Laws Separating Commercial Banking and Securities Activities as an Impediment to Free Trade in Financial Services: A Comparative Study of Competitiveness in the International Market for Financial Services
Michigan Journal of International Law
Financial Ser vices
Sarah A. Wagman 0 1
0 Part of theBanking and Finance Law Commons , Comparative and Foreign Law Commons
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SECURITIES ACTIVITIES AS
TO FREE TRADE IN
OF COMPETITIVENESS IN THE
Sarah A. Wagman*
In recent years, the market for financial services' has experienced significant
internationalization.2 In response to this change in the structure of the financial
services market, banks have increasingly sought new business opportunities
abroad and, in the process of doing so, have encountered new sources of
competition. The ability of banks to meet this competition, although a product
of many factors, is closely related to the domestic regulatory regime under
which they operate.3 This Note contends that, in the context of the international
market for financial services, domestic regimes which substantially restrict
the range of banks' permissible activities impede their banks from effectively
competing with banks operating under less restrictive regimes.
* University of Michigan, B.A. (1991); University of Michigan Law School, J.D. (1994).
The author thanks Professor William J. Adams, Professor Merritt B. Fox, and Frank G.
Goldman for their helpful comments on drafts of this Note.
1. "Financial services" may be broadly defined to comprise deposit-taking, lending, underwriting
and distribution of new issues of debt and equity securities, securities trading and brokerage,
investment management, fee-based advisory activities, insurance foreign exchange transactions,
and derivative instruments related to risk management (e.g., futures and options). ANTHONY
SAUNDERS & INGO WALTER, UNIVERSAL BANKING IN THE UNITED STATES 5 (1994).
2. Between 1960 and 1985, the presence of foreign banks in Organization for Economic
Co-operation and Development (OECD) Europe increased from 141 to 1187 and in OECD Asia
the increase was from 40 to 127. G. BR6KER, COMPETITION IN BANKING 42 (1989). Between
1970 and 1985, the presence of foreign banks in North America increased from 79 to 291. Id.
Countries have also dramatically increased their banking presence abroad during this time. Between
1960 and 1985, the presence of domestic banks abroad increased from 131 to 916 for the United
States, from 34 to 666 for OECD Europe, and from 37 to 346 for Japan. Id.
3. Factors other than domestic regulation which may affect a bank's ability to compete in
the international market include: book and market capitalization, credit standing, wholesale and
retail funding access, wholesale and retail placing power, wholesale and retail borrower access,
scale economies, scope economies, financial product and process technologies, human resources
(both professional and support), staying power, cross-subsidization ability, organizational structures,
cost structures, and risk management SAUNDERS & WALTER, supra note 1, at 56. For an assessment
of how the United States, Europe, and Japan fare in each of these areas, see id at 56. For discussion
of these factors, see id. at 55-68.
There has been much debate, both domestically and internationally,
about the advisability of retaining the Glass-Steagall Act, the U.S. law
which imposes a separation between commercial and investment banking
activities.4 In the domestic context, this debate has traditionally focused
on the U.S. market for financial services, with little attention to the
international implications of the law. 5 However, as the nature and scope
of the market for financial services has changed, the United States has
begun to look to the more liberal banking laws of other countries, both
as possible models for reform, and as potential sources of threatening
competition for U.S. banks. Thus, increased trade in financial services has
created an additional pressure for the reform of the Glass-Steagall Act
the need for U.S. banks to be able to compete effectively with their
foreign counterparts. Arguably, the Glass-Steagall Act has imposed
increasing costs on the U.S. economy, both as a result of the increased
internationalization of the market for financial services and the financial
liberalization undertaken by the United States' trading partners, notably
the European Union and Japan.6 By comparing U.S., Japanese, and
European institutions' competitiveness in the international market for
financial services, this Note focuses on the possible implications of the
Glass-Steagall Act in the international trade context as a means of
exploring some of the additional arguments which have emerged in favor
of reforming U.S. bank regulation.
In Part I, the scope of the comparison is delineated. In order to
establish a basis for comparison, Part II discusses the institutional
structures relating to commercial banking and securities activities in the United
States, the European Union, and Japan. Part III introduces some of the
arguments which have been made for and against imposing a separation
between securities and banking activities in an economy by exploring the
function of laws which accomplish such a division. Part IV discusses
some of the implications of the Glass-Steagall Act in the international
context, with a focus on the Act's potential to impede the ability of U.S.
banks to compete with European and Japanese banks. Alternatives to the
Act are discussed in a general manner in order to explore the types of
4. See, e.g., on the domestic debate, infra note 194 and accompanying text; Keith R.
Fisher, Reweaving the Safety Net: Bank DiversificationInto Securitiesand InsuranceActivities,
27 WAKE FOREST L. REV. 123, 128 n.8 (1992) and accompanying text; William M. Isaac &
Melanie L. Fein, Facingthe Future- Life Without Glass-Steagall,37 CATH. U. L. REV. 281
(1988). On the European debate on the Glass-Steagall Act see, e.g., infra note 189 and
5. "The United States is virtually alone as a nation where these discussions have
traditionally relegated international competitiveness consequences to a subordinate position."
