Chapter 1

Introduction

Background

Eliminating competitive barriers has become increasingly important to financial institutions as competition has burgeoned in the world's financial markets. Advancements in technology and efficiency, the increasing sophistication of markets, and growing competition have combined to put tremendous pressure on the profit margins of financial firms participating in these markets.

In this competitive environment, relatively minor barriers can have an
impact on the ability of financial institutions to compete internationally.
Therefore, it is not surprising that the concept of national treatment,
i.e., equality of competitive opportunity, is of importance to financial
firms wishing to compete in world markets. While national treatment is
concerned with providing equivalent competitive opportunities to both
foreign and domestic firms operating within a particular nation, an
alternative approach, reciprocity, focuses on subjecting foreign firms to
the same restrictions in the United States that U.S. firms face in their
countries.

Current U.S. policy, however, is based on a belief that national treatment, both in principle and implementation, is the best way to treat foreign firms in this country. This policy is based partly on recognition of the disadvantages of reciprocity. A policy of reciprocity would result in a matrix of regulations virtually impossible to administer. U.S. firms would also suffer increased trade barriers abroad under reciprocity due to the Glass-Steagall Act and to state-level restrictions faced by foreign financial firms in the United States. While the potential threat of reciprocal regulatory treatment may be a useful negotiating device, the guiding principle of the U.S. regulatory framework is to accord foreign financial institutions the same competitive opportunities available to their domestic counterparts.

The Congress established the policy of national treatment for banking institutions in the International Banking Act of 1978 (IBA). The IBA provided that foreign banks operating in the United States be subject to regulations and requirements equivalent to those applied to U.S. banks. Before the IBA was enacted, individual states, rather than federal regulatory authorities, exercised primary control over foreign bank operations in the United States. The principle of national treatment for securities firms has also been the practice in the administration of federal securities laws.

The Congress has been concerned that U.S. financial firms abroad should be accorded national treatment as well. Section 9 of the IBA required the Department of the Treasury to report to the Congress on the status of national treatment for U.S. banks overseas and the Department has prepared three national treatment reports; the first was issued in September 1979, and updates were released in 1984 and 1986. The 1986 update extended the review to include the treatment accorded U.S. securities firms operating overseas. In general, the reports concluded that U.S. financial firms operating in Japan and the United Kingdom are accorded national treatment.

Since passage of the IBA, Japan and the United Kingdom have made progress in addressing national treatment concerns. The elimination of many regulatory inequities has helped to facilitate the entry of financial firms into overseas markets. This ability to expand worldwide has also coincided with the increase in international financial flows, increasing the demand for firms capable of conducting international business. These two developments have played a significant role in the evolution of truly international capital markets, which have both unique benefits and risks.

Objectives, Scope, and
Methodology

The Senate Committee on Banking, Housing, and Urban Affairs and its Subcommittee on International Finance and Monetary Policy asked us to review the regulatory treatment of U.S. financial institutions in Japan and the United Kingdom and the treatment of foreign financial firms in the United States to determine whether national treatment is being uniformly applied. Our review focused on legislative and regulatory barriers to national treatment of banks and securities firms rather than on market-driven differences that are part of conducting business outside of a firm's home market. We interviewed a selected group of regulatory officials, bank and securities firm representatives, trade association members, and academic experts in Japan, the United Kingdom, and the United States to obtain their views on the status of national treatment in all three markets. Interviews took place both before and after the stock market crash of October 19, 1987, to include changes in viewpoints which might have resulted from this important event. We reviewed relevant documents on the Japanese, British, and U.S. financial markets, including legislation, regulations, studies, surveys, and reports prepared by the Department of the Treasury, the Securities and Exchange Commission, the Federal Reserve Board, and various private sector organizations.