Statements to Congress.

Statement by Thomas D. Thomson, Executive Vice President, Federal Reserve Bank of San Francisco, before the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, September 13, 1991

I am pleased to appear before this committee to provide information on the Federal Reserve Bank of San Francisco's supervision and regulation of Bank of Credit and Commerce International (BCCI) and related entities. My name is Thomas D. Thomson. I have overall executive responsibility for the San Francisco Reserve Bank's supervision and regulation activities, among other functions, and, therefore, the supervision and regulation of BCCI in the Twelfth Federal Reserve District. President Parry is unable to deliver this testimony today because he is traveling in Asia to keep a long-standing commitment to meet with other Pacific Rim central bankers.

Overall Federal Reserve supervision of BCCI has been described by other representatives of the Federal Reserve System. My comments will fall into two parts: first, the Federal Reserve Bank of San Francisco's participation in the supervision and regulation of BCCI, and second, our role in the regulation of Independence Bank in Encino, California.

BANK OF CREDIT AND COMMERCE INTERNATIONAL

Twelfth District Supervision and Regulation

The San Francisco Reserve Bank's initial supervisory contact with BCCI was indirect, through the initial acquisition by Bank of America of 2.5 percent of BCCI's outstanding shares on December 21, 1973. Bank of America was a founding shareholder and, over the next three-year period, increased its equity interest in BCCI to 45.0 percent. In 1978, Bank of America began to withdraw from its investment in BCCI and completed its divestment on June 30, 1980.

This Reserve Bank reviewed Bank of America's investment in BCCI annually through the examination of the Edge Act corporation that held Bank of America's interest in BCCI. Because it was not a subsidiary, information required to be made available to our examiners was limited to financial data such as balance sheets and income statements and other documents such as Bank of America's internal investment files on BCCI. Because it was not a controlled subsidiary, no on-site examination was conducted. Our examinations of Bank of America's investment in BCCI during this period did not disclose any suspicious or criminal activities.

BCCI's presence in the Twelfth Federal Reserve District began on September 1, 1981, when its subsidiary, Hong Kong Metropolitan Bank Limited, opened an agency in San Francisco licensed by the State of California. It was converted to a direct office of BCCI on June 1, 1985, and its name changed to reflect its ownership status. BCCI established an agency in Los Angeles on February 7, 1983.

The Federal Reserve Bank of San Francisco has been involved directly in the examinations of both the San Francisco and Los Angeles agencies since their inception as a result of an arrangement with the California State Banking Department. This arrangement was worked out with the state under the provisions of the International Banking Act of 1978, which, at the federal level, gave the Federal Reserve System supervisory responsibilities for monitoring the consolidated operations of foreign banks in the United States, while primary supervisory responsibilities for each branch or agency remained with its chartering authority. Under this arrangement, our Reserve Bank shared examination responsibilities with the California State Banking Department.

The oversight efforts of this Reserve Bank intensified after notification of the BCCI indictments in October 1988 in Tampa, Florida. Our examiners participated in special examinations that were conducted in conjunction with investigations of BCCI's money-laundering activities. Special examinations were conducted at both the Los Angeles and San Francisco agencies of BCCI beginning on October 11, 1988. These examinations focused on a review of the agencies' policies and procedures to ensure compliance with the Bank Secrecy Act. Currency transactions that occurred within the previous year were reviewed for compliance with currency reporting requirements.

No evidence warranting the filing of a criminal referral was discovered as a result of the special examinations of BCCI's Los Angeles and San Francisco agencies in 1988. However, examiners cited BCCI for asset-quality problems and lack of adequate credit documentation, internal control deficiencies, errors in regulatory reporting, and inadequate record-keeping procedures. BCCI's management was criticized for lax supervision. Violations of both state and federal laws and regulations were noted; however, they were technical in nature and related principally to deposit-taking activities.

As a result of these findings, our Reserve Bank participated actively in drafting a Memorandum of Understanding, which was issued to BCCI by the California State Banking Department on February 14, 1989. Our Reserve Bank also participated in drafting a cease and desist order, which addressed these and other deficiencies in BCCI found by other Reserve Banks, which was issued to BCCI by the Federal Reserve Board on June 12, 1989. The memorandum of understanding and the cease and desist order required that BCCI improve asset quality and credit procedures, correct internal control deficiencies, and develop procedures to ensure compliance with all state and federal laws and regulations, including the Bank Secrecy Act.

Adverse publicity surrounding the filing of the indictments against BCCI caused a moderate shrinkage in assets and liabilities at both the San Francisco and Los Angeles agencies, as certain customers elected to curtail their business relationship with BCCI. Also as a result of these indictments, the California State Banking Department required both agencies to maintain a more restrictive ratio of assets to liabilities and to require a higher-than-normal level of assets pledged to the State of California for faithful performance. The result of these more restrictive requirements was to increase the costs of operating these offices.