SAUNDERS & WALTER, supra note 1, at 8.
6. See id. at 229; infra notes 190-94 and accompanying text.
be used to achieve the goals
profitability, efficiency, and stability.
I. DEFINING THE SCOPE OF COMPARISON
A. "Competitiveness" in the Context of the International
Market for FinancialServices
In order to effectively
measure the relative "competitiveness" of
different countries' banks, it is first necessary to choose a definition of
"competitiveness" which encompasses the proper goals of a financial
system.7 For the purposes of this Note, profitability, efficiency, and
stability are adopted as the most useful indicators of bank competitiveness
in the international context. Profitability is defined in traditional terms of
return on equity or return on assets. It is a useful measure of
competitiveness because it encompasses characteristics of cost, productivity, and
which cause certain firms to achieve higher profits than
others.' Efficiency is defined to encompass those characteristics which
allow a bank to offer innovative, high-quality services at the lowest
7. In making a comparative analysis of banking systems in different countries, it is
important to keep in mind the disparities which may result from international trade among
countries with divergent institutional structures. These disparities include difficulties in
classifying foreign financial institutions which do not cleanly fit within a domestic category of financial
institutions, different regulatory requirements imposed on financial institutions from country to
country, and differing preferences for financial products and currencies among investors and
borrowers of different countries. ORGANIZATION FOR ECONOMIC COOPERATION AND
DEVELOPMENT, INTERNATIONAL TRADE IN SERVICES: SECURITIES 38 (1987) [hereinafter OECD]; Giorgio
Szego, Regulation and Competition in InternationalBanking, in LIBERALIZATION OF SERVICES
AND INTELLECTUAL PROPERTY IN THE URUGUAY ROUND OF GATT 190 (Giorgio Sacerdoti ed.,
1990); Gunter Dufey, Banking in the EC After 1992, in SINGULAR EUROPE: ECONOMY AND
POLITY OF THE EUROPEAN COMMUNITY AFTER 1992, at 171, 188 (William James Adams ed.,
1992) [hereinafter SINGULAR EUROPE]. In addition to complicating any comparative analysis
of financial services, these disparities create additional impediments to international trade.
OECD, supra, at 37.
Other factors complicating a comparison of banks' competitiveness in the international
context include different accounting and disclosure standards among countries, exchange rate
fluctuation, inflation rates, comparative stock market performance, and any extraordinary gains
and losses which may be reflected in the data. SAUNDERS & WALTER, supra note 1, at 24.
8. See SAUNDERS & WALTER, supra note 1, at 31. In focusing on profitablity as a measure
of competitiveness, abanking sector's high profits may alternately reflect asheltered domestic
market (i.e., protectionism). Id. This alternate explanation for high profits becomes less
important as the market for financial services becomes more international and barriers to
entering foreign markets are lowered.
Although profitability is a useful measure of competitiveness, the ultimate result of
competition will be to lower profit margins for the banking sector as a whole, since increased
international competition eliminates the rents that banks may have traditionally enjoyed in
protected domestic markets. See Time to Leave: Romantic ForeignPhrases,ECONOMIST, May
2, 1992, at Survey 36, 42.
possible cost.9 Efficiency is closely related to a bank's ability to achieve
an optimal level of risk by balancing the variety of activities in which it
engages with profitability considerations.'0 Stability is defined to
encompass safety and soundness concerns of a financial system." Stability is
ultimately dependent to some degree on profitability and efficiency
because an institution which is unprofitable and inefficient will have
difficulty maintaining a level of capital sufficient to preserve stability.' 2
Different types of empirical data have been proposed as reflecting the
relative "competitiveness" of various countries' financial institutions. 3
This data is confusing in the different measures it reflects and is mixed
in its implications for the competitiveness of U.S. banks. 4 However, by
focusing on antecdotal evidence of bank competitiveness in the
international market and by attempting to reconcile this evidence with the
empirical data, the measures of profitability, efficiency, and stability
emerge as the most useful measures of competitiveness. Antecdotal
evidence seems particularly relevant since it reflects those measures upon
which banks have focused in responding to the pressures of market
forces' A comparison of empirical and antecdotal evidence suggests that
comparative market shares and size rankings are not very useful as
measures of competitiveness. Market share arguably reflects a number of
9. See SAUNDERS & WALTER, supra note 1, at 17. The efficiency of a financial services
industry has implications for national and global resource allocation because the financial
services sector is the means by which capital is allocated in an economy. Id. at 19.
10. See Greenspan Warns Against "Unnecessary" Regulation, Reuters, May 26, 1993,
available in LEXIS, Curnws Library, Reuters File; Time to Leave; Banks Meet the Marketplace,
ECONOMIST, May 2, 1992, at 3. Diversification is not a useful goal in itself for a financial
institution. Rather, it is a means of achieving efficiency, both in terms of profitability and risk
allocation. See id.; Pruning the Universal Bank, ECONOMIST, Aug. 21, 1993, at 57.
