank Supervision Enhancement Act of 1991, which prohibited branches from accepting retail deposits, significantly changed the underlying premise of the asset pledge requirement. Thus, in 1993, the depositor preference was repealed. In a memorandum in support of the legislation effecting this repeal, the banking department explained that “[t]he pledge requirement now is seen primarily as a means by which the superintendent may be assured that there will be sufficient funds in New York to pay the initial expenses of a liquidation.” It is my understanding that in the last 30 years there have been only a handful of New York-licensed branch liquidations, and in all of those cases depositors were paid in full. POSITION OF THE INTERNATIONAL BANKS The international banks, their home county regulators and others, including the Institute of International Bankers (IIB), an association representing the interests of the International Banks in the U.S. favor significant revisions to the security requirements for a number of reasons, including the following: The amount of assets required to be pledged under the current regime in almost all cases greatly exceeds the amount that would be necessary to cover liquidation expenses. In New York, for example, many branches are required to pledge assets in amounts equal to hundreds of millions of dollars, and, in the case of the largest branches, billions of dollars. Banking authorities have a wide range of supervisory and enforcement tools at their disposal to protect depositors and other creditors against the risk of failure of a branch apart from imposing asset pledge requirements. Robust, risk-focused supervisory standards and examination and audit practices are significantly more important to the safety and soundness of a branch than the pledge of five percent (or some other limited percentage) of liabilities. In addition, bank supervisors, including the New York Superintendent of Banks, have the discretion to require a branch to maintain a specified minimum percentage of assets to liabilities (asset maintenance) upon their determination that such action is warranted by the particular circumstances of the branch. In a liquidation, all the assets of a branch are available to pay the claims of depositors and other creditors. The asset pledge constitutes only a very small portion of these assets. Moreover, in New York the banking law contains “ring fence” provisions enabling the superintendent to apply to payment of claims of depositors and other creditors not only the assets of a branch, but also all other assets of the bank in New York regardless of whether they appear on the books of the branch. The significant cost of acquiring and/or maintaining the assets to pledge in the amounts required (see below), including the loss of business opportunity from the use of such pledged assets. SPECIFIC REQUESTS International banks with New York-licensed branches have requested that (i) a $10 million cap be placed on the amount pledged and (ii) the type of permissible pledged assets be expanded to include any assets eligible for security purposes at the discount window of the Federal Reserve Bank of New York (reserve bank). This all is in the banking department’s discretion to effect by amending Part 322. International banks also are seeking comparable changes in the asset pledge requirements of other states. Connecticut, for example, is considering such revisions to its requirements. Efforts are also under way at the federal level, where an amendment to the IBA is necessary to relieve OCC licensed branches from the burden of existing requirements. These efforts contemplate that the OCC would be given discretionary authority under the IBA that would enable a substantial reduction, or perhaps even the elimination (subject to reimposition as warranted by the circumstances of a particular branch), of the asset pledge requirement for OCC licensed branches. THE ECONOMIC BURDEN Compliance with the security requirements is extremely burdensome and costly to international banks. As mentioned above, the amount of the asset pledge typically exceeds by a substantial measure what would be necessary to cover liquidation expenses and does not provide any significant additional protection to depositors and other creditors. For many branches, eligible assets are usually not available in their inventory in sufficient amounts. Assets that are held for liquidity purposes cannot be used for the asset pledge and still be available to meet liquidity needs. In this situation, eligible assets must be obtained from the market, thereby generating negative carry, market risk and/or capital charges. Further, the asset pledge ties up funds that could be used for potentially more profitable purposes. For example, the IIB estimates that the negative carry incurred in connection with the asset pledge ranges from 20 to 60 basis points and the opportunity cost of complying with the requirement ranges from 55 to 160 basis points. This substantial economic burden undermines the “level playing field” concept under our law in the treatment of international banks versus U.S. banks. In this connection, a recent survey by the IIB of practices in more than 40 countries around the world found that only one country applied similar requirements to branches of U.S. banks operating in their territory. CURRENT POSTURE The banking department is considering the international banks’ request mentioned above to both reduce the amount of the security requirement and to relax the type of assets that may be pledged. An initiative is also under way to reduce the amount of Connecticut’s asset pledge requirements. The OCC has indicated that it looks favorably on amending the IBA in the manner described above, but as yet the necessary congressional legislation has not been introduced. CONCLUSION Based on the original purpose of the security requirements, the history involved, the reasonable arguments made by the international banks and the huge sums involved, it seems clear that the security requirements should be modified along the lines described above. Also, our regulators need to appraise the risk that bank regulators in other countries will retaliate similarly against U.S. banks operating there. Clyde Mitchell is adjunct professor of banking law at Fordham Law School, having practiced in the Banking and Financial Services Group at White & Case for more than 38 years. He is a member of the committees on Banking Law of the ABA and the New York City Bar.

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