In light of the above developments, BCCI management closed the San Francisco agency on December 1, 1990, and transferred the assets to the Los Angeles agency. Also in December 1990, BCCI management transferred the assets of the Miami office to Los Angeles when the Miami agency was closed by the State of Florida. In both cases, the assets that were transferred were principally loans to small businesses and trade-related financing.

In terms of asset size, the Los Angeles office reached its zenith at year-end 1990, after the transfer of assets was complete. On December 31, 1990, the Los Angeles agency reported total loans of $142.9 million and total assets of $190.4 million.

On February 19, 1991, in conjunction with the Federal Reserve Board staffs coordinated supervisory efforts, we conducted an examination of the Los Angeles agency. Besides the standard procedures conducted in a full-scope examination, particular attention was devoted to testing compliance with state and federal laws and regulations, including the Bank Secrecy Act. Examiners also reviewed the loans transferred from the Miami and San Francisco agencies in December 1990. As with other recent examinations, the results of this examination disclosed weaknesses in asset quality, internal controls, and management supervision.

On July 5, 1991, the State of California closed the Los Angeles agency in conjunction with the coordinated closure of BCCI's offices worldwide. On that date, the state assumed responsibility for the disposition of the assets of the agency. At the time of its closure, all funding of the agency was from either its head office or BCCI affiliates. Accordingly, no U.S. depositors or institutions are likely to suffer depository losses from the closure of the California office.

Our Reserve Bank has maintained a continuous presence at the Los Angeles office since the start of the February 1991 examination. Our examiners are still on site and are reviewing the agency's records. We are continuing to cooperate with the investigations now under way. Relevant information is being shared with appropriate federal and state judicial authorities, other regulators, and the Congress.

INDEPENDENCE BANK

Independence Bank is a state-chartered nonmember bank and is not owned by a bank holding company. Accordingly, the Federal Deposit Insurance Corporation (FDIC) and the California State Banking Department are the bank's primary regulators and supervisors. Our relationship has been limited essentially to an application that was made in 1986 to form a bank holding company. We have not examined Independence Bank, nor have we participated in examinations of the bank by the California State Banking Department or the FDIC. Because it is a nonmember bank, its acquisition by Gaith Pharaon in November 1985 was reviewed by the FDIC and the California State Banking Department, not the Federal Reserve.

Bank Holding Company Application

The San Francisco Reserve Bank did, however, have discussions with the management of Independence Bank about the possibility of forming a bank holding company because bank holding company formations require Federal Reserve approval.

On January 8, 1986, we received a draft application to form a multitiered holding company structure over Independence Bank. This application raised significant concerns related to the proposed bank holding company's high debt level and low consolidated capital ratios.

The draft application reflected proposed debtto-equity and consolidated primary capital ratios that did not meet Federal Reserve System guidelines. The applicant was informed that additional equity would be needed if the proposed holding company was to maintain an adequate tangible primary capital ratio.

On August 6, 1986, the Federal Reserve Bank of San Francisco received the final application to form a multitiered holding company that would own Independence Bank. In a subsequent exchange of correspondence, we requested certain commitments from the applicant.

The applicant was requested to commit itself to achieve and maintain minimum capital ratios meeting Federal Reserve System guidelines at both the parent company and Independence Bank. It also was requested to declare that Independence Bank, if acquired by the applicant, would not engage in nonbanking activities prohibited to bank holding companies and national banks by federal law but permitted to state-chartered banks by California law, such as real estate investment and development. The applicant indicated to the San Francisco Reserve Bank's staff that it did not want to make this commitment because it limited the powers and rights of Independence Bank as a state chartered bank.

San Francisco Reserve Bank staff actions, namely requests for these commitments and discussions with the applicant of the financial issues raised by its proposal, apparently discouraged the applicant from proceeding with its proposal to form a holding company over Independence Bank. The applicant, after these discussions and requests for commitments, never submitted the information and the commitments necessary to complete the application for acceptance, processing, and action by the Federal Reserve System. The Reserve Bank returned the application to the applicant on December 5, 1986, as a result of its failure to provide the various required commitments.

Because the applicant failed to proceed with the application, it never reached the stage at which the Federal Reserve System would have conducted background investigations of principals of the applicant and formed conclusions concerning management of the applicant and Independence Bank. The Reserve Bank ceased having any direct supervisory or regulatory role with Independence Bank following the return of the application.

SUMMARY AND CONCLUSION

In summary, our efforts to determine the ownership of Independence Bank were limited, as we had no direct supervisory or regulatory role with the bank other than its application to form a bank holding company. The application never reached the stage at which the Federal Reserve System would have investigated and formed conclusions about the management and ownership structure of Independence Bank.

The Federal Reserve Bank of San Francisco's supervision and regulation of BCCI was concentrated on our on-site examination program adopted in cooperation with the California State Banking Department, our role in the drafting of enforcement actions issued against BCCI, our intensified oversight efforts in light of money laundering allegations in 1988, and our continuous on-site presence at the Los Angeles agency since February 1991.