11. Safety and soundness concerns are discussed in more detail, infra at part III.A.2. There
inevitably are trade-offs between stability and efficiency in a financial system. The goal should
be to "find asocially optimum balance in aglobally competitive environment," adetermination
which is beyond the scope of this Note. SAUNDERS & WALTER, supra note 1, at 18. See Time
to Leave; Banks Meet the Marketplace, supra note 10, at 3.
12. For further discussion of the relationship among profitability, efficiency, and stability,
see infra parts IL.B.1, IV.E.2.
13. See UNITED STATES DEPARTMENT OF THE TREASURY, MODERNIZING THE FINANCIAL
SYSTEM: RECOMMENDATIONS FOR SAFER, MORE COMPETITIVE BANKS ch. XVIII, Tbl. 8 (1991)
[hereinafter TREASURY REPORT] (using comparative market shares as ameans of measuring the
relative competitiveness of U.S. banks); AMERICAN BANKER, RANKING THE BANKS 119 (1992);
1989 STATISTICAL INFORMATION ON THE FINANCIAL SERVICES INDUSTRY XII-1 1 (American
Bankers Association ed., 5th ed. 1989) [hereinafter 1989 STATISTICAL INFORMATION] (using
size rankings as a means of measuring the relative competitiveness of U.S. banks); SAUNDERS
& WALTER, supra note 1, at 31-38 (citing various profitability criteria as possible
measurements of the relative competitiveness of U.S. financial institutions).
14. See sources cited in note 14.
market structure and cost factors other than profitability. 5 For example,
a declining market share, rather than reflecting a decline in profitability,
may reflect a shift by banks to more efficient methods of doing
business. 16 A bank's size may reflect factors besides profitability, including
factors controlled by domestic regulation such as geographical integration
and ownership structure, and inefficiencies in the bank's institutional
structure and choice of activities.17
The recent experiences of some European and Japanese banks suggest
that a focus on profitability and efficiency is preferable to focusing on
size and market share. For example, under the traditional European model
of universal banking, many of the European universal banks attempted to
carry on the full variety of activities in which they were allowed to
engage.'" As competition in the market for financial services increased,
these banks have begun to recognize which of their offered services are
unprofitable and the cross-subsidization costs imposed by the retention of
these activities. 19 In response to these concerns, European banks have
begun to focus on those services in which their risk-adjusted returns are
the highest, which may either involve current activities or may involve
diversifying into new activities. ? They have also aggressively pursued
efficiency by consolidating operations with the goal of cutting costs. 2'
Japanese banks, as they respond to increased competition and the
deregulatory reform of their financial system, appear to be experiencing
pressures similar to those experienced by the European universal banks. 22
As limitations on activities have been relaxed, Japanese banks have lost
traditionally profitable niches and have begun to compete with one
another more on the basis of quality and price.23 However, it is predicted
that, as deregulation proceeds and banks are permitted to engage in an
increasing variety of activities, it will take some time before Japanese
15. SAUNDERS & WALTER, supra note 1, at 24. However, market share does suggest
something about the results of competitition, since those financial institutions that are most
efficient and profitable are likely to hold a greater share of the market compared with less
efficient and profitable institutions. Id.
16. See ime to Leave; Banks Meet the Marketplace, supra note 10, at 3.
17. See id.
18. Pruning the Universal Bank, supra note 10, at 57.
20. Id.; Time to Leave; Banks Meet the Marketplace, supra note 10, at 3.
21. Banks Meet the Marketplace, supra note 10, at 3. "After a decade of failed expansion
and lending gone bad, some [European] banks are changing their ways. They prefer profitability
to asset growth and pursue efficiency more keenly than market share. Overcapacity is their
bugbear, and some seek to eliminate it through mergers." Id. at 3.
22. See Time to Leave; the Convoy Scatters, ECONOMIST, May 2, 1992, at 44. For a
discussion of Japanese financial regulation and deregulatory reform, see infra Part II.C.2.
23. See Time to Leave; the Convoy Scatters, supra note 22, at 44.
banks learn the importance of narrowing their focus in order to achieve
efficiency,24 a lesson that European banks have already learned.
