Federal Deposit Insurance Corporation
Institute of International Bankers
March 4, 1996
In 1974, the collapse of Bankhaus Herstatt reminded us that a
global system of financial institutions is only as strong as its weakest
component. The failure of Herstatt -- a small bank in Cologne --
temporarily halted the Clearing House Interbank Payments System
(CHIPS). In the words of Institutional Investor "its failure to meet its
obligations to other banks nearly undermined the entire interbank
Four months later, the closing of the $3.6-billion-in-assets
Franklin National Bank in New York taught us that we could no longer
assume that no large American bank could fail.
With those two failures, the American Banker said, "the fragility
of the emerging global market became painfully clear."
By contrast, when Barings Bank failed last year, the global
financial markets took note, and continued to operate smoothly,
efficiently, and effectively. No panic in the international financial
The world of 1974 and the world of 1995 were, in many ways,
different places. One of the more significant ways they differed was in
the closer consultation among supervisory agencies in 1995. Just as
banking supervision on a national level produces confidence against
systemic collapse, international cooperation gives greater global
assurance of stability.
The failures of Herstatt and Franklin twenty-two years ago -- the
fragility they revealed -- were two of the events that prompted national
banking authorities to create the Basle Committee on Banking
Global markets made cooperation among regulators imperative -
- money knew no boundaries -- and that meant that bank supervisors
had to function more effectively across borders. There was no choice.
It was necessary to find common approaches to international
supervision over a range of institutions and national regulatory systems
that differed widely. We had to develop principles such as consolidated
supervision and structures such as capital requirements that would pull
the disparate systems into the same sphere.
The structure that was built made it less likely that one
irresponsible institution could trigger a systemic meltdown.
Complacence, however, has no place in bank supervision.
In a fast-moving world of telecommunications, financial
innovations and capital mobility, we must continually ensure
safeguards, standards, and systems necessary to monitor and contain
risks. Todays markets -- and financial institutions -- move quickly.
Given the technical and technological sophistication and
orientation of the financial markets, it is striking how much they -- and
international banking supervision -- rest on the human factor. Neither
markets nor supervision would work if the participants did not
cooperate. Neither markets nor supervision would work if the
participants did not trust each other.
Sometimes that trust is betrayed.
Last year the Daiwa Bank revealed a loss of more than $1 billion
from trading activities in its New York branch. Later, it revealed a
loss of $97 million in its New York trust company during the mid-1980s.
It soon became clear that despite the success of international
bank supervision in maintaining confidence, there had been a
breakdown in the supervisory system. That breakdown arose from a
breach of trust -- a conscious effort over time by senior Daiwa
managers to deceive regulators about the losses. Simple fraud was
compounded by collusion, which made the detection of various
fraudulent acts more difficult to discover in bank examinations.
A bank examination is based on the books and records of a
bank, statements made to the examiner by bank officials, and
information obtained from other reliable sources. Like a medical
examination, a bank examination is a disciplined look for warning
signs. Where warning signs are concealed, examinations may not find
U.S. federal and state regulators ordered Daiwa to terminate
operations in the United States not because our citizens lost money --
none did -- nor because the FDIC insurance fund sustained losses -- it
did not -- nor because Daiwa lost a lot of money from trading
U.S. regulators withdrew the privilege granted Daiwa to operate
in the United States because the bank betrayed our trust.
Trust is the cement that binds both the financial structure and
the regulatory structure together.
Consider the alternative -- supervisors policing every aspect of
the industry -- with every decision by every manager being suspect.
None of us would find the alternative acceptable
Bank examinations focus on detailed answers to the simple
question: how good a job does this institution do in knowing, assessing
and monitoring the risks that it faces? An examination is more than an
inspection -- it is a qualitative evaluation -- ultimately an evaluation of
the quality of management. Without communication between bank
management and examiners -- communication in good faith -- the
process will not work as it is intended.
Examinations are sometimes confused with audits. Audits are
conducted to verify the numbers in an institutions financial statements
and accounting records, and to provide an extensive evaluation of an
institution's internal controls.
Audits have a somewhat greater tendency to detect fraudulent
activity than do bank examinations, but even a complete audit may not
expose deceptive practices.
