from growth in this protected environment may provide a
significant boost to entry into another market such as the
U.S.

Likewise, Mr. R. Taggart Murphy, an expert on Japanese financial markets and formerly with Goldman-Sachs in Tokyo, wrote in the March-April 1989 edition of the Harvard Business Review:

Japanese commercial and investment bankers have succeeded overseas partly because of their diligence and attention to detail, but also because they can offer lower spreads and lower fees to borrowers thanks to the profits they enjoy from a cartel-like protected market at home.

When asked at the April 5, 1990, hearing whether he agreed with Mr. Murphy's analysis on that point then Under Secretary of the Treasury Mulford stated:

I have acknowledged repeatedly, including in my Financial Times article of November 29, 1989, that Japanese banks have benefitted significantly by interest rate restrictions in Japan. The substantial earnings Japanese banks have acquired in their regulated domestic market has enhanced their ability to pursue market share abroad aggressively.

Assistant Secretary of State Daniel Tarullo made the same point in testimony he submitted at the Committee's October 26, 1993, hearing on the Fair Trade in Financial Services Act. He wrote:

When major countries refuse to open their own financial services sectors while claiming the benefits of other countries' open markets, a problem of basic fairness arises. The financial services sectors of these "free riders" gain significant benefits, while the firms of their trading partners are handicapped by the absence of broadly comparable competitive opportunities.

At that same hearing, Mr. Stephen Verdier, of the Independent Bankers Association of America, declared:

The IBAA is deeply concerned about the growing number of U.S. banks controlled by foreign interests and the increasing control of U.S. financial resources by foreign interests ***The fact that some foreign banks operate in protected home markets gives them a competitive advantage in the United States.

In order to illustrate this fact, Mr. Verdier cited the case of California Korea Bank in Los Angeles, which is a wholly-owned subsidiary of the Korea Exchange Bank. It controls more than 42 percent of the Korean-American community banking market in the greater Los Angeles area. It has been granted unconditional national treatment in the United States, but California Korea Bank has several distinct advantages over its community counterparts. According to Mr. Verdier those advantages are:

One, it has the image of a too-big-to-fail bank with local Koreans because of the towering status of its parent bank in Korea. Two, it has access to virtually unlimited capital

from the parent company. Three, it has institutional connections to the parent bank's extensive branch network to serve the local Korean consumer and business market. And number four, its parent bank operates in a protected home market. The fact that California Korea Bank operates in a protected home market gives it crucial advantages over local banks in the U.S.

The United States thus has good reason to be concerned whether its financial institutions receive the same opportunities to compete in foreign markets that we grant foreign financial institutions in our domestic market. Fair treatment of our financial firms abroad will not only help exporters of U.S. goods, but it will also ensure that our financial institutions do not lose market share at home because of unfair competitive disadvantages enjoyed by their competition. Protecting against the latter is also important for the safety and soundness of our financial system. If foreign banks engage in "financial dumping," offering loans and services at cut rate prices to the better credit risks here, then U.S. banks may be forced to pursue higher risk business in order to maintain their profits. This in turn would increase risks to our deposit insurance funds, which are ultimately backed by taxpayer money. Satisfying short term consumer interests with cheap financial services may not promote the long term interests of our nation.

MARKET BARRIERS IN FOREIGN COUNTRIES

JAPAN

While S. 1527 would give U.S. officials the authority to negotiate for the equality to compete with domestic institutions in all foreign markets, a particular focus of U.S. negotiators has been to seek such treatment in Japan. Despite almost 15 years of deregulation and liberalization, foreign firms are still only marginal players in that market, excluded explicitly from certain types of business by regulation, as well as informally from other operations by other barriers. The Treasury Department's 1990 National Treatment Study stated:

Despite modest improvements, a variety of factors have kept the Japanese banking market difficult to penetrate and the slow pace of liberalization and deregulation has provided domestic banks with an unfair competitive advantage over foreign banks both in Japan and globally. Foreign banks continue to find the Japanese market difficult to penetrate, particularly in traditional banking functions.

The situation is not any better in Japan's securities markets. The Treasury report concludes:

Full and easy access to the Japanese investor base and entire range of securities activities is still difficult despite continued efforts to open and liberalize Japanese securities markets * * * In general, Tokyo is viewed as a key financial center, but one in which change has not kept pace with that in other major centers. By any standard of open

ness, Tokyo lags substantially behind New York and London *** Thus, despite significant steps forward, the process of creating a truly level playing field is far from complete.

In his testimony before the Committee in October 1993, Under Secretary Summers cited the following examples of both formal and informal barriers:

Over 80 percent of the $900 billion corporate and public pension fund markets are closed to discretionary investment advisors. Moreover, rules on how these assets must be invested limit the ability of investment advisers to mobilize their considerable skills even in those portions of the market open to them.

In the securities area, U.S. investment banks are virtually excluded from Japanese underwriting by a combination of industry practices and legal and regulatory barriers hindering the development of a viable corporate finance market. There are also constraints on distribution of securities products, such as who can issue them and how they can be structured.

The $450 billion mutual funds market in Japan has only a handful of foreign participants due to economic barriers. It cost 30 times more to establish a mutual fund in Japan than in other major markets, and foreign mutual fund managers must market their products through Japanese securities firms, which are their major local competitors.