B. "InternationalBanking:" Defining the Market
The term "international banking" may be used to refer to several
different types of activities. Traditional international banking consists of
cross-border transactions - payments and credits received from or
extended to customers in other countries. 25 "International banking" may
also be used to refer to the entry of financial institutions into foreign
markets via the creation of offices, agencies, branches, or subsidiaries.26
Finally, "international banking" may be used to refer to the offshore
banking activities of domestic or foreign banks.27 This Note is only
concerned with the former two activities and does not discuss offshore
banking, an area which has been characterized by significant liberalization
for many years.28
International banking is further defined by the relevant product
market. There are two main product markets for banking services. The
wholesale market is geared primarily toward medium and large-sized
businesses, as well as other banking organizations, and relies mainly on
the money markets as a source of funds. 29 The retail market is geared
primarily toward individuals and small businesses and relies mainly on
deposits from those two groups as a source of funds.30
In the context of international trade in banking services, many
commentators suggest that there are greater opportunities for financial
institutions in the wholesale sector, rather than the retail sector, of foreign
financial services markets. 3' However, the effects of increased competition
and liberalization in the European Union suggest that significant
opportunities in the retail sector may exist for those foreign financial institutions
able to establish branches or subsidiaries which are geographically
convenient for local customers and competitive, in price and range of
services, with local institutions.32
II. BANKING LAWS GOVERNING COMMERCIAL BANKING
AND SECURITIES ACTIVITIES IN THE UNITED STATES,
THE EUROPEAN UNION, AND JAPAN
A. The United States
1. The Glass-Steagall Act
The Glass-Steagall Act restricts the ability of banks to engage in
certain types of securities-related transactions.33 It was enacted in 1933 in
response to perceived abuses by banks during the 1920s which were
thought to have contributed to the 1929 stock market crash and the
subsequent banking crisis of the early 1 9 3 0 s.3 The Act limits the
securities activities of banks to the purchase and sale of securities solely upon
the order of, and for the account of, customers, and it prohibits banks
from underwriting securities or purchasing or selling securities for their
own accounts.3 5 Similarly, securities firms are prohibited from receiving
deposits.36 Member banks of the Federal Reserve system are prohibited
from maintaining affiliations with organizations whose principal business
consists of securities activities.37 In addition, officers, directors, and
employees of securities firms are prohibited from simultaneously serving
as officers, directors, or employees of Federal Reserve member banks.38
However, banks are permitted to underwrite and trade certain types of
government securities for their own accounts.39 Banks also may purchase
for their own account other types of securities, as permitted by federal
bank regulatory authorities and subject to a limit of ten percent of
unimpaired capital stock.'
The effect of the Glass-Steagall Act is to impose a basic separation
between commercial and investment banking.4 However, this separation
is not absolute.4 2 As discussed above, the Act permits banks and bank
holding companies to purchase and sell securities pursuant to customer
orders and solely for customer accounts. The judiciary and the federal
banking agencies have further expanded the scope of permissible bank
activities through a series of decisions interpreting the Act, although the
basic separation of functions has remained in place.43
2. Nonbanking Activities of Foreign
Banks in the United States
The general approach of U.S. banking authorities to the activities of
foreign banks located in the United States is national treatment 44
foreign banks are basically subject to the same regulatory regime as
domestic banks and are thus generally forbidden from engaging in those
activities prohibited for U.S. banks.4 5 However, there are several possible
exceptions under which foreign banks may engage in securities activities
in the United States.4' Foreign banks which engaged in nonbanking
activities in the United States prior to the enactment of the International
39. Id. ?? 16, 21. Bank holding companies are permitted to hold a somewhat broader
range of securities. Bank Holding Company Act ? 4(c).
40. Glass-Steagall Act ?? 16,21. Bank holding companies are permitted to hold up to five
percent of the outstanding voting shares of any company. Bank Holding Company Act ? 4(c).
42. Golembe & Holland, supra note 29, at 80. For a detailed discussion of securities
activities in which various types of banks may engage, see Isaac & Fein, supra note 4, at
43. See Isaac & Fein, supra note 4, at 323-42.
44. US NATIONAL STUDY ON TRADE IN SERVICES 138 (U.S. government submission to
the General Agreement on Tariffs and Trade, 1984); Joel P. Trachtman, Recent Initiatives in
InternationalFinancialRegulation and Goals of Competitiveness, Effectiveness, Consistency
and Cooperation, 12 Nw. J. INT'L L. & Bus. 241, 259 (1991).
JAMES J. WHITE, BANKING LAW 743 (3d ed. 1991). The Act brought within the scope of the
Bank Holding Company Act any foreign bank which maintains a branch, agency, or bank
subsidiary within the United States. International Banking Act of 1978 ? 8(a). See WALTER,
supra note 31, at 95-96.
46. See SYMONS & WHITE, supra note 45, at 762.
SFree Trade in FinancialServices
Banking Act of 1978 are permitted, under a grandfather provision, to
continue engaging in nonbanking activities, subject to Federal Reserve
Board discretion.47 If a foreign bank does not qualify for grandfather
status, it may nonetheless be permitted to invest in certain foreign
corporations that are principally engaged in business outside the United
States, provided that the foreign bank's principal business is banking."
Also, a foreign bank, the majority of whose internatinonal business is
banking and more than half of whose banking business is outside the
United States, may engage in certain limited securities activities within
the United States. 49 An additional exemption permits foreign banks,
whose business is primarily conducted outside the United States, to
engage in nonbank activities in the United States if the Federal Reserve
Board determines that such activities are consistent with the purposes of
the Bank Holding Company Act and in the public interest.50
3. Activities of U.S. Banks Operating Abroad
Technically, the prohibitions of the Glass-Steagall Act do not apply
to U.S. banks operating abroad.5' Howeyer, the Glass-Steagall Act does
apply in effect, since it limits the ability of U.S. banks engaging in
securities activities abroad to market foreign securities in the United
States, their principal market.52
There are two mechanisms by which U.S. banks may engage in
securities activities abroad. The first is Regulation K of the Bank Holding
Company Act, which provides that foreign subsidiaries of U.S. banks and
bank holding companies may underwrite and deal in equity securities
outside the United States, within specified dollar limitations, and subject
to certain capital levels.53 These limits, which are to be approved by the
Federal Reserve Board, have been set at a fairly restrictive level.54
The second mechanism by which U.S. banks may engage in securities
activities outside of the United States is by establishing an Edge Act
subsidiary.5 Section 25 of the Federal Reserve Act, known as the Edge
Act, permits subsidiaries of banks or bank holding companies established
under that section to engage in activities which the Federal Reserve Board
has determined are "usual ...in connection with the business of banking
or other financial operations in the countries in which [the subsidiaries]
B. The European Union
1. Introduction to European Union Financial Systems
In order to understand the current state of European Union 57 (E.U.)
banking law, it is necessary to have some knowledge of the historically
diverse financial systems of the E.U. Member States. The most relevant
system, for purposes of examining current E.U. law, is universal banking,
which is found in Germany, Denmark, Luxembourg, and the
Netherlands.58 Although the characteristics of particular universal banking
systems may vary, under a universal banking system banks generally are
allowed to engage in a full range of financial activities, which includes
both traditional commercial banking and securities activities, and may
include additional nonbanking activities.59
Universal banking may be viewed as having a number of distinct
advantages over traditional banking systems such as that of the United
States. Some commentators believe that diversification in the range of
financial services which a bank may offer lowers the risk of financial
failure arising from losses in a particular area of activity. 60 Proponents of
the system also argue that the variety of financial services offered by each
bank enhances competition in the market for financial services; that
universal banks are able to react quickly and flexibly to changing market
conditions; and that overregulation of financial activity will only drive
55. WALTER, supra note 31, at 91.
56. 12 U.S.C. ? 615(a) (1988). See Trachtman, supra note 44, at 257; SYMONS & WHITE,
supra note 45, at 765-69.
57. The European Community became the European Union (E.U.) as a result of the twelve
Member States' ratification of the Maastricht Treaty. See TREATY ON EUROPEAN UNION [TEU].
58. Golembe & Holland, supra note 29, at 80.
59. OECD, supra note 7, at 14. For a more in-depth discussion of universal banking, see
SAUNDERS & WALTER, supra note 1, at 84-126.
60. OECD, supra note 7, at 14. However, diversification must be viewed in terms of
efficiency. See supra note 10 and accompanying text; supra text accompanying notes 18-24.
activity into unregulated sectors, where it is difficult to monitor and,
therefore, more destabilizing to the financial system. 6' As discussed in
Part III.A below, in the context of traditional justifications for laws
separating securities and commercial activities, opponents of a universal
banking system have raised a number of important arguments to refute
the claims of supporters of the system.
Nonuniversal banking systems in E.U. Member States take a variety
of forms, spanning the spectrum from near universal banking to strict
separation of commercial banking and securities activities. Banks in the
United Kingdom, for example, function essentially like universal banks,
in that they are able to perform both commercial and investment banking
activities within the same institution. 62 They differ, however, in that the
two types of activities are subject to separate systems of regulation and
legislation.63 In contrast, Italian commercial banks are very limited in the
range of activities in which they may engage. 4
2. Current E.U. Law: The Second Banking Directive
The Second Banking Directive 65 was adopted by the E.U. Council in
1989. The stated purpose of the Directive is to allow, by means of mutual
recognition, freedom for banking institutions licensed in a Member State
to perform a full range of activities throughout the Community, without
the need for licensing in each Member State.6 On a broader level,
[t]he ultimate objective of the Community is ... to speak as a
single European banking market, where it will be as easy for a bank
to establish branches anywhere in the Community as in its home
Member State, and offer the full range of its banking services across
the entire Community, and also offer European securities and capital
market [sic] with enough capacity to meet European industry's
financing needs, which will attract investors from all over the
The Second Banking Directive applies only to credit institutions,
which are defined as "[undertakings] whose business is to receive
deposits or other repayable funds from the public and to grant credits for [their]
own account[s]." 68 Credit institutions may be viewed as analogous to
commercial banks, and are to be distinguished from financial institutions,
which are analogous to investment banks, and are not within the scope
of the Directive.69
The Second Banking Directive, which is modeled on the universal
banking system, permits credit institutions to engage in a variety of
activities.70 These activities include traditional commercial banking
activities; trading for customers or the institution's own account in a
variety of instruments, including futures, options, and transferable
securities; and underwriting activities.7 ' The only major nonbank activities
which are not permitted under the directive are insurance activities,
guarantees, and commitments. 72
The Directive does not restrict the ability of a Member State to limit
the range of activities in which banks established within its jurisdiction
may engage, provided that the Member State complies with the mutual
recognition provisions of the Directive. 73 However, it is likely that
Member State regulatory systems will converge toward universal banking
as a result of competitive forces, which will cause an outflow of banking
business from those Member States with greater restrictions on bank
activities. 74 This process may be viewed as part of E.U. efforts to
harmonize banking and securities regulation in order to permit undistorted trade
in the financial services sector.
