New rules cast a shadow over the growth of foreign banks.

New federal restrictions on foreign banks, including a new requirement that FDIC-insured branches become U.S. corporations, and new oversight power given to the Federal Reserve Bank could inhibit the growth and the introduction of foreign banks in California, according to local international banking experts.

The Federal Deposit Insurance Corp. Improvement Act, signed into law by President Bush in December, is the most significant reform of foreign banking law in 14 years, industry experts said.

California is second in the U.S. for the number of foreign banks operating here, with 122 foreign bank branches boasting assets of $89.1 billion, about 21 percent of total bank assets in the state, according to the State Banking Department.

Stan Cardenas, chief deputy superintendent of the state Banking Department, said the new law means "for new applicants there are additional application procedures and for the existing (foreign banks) there is additional enforcement by the Federal Reserve Bank in this new banking bill."

Congress, spurred by the alleged fraud involving the Bank of Credit and Commerce International, gave more control of foreign bank regulation to the Fed. Previously, most foreign bank regulation was conducted by state banking departments.

But in California, according to Cardenas, the new regulation authority given to the Fed may seem like less of a "dramatic change" than in other states. In California, state and federal regulators have had a history of cooperation in examining foreign bank branches, alternately examining the institutions, he said.

"We would go in one year and they would go in the other," Cardenas said. The only difference now is that the Fed is required to examine foreign banks every other year, he said.

Notably, the law requires all banks which are insured by the FDIC to become U.S. corporations. In addition, foreign banks cannot accept deposits of less than $100,000 without FDIC insurance.

In Los Angeles, the law will quash the applications of two foreign banks with branches here, Bank Leumi le Israel and Liu Chong Hing Bank, Ltd., to open additional branches, Cardenas said.

Bank Leumi le Israel, which had a Beverly Hills branch, had hoped to open one in Los Angeles, Cardenas said. Conversely, Liu Chong Hing Bank, Ltd., which currently operates a branch out of downtown Los Angeles, had hoped to open one in Beverly Hills, he said.

Now, under the law, both banks will be required to get permission from both the Fed and the state banking department and must incorporate a banking subsidiary in the U.S. if the branches take FDIC-insured deposits, Cardenas said.

The main concern of foreign banks in California is that their authority to take commercial deposits of less than $100,000 is put in question by the new law, said T.J. Grasmick, a partner in the Los Angeles office of Pillsbury, Madison & Sutro, and general counsel for the International Bankers Association of California.

Because of what is widely reported as an error made in the early morning hours of Nov. 27, 1991 by a tired Congress, the law said all deposits of under $100,000, not just retail deposits, must be made in a U.S.-owned subsidiary bank. Commercial deposits have never required FDIC insurance and the Fed has frozen that provision of the law for study, said Kathleen O'Day, assistant general counsel for the Federal Reserve.

A majority of the 100 foreign banks operating in California could be affected by the law, Grasmick said. "The authority of all these offices is in doubt until this is clarified," he said.

In addition to the FDIC requirements, the law also asked the Federal Reserve to study new capital requirements and accounting procedures for foreign banks. Congress is expected to act on the Fed's recommendations in the next year.

David Kenny, a partner and international banking law expert with Graham & James, an international law firm with offices in Los Angeles, San Francisco, Tokyo and Hong Kong, said that most of the large Japanese banks with California subsidiaries additionally run offices which are branches of the foreign, parent bank. "In those branch offices, very, very large loans and credits are housed there because they don't have lending limits," Kenny said.

Under the banking bill the Fed will study whether there should be a limit, tied to the capital of the bank branch office, on loans, Kenny said. If a single-borrower loan limit is established, it could significantly change the way trade is financed in California, Kenny noted.

Grasmick noted that another significant aspect of the bill is that it will prevent foreign banks from competing with American banks when and if Congress approves interstate branching.

Currently, both American and foreign banks are required to set up separate corporations in states in order to operate retail branches, Grasmick said. A bill that would have allowed interstate branching was not passed, as some banking experts expected, by Congress last year but it is expected that an interstate branching may be possible in the future, he noted.

"The main reason that Bank of America and others are so anxious to have interstate banking is because they don't have to have the overhead of having separate banks in separate states," said Grasmick. If interstate branching is approved, banks would be able to make loans based on their worldwide capital base and not just on the capital base of the bank in that state, he said.

"I think the foreign bank community is not going to be able to take advantage of interstate branching," unless some of the new provisions dealing with FDIC insurance requirements are repealed, Grasmick said.

Frank Meister, chair of the International Bankers Association of California and a senior vice president for Credit Suisse in Los Angeles, said that most of the bankers he has talked to still don't understand what the regulations mean.

"They are concerned about more restrictive regulations and more restrictive supervision," Meister said. "I think that their main concern is that the operating ability they have now remains in place."