Restrictions in Japan's foreign exchange regime are, despite Japan's large external surplus, the most comprehensive of the G-7 countries. This hampers Japanese investors' access to the full range of financial products offered cross border in overseas markets. Innovative products and efficient services provided by foreign financial institutions are effectively shut out of the market.

THE EMERGING MARKETS

Since 1978, as noted above, the Treasury has been required to conduct studies on the extent to which American banks are denied national treatment in banking operations abroad. In its most recent report, submitted to Congress in 1990, the Treasury identified several restrictive practices in financial services that effectively deny national treatment to U.S. financial firms in a large number of countries. Many of these countries are among our most important trading partners and have rapidly emerging financial markets. Following are a few examples of the problems our financial institutions face in seeking access and competitive opportunities in the emerging markets:

In Korea, inadequate access to local currency funding sources by foreign banks, tight restrictions on offering new financial products, and pervasive foreign exchange and capital controls severely limit U.S. banks' opportunities for expansion in this important market.

In Indonesia, there are serious limitations on the ability to establish a commercial presence, including a requirement to

establish joint ventures with Indonesian firms, and a 49 percent equity limit on those investments.

The Philippines denies national treatment to banks with more than 40 percent foreign equity. Among other restrictions on foreign banks are limitations on the number of branches they may have and prohibitions on establishing additional branches or shifting existing ones.

Taiwan, while not yet in the GATT, engages in financial policy discussions with Treasury. At present, Taiwan still imposes ceilings on banks' foreign exchange liabilities, particularly by limiting capital flows, and also imposes unfair restrictions on branching.

Brazil's current legal framework presents a variety of problems. There are constitutional prohibitions on foreign investment. Financial institutions may not hold private issues of securities in their portfolios or place them. Most pension funds are in the public sector and managed by public sector entities, which effectively excludes foreign institutions from a major role in the sector.

LEVERAGE FOR U.S. NEGOTIATORS

Witnesses at the October 26, 1993, hearing strongly supported the passage of S. 1527 in order to give U.S. negotiators increased leverage in their efforts to open foreign financial markets. Marc Lackritz, President of the Securities Industry Association, stated:

This legislation will provide our government with the means necessary to actually use the leverage of our open markets to secure liberalization of the world's financial markets. Passing this legislation will help to assure our negotiators have the tools that they need to actually accomplish these objectives. And finally, this version of the legislation provides our government with a moderate, I think, and balanced trade policy tool * * *.

Matthew Fink, President of the Investment Company Institute, stated:

Enactment of this legislation *** will help preserve our country's leverage and negotiating ability and send a very strong signal that we will insist that foreign countries deal fairly with U.S. financial firms * * * By equipping the U.S. Government with the means to redress the competitive inequities that arise today in the marketplace, the bill would be an important step in ensuring that U.S. firms are treated fairly.

Helping U.S. firms gain access to foreign markets is one of the highest priorities of the Clinton Administration. The Fair Trade in Financial Service Act is a necessary tool in the Treasury Department's negotiating strategy. Under Secretary of the Treasury Summers testified at the Committee's October 26, 1993, hearing that:

Fair Trade in Financial Services legislation will complement our efforts multilaterally, bilaterally and regionally to gain access to foreign markets on the basis of national treatment and equality of competitive opportunity.

Assistant Secretary of State Daniel Tarullo, in testimony he submitted at that same hearing, made the point that the Administration needed this authority. He wrote:

Withholding new opportunities from a country in response to its failure to give adequate opportunities for fair competition to U.S. financial firms is a power that should rest firmly in the hands of the Executive, not regulatory agencies. Specifically, we believe that this responsibility should be lodged with the Secretary of the Treasury, in consultation with the Secretary of State and the U.S. Trade Representative, and subject to the specific direction, if any, of the President.

GENERAL AGREEMENT ON TARIFFS AND TRADE

The Fair Trade in Financial Services bill is also tied into the ongoing negotiations to complete the chapters of the General Agreement on Tariffs and Trade (GATT) agreement that deal with financial services. Financial services are included within the General Agreement on Trade in Services (GATS), which establishes a multilateral framework of principles and rules for trade in financial services. However, the commitments made by many countries to open their markets to U.S. financial institutions under that framework were less than the U.S. had hoped for.

The United States, therefore, has take a Most Favored Nation (MFN) exemption for banking and other financial services including insurance, but will suspend it for six months after the GATT agreement goes into effect. Until that time, negotiations will continue within the GATS framework. In a February 11, 1994, speech to the Bankers' Association for Foreign Trade, Assistant Treasury Secretary Jeffrey Shafer articulated the Administration's goals during this period:

Our goal will continue to be achieved of substantially full market access and national treatment, at least over some agreed time frame. * * * If we do not obtain good commitments, we will retain the exemption and grant full market access only to those countries that we judge to be doing essentially the same for us.

Shafer went on to state:

If Fair Trade in Financial Services does not pass, those who bet that the U.S. would not be tough on free riders would be vindicated. We would see no better commitments to market access.

John R. Price, of the American Bankers Association and the Bankers Associations for Foreign Trade, noted at the Committee's October 26, 1993 hearing that:

Although the Act in various forms has been considered and passed many times over the years *** this is the first time it has enjoyed united Administration support *** and also a clear and express integration with the U.S. negotiating objectives on financial services in the GATT.

S.Rept. 103-235-94 - 2