3. Activities of Foreign Banks in the European Union
Under the Second Banking Directive
Under the Second Banking Directive, the treatment of foreign
(nonUnion) banks located in the European Union will depend upon whether
they are subsidiaries or branches of foreign banks. Subsidiaries are
governed by the Directive and are subject to the restrictions of the
Member State in which they are established. They are entitled to engage
throughout the Community in the variety of activities which the Directive
permits. Branches of foreign banks are not within the Directive's
jurisdiction and remain subject to individual Member State regulation.76 A further
distinction is made between subsidiaries of foreign banks which were
already established in the European Union at the time of the Second
Banking Directive and subsidiaries which have been established after the
Directive. The former benefit from the Directive's grandfather clause,
while the latter must meet the Directive's reciprocity requirements in
order to enjoy its freedoms.77
4. Activities of E.U. Banks Operating Abroad
Because the Second Banking Directive permits E.U. credit institutions
to engage in a wide variety of activities, the activities in which they may
engage abroad are only limited by the regulatory regimes of the foreign
countries in which they establish a presence. Through the national
treatment provision of the Second Banking Directive, the European Union
seeks to ensure that foreign countries do not restrict the activities of E.U.
credit institutions to a greater extent than they restrict domestic
institutions, so that E.U. institutions may enjoy the same competitive
opportunities available to domestic institutions. 78 The European Union may enforce
this provision against foreign regulators through retaliatory use of the
reciprocity provision of the Directive.79
1. Introduction to the Japanese Financial System80
Until recently, the Japanese financial system has been characterized
by a "rigid compartmentalization"
of financial services.8
There are a
variety of financial institutions in Japan, and each traditionally has been
restricted to specific functions within the system. 82 Commercial banks,
which are the focus of this Note's analysis of Japanese financial
institutions, fall into four categories: ordinary, long-term
credit, trust, and
foreign exchange banks.83 Ordinary banks (futsuu ginkou) are short-term
credit facilities, and are further subdivided into city banks, which restrict
their activities to business based in the large cities, and local banks,
which restrict their activities to business based in regional areas.84
Longterm credit banks (chouki shinyou ginkou) provide long-term financing to
Japanese industry. They engage in securities activities, as well as
participate in the international money markets.85 Trust banks (shintaku ginkou)
engage concurrently in ordinary and trust banking to provide long-term
financing to Japanese industry. 86 Foreign exchange banks (gaikoku kawase
ginkou), of which there is currently only one (Bank of Tokyo), specialize
in international finance, including foreign exchange transactions and trade
Securities companies, which are analogous to investment banks, are
even more compartmentalized in their activities, and they
PROPERTY IN THE URUGUAY ROUND OF GATT, supra note 67, at 26, 37. The role of
reciprocity in international trade for financial services will be discussed further infra part IV.B.
81. Id. at 94.
82. The various institutions constituting Japan's financial system include: (1) the Ministry
of Finance (the central government regulatory body for the financial system); (2) the Bank of
Japan (the government central bank); (3)ordinary banks (which include city, local, and foreign
banks); (4) long-term credit banks; (5) trust banks; (6) specialized foreign exchange banks; (7)
specialized financial institutions for small and medium-sized businesses; (8) financial
institutions for agriculture, forestry, and fisheries; (9) government financial institutions; (10)
securities companies; (11) securities finance companies; (12) insurance companies; and (13) the
postal savings system. Id. at 93, 95.
Masabumi Yamane, FinancialTransactionsin JapaneseLaw, in JAPANESE BANKING,
SECURITIES & ANTI-MONOPOLY LAW 17-18 (Hiroshi Oda & R. Geoffrey Grice eds., 1988).