To audit every bank in the country, U.S. supervisors would
have to create an army of auditors -- and the benefits derived from
doing so would not warrant the increased regulatory burden of
imposing such comprehensive reviews on healthy, well-managed
Fortunately, experience has shown that mutual trust can be an
effective, if not perfect, foundation for the operation of markets and for
Experience has also shown that -- in developing bank regulation
-- dialogue between a bank and its supervisor will enhance, not impede,
supervision by assuring that regulation comports with the facts and the
Accordingly, bank supervisors around the world have
increasingly opened up the process of developing bank regulations to
the reasoned views of other market regulators and the private sector.
In recent years, the Basle Committee has recognized the value of
including the views of other financial regulators and the private sector
in its deliberations on international supervision.
I commend Dr. Tommaso Padoa-Schioppa, the president of the
Basle Committee, for his leadership in this effort.
As you know, the Basle Committee broke new ground recently
in formulating capital charges to market risk by responding to the
private sector's request that banks be allowed to use their own internal
models to measure these risks.
Several large, internationally active banks participated in testing
the internal market-risk methodology. They ran a test trading portfolio
through their models and reported the results to the Committee, along
with analyses and suggestions for improvement.
A second test of the internal market risk models produced
results that gave policy makers sufficient confidence in the methodology
to endorse the internal model approach. The successful interaction
between the Committee and the banks in these testing exercises resulted
in what the committee recognized as a "significant innovation in
Federal banking regulators in the United States have long sought
reasoned views from the private sector in developing U.S. regulations.
For 50 years -- since the enactment of the Administrative Procedure
Act in 1946 -- our laws have spelled out detailed procedures for
proposing regulations and receiving public comments on them. We
have also long considered regulations in public deliberations. Better
regulations have been the result. Working together in the regulatory
process has enhanced trust.
Just as trust is indispensable to banks if they are to attract
customers and retain them over the long run, trust is indispensable to
supervisors if we are to communicate and work with supervised
institutions most effectively.
Because trust can be betrayed, however, banks maintain systems
of internal controls and conduct audits, and bank supervisors conduct
examinations. Because trust can be betrayed, supervisors retain the
power to compel.
The privilege of any bank to operate in the United States carries
with it obligations -- among them the obligation to maintain accurate
records and financial reporting, the obligation to maintain adequate
internal controls for assessing risks; and the obligation to maintain the
utmost credibility. While cooperation in international bank supervision
has made it less likely that one institution could trigger a systemic
meltdown, we U.S. regulators must still deal with the institutions --
foreign and U.S. -- that betray the trust placed in them and the
privileges granted them.
Last year, the FDIC began a top-to-bottom review of how the
FDIC supervises the international banking activities of federally insured
institutions -- both the U.S. operations of foreign organizations and the
international operations of U.S. banks. As part of this effort, we will
establish a special unit within our organization with expertise in
In these efforts, we know that we have to strike a balance -- we
take care to assure that, by legislation, by regulation and by
supervisory practice, we do not put foreign banks at a competitive
disadvantage in relation to our domestic institutions.
We value your presence here.
From its beginnings, the United States has been open to
international finance -- not surprisingly in that we were a debtor nation
during the formative part of our history when we were, to use a
modern term, a developing nation. To a large extent, international
capital financed our revolutionary war, our railroads and our early
factories. As a beneficiary, we saw the virtue in the international flow
Today, in the U.S. foreign banking organizations hold 21
percent of banking assets and hold 30 percent of all bank loans to U.S.
commercial borrowers. You are a large part of the U.S. banking
A threat to the integrity of the U.S. banking system is a threat
to all of you who act in good faith. You have a direct interest in
seeing that the bad actors are identified and that the threat they pose to
you is addressed.
The coda to the collapse of Franklin National 22 years ago is
apt. Those of you with long memories know that the FDIC resolved
the failure with a purchase and assumption transaction -- and that the
winning bidder was European-American Bank, a New York-chartered
bank that was a subsidiary of several very large European banks.
A domestic bank failure triggered international worries -- and an
international solution ultimately resolved the domestic failure. The
circle closed. The FDIC learned a number of lessons from the
Franklin failure -- and one was that the U.S. banking system can
benefit if foreign banks or their U.S. subsidiaries are a part of efforts
to resolve problems and crises.
The greater lesson was also clear: we are all in this together --
or, as the former head of state of Canada once put it, we may be in
different boats, but we are all afloat on the same lake.
We here today come from many different boats, but all those
boats are affected in some measure by the same winds, currents and
tides. Working together, we can enhance our common ability to
address the risks that we -- and our financial system -- all face.