84. Id. at 17-18; Semkow, supra note 80, at 99.
85. Yamane, supra note 83, at 18; Semkow, supra note 80, at 102-03.
86. Yamane, supra note 83, at 18; Semkow, supra note 80, at 103.
87. Yamane, supra note 83, at 18; Semkow, supra note 80, at 105.
separate licenses for each category of business in which they wish to
engage.8 8 They may obtain a license for dealing for or trading on their
own accounts, a license to perform brokerage activities for customers, a
license for the underwriting of and subscription to shares at the time of
issuance, and a license for the distribution of securities to the public. 9
Most securities companies do not possess all four types of licenses, and
many restrict their activities to brokering, dealing, and distributing
The Japanese financial system is distinct from the financial systems
of the United States and European Union in several respects. The banking
system is structurally more important to the Japanese economy than the
banking systems in the United States or the E.U. Member States are to
their respective countries. 91 This is because Japanese corporations, which
are highly leveraged, obtain a large portion of their financing from banks
rather than from the capital markets. 92 Japan's financial services sector is
much more concentrated than that of the United States93 or the European
Union.94 As of 1990, the United States had more than 14,000 commercial
banks, while Japan only had 158.95 The combined market value of Japan's
twenty-five largest ordinary banks was $550 billion, compared to a
market value of only $110 billion for the fifty largest U.S. banks.96
2. Laws Separating Commercial Banking and Securities Activities in Japan
During the first half of the twentieth century, Japan had a universal
banking system under which banks were permitted to engage in a full
range of financial activities, including all types of securities activities.'
As part of the U.S. occupation of Japan following World War II, the
United States demanded that the Japanese government enact a new
securities and exchange law modeled on the U.S. Glass-Steagall Act. 98
The resulting provision, article 65 of the Securities and Exchange Law of
1948, imposed a separation between commercial and investment banking
activities." The United States' purpose in demanding the change in law
was to make the Japanese economy more democratic and to decentralize
the economic power of the zaibatsu, the enormous pre-World War II
holding companies, which the United States believed were largely
responsible for financing the Japanese war effort."?
b. The New Banking Law and the Amended
Securities and Exchange Law
It was not until fairly recently that Japan modified its laws separating
securities and banking activities. Beginning in the mid-1970s, following
the first oil crisis, Japan began to experience difficulties in financing its
heavy government borrowing.'" Under the government debt-financing
system which existed at the time, the various types of Japanese financial
institutions, including commercial banks and securities companies, were
required to underwrite some portion of government bond offerings.'12 The
underwriting requirements became so strict following the oil crisis that
financial institutions were forced to devote a large proportion of their
deposit base to underwriting government bonds. 3 This development
created a need for financial institutions to free up bank funds in order to
realize greater profits in the holding and disposing of the bonds." The
need for greater profits was particularly. acute for commercial banks,
which were prohibited from selling government bonds directly to the
public (where the majority of profit would be realized, as commission
fees could be charged on public sales) and were instead required to sell
97. Osamu Karihara, Recent Developments in the Securitiesand Exchange Law in Japan,
in JAPANESE BANKING, SECURITIES & ANTI-MONOPOLY LAW, supra note 83, at 77, 80;
Semkow, supra note 80, at 118.
98. Semkow, supra note 80, at 117-19.
99. Id. at 119-20.
100. Id. at 119; ANDREW MULLINEUX, INTERNATIONAL BANKING AND FINANCIAL
SYSTEMS: A COMPARISON 67 (1987).
101. Karihara, supra note 97, at 81; BROKER, supra note 2, at 62.
102. Semkow, supra note 80, at 122-23.
the bonds to securities companies, which would then reap the profit from
sales to the public. 5
The government addressed these problems by passing the New
Banking Law of 1981'06 and, also in 1981, amending article 65 of the
Securities and Exchange Law of 1948.1o7 The New Banking Law
broadened the activities in which banks0 8 could engage to include the buying
and selling of government securities for the bank's own account and for
customers; underwriting and handling the placement or secondary sale of
government bonds; "other businesses incidental to the banking business;"
and other business related to national government bond offerings, to the
extent not inconsistent with the bank's principal business. ?9 Japanese
banks also are permitted to purchase, for investment purposes, shares of
corporations for their own accounts, as well as corporate bonds, subject
to a five percent limit of the outstanding stock of a domestic
corporation."0 This power contrasts with the power of U.S. banks, which is
limited to purchasing corporate bonds for their own accounts."'
The provisions of the New Banking Law which permit banks to
engage in securities activities, with respect to government securities, mark
a significant change from prior practice under the Old Banking Law,
because they explicitly extend the permissible range of "banking-related
business."'" 2 Although the law on its face does not seem to liberalize the
Japanese banking system in comparison with systems such as that of the
United States, whose banks have long been permitted to sell government
securities to the public, the real effects are significant.' These effects
include increasing the competitiveness of banks by permitting them to
engage in activities formerly reserved to securities companies." 4
Securities companies benefit as well, by being permitted to engage in certain
activities formerly reserved to banks." 5
Article 65 of the amended Securities and Exchange Law defines the
scope of expansion of banks' activities which is effected by the New
Banking Law. 16 It prohibits banks from engaging in securities business," 7
with the exceptions of purchases or sales of securities upon the order of,
and solely for the account of, customers and purchases or sales of
securities on a bank's own account for investment purposes."I 8 However, the
second paragraph of amended article 65 codifies the New Banking Law's
broadening of bank activities by specifically exempting from the
prohibitions of the Securities and Exchange Law the government bond activities
in which banks may engage under the New Banking Law." 9
Japanese banks and securities companies also have broadened the
scope of their activities by taking advantage of loopholes in amended
article 65.120 Banks have relied on the article's lack of any prohibition
against bank affiliates owning securities companies to effect substantial
control positions in such institutions.' 12
This trend also includes the
shifting of bank personnel to the securities affiliate in which the bank
holds a stake.'12 Securities firms have similarly made significant inroads
into traditional banking activities by establishing money market funds
115. These activities include making loans secured by government bonds, underwriting
commercial paper and import-negotiable certificates of deposit, dealing in certificates ofdeposit
in the secondary markets, and dealing in bankers' acceptances. Id. at 125; BR6KER, supra note
2, at 63.
116. Yamane, supra note 83, at 21, citing A. VINER, INSIDE JAPAN'S FINANCIAL MARKET
117. The law defines "securities business" to include: (1) the purchase or sale of securities;
(2) acting as an intermediary, broker, or agent with respect to the purchase or sale of securities;
(3) acting as an intermediary, broker, or agent with respect to entrustment of transactions on
a securities market; (4) underwriting securities; (5) engaging in public offerings of securities;
and (6) handling public offerings of new or outstanding securities. Amended Securities and
Exchange Law, supra note 89, art. 2(8).
118. Amended Securities and Exchange Law, supra note 89, art. 65. The intent in
permitting banks to purchase and sell securities for their own account for investment purposes
is to encourage profitable use of surplus funds. Semkow, supra note 80, at 120-21.
119. The article states that "[t]he provisions of the foregoing Paragraph shall not apply to
national and local government bonds, corporate debentures and other debt issues with respect
to which principal redemptions and interests are guaranteed by the Government." Amended
Securities and Exchange Law, supra note 89, art. 65(2).
120. JONATHAN ISAACS & TAKASHI EJIRI, JAPANESE SECURITIES MARKET 86 (1990).
121. The banks have used this control to enjoy commission savings on their securities
trading and by taking advantage of the larger capital base available to them. See id. at 86-87.
which can be accessed through automatic teller
machines, in effect
engaging in deposit-taking. 2 3 These pressures from both sides of the
financial services industry, as well as concerns about anticipated
competition from the growing European universal banks, have led Japan to
begin reforming article 65.'24 On April 1, 1992, the Law to Provide for
the Reform of the Financial and Securities Systems took effect. Under
this law, banks and securities firms are permitted to engage in each
other's business through majority owned subsidiaries. 25
3. Activities of Foreign Banks in Japan
The New Banking Law and regulations of the Ministry of Finance
and the Bank of Japan govern the activities of foreign banks in Japan.
Since 1985, Japan has allowed foreign securities firms owned by
commercial banks to conduct securities activities in Japan, provided that the
parent bank's equity holding in the subsidiary does not exceed fifty
percent and that the remaining share is held by a nonfinancial
Although the New Banking Law's applicability to foreign banks
suggests that foreign banks have the same powers as domestic banks,"~
the actual effect of these provisions of the New Banking Law is unclear.
Because the Bank of Japan and the Ministry of Finance could continue
to limit by regulation, as they do currently, the branching abilities of
foreign banks, the ability of foreign banks to build an adequate deposit
base for widespread growth in Japan may be limited.' 29
123. Id. at 87.
124. See id. at 87-88; MULLINEUX, supra note 100, at 86; Michelle Celarier,
GlassSteagall is a Global Issue, UNITED STATES BANKER, May 1989, at 72.
125. Law to Provide for the Reform of the Financial and Securities Systems (Kinyu Seido
oyobi Shokentorihiki Seido no Kaikaku no Tame no Kankei Horitsu no Seibito ni Kansuru
Horitsu), Law No. 87 of 1992. The reform of article 65, although significant in theory, has
been somewhat disappointing in practice. Banks' expansion into securities activities has been
restrained by the Japanese Ministry of Finance. This restraint has been justified as gradualism
necessary to protect the banks, although the reluctance to act may be better explained as
protectionism of the securities firms. See Japanese Regulation: Hold the Bouquets, Please,
ECONOMIST, July 31, 1993, at 67. See also Michael Hirsch, It's Bankers Versus Brokers as
Japan'sGlass-Steagall Starts to Break Down, INSTITUTIONAL INVESTOR, Apr. 1993, at 27.
126. See Shimojo, supra note 93, at 93; Semkow, supra note 80, at 117.
127. Brian Semkow, The Deregulationof Japan'sFinancialMarkets, INT'L FIN. L. REV.,
Aug. 1987, at 34, 35; OECD, supra note 7, at 39. This power of foreign banks to operate
securities subsidiaries in Japan, which is not permitted to domestic Japanese banks, is cited by
Japanese commercial banks as additional evidence that the reform of article 65 is necessary for
their increased competitiveness. Semkow, supra, at 35.
128. See Shimojo, supra note 93, at 93.
129. Semkow, supra note 80, at 127.
4. Activities of Japanese Banks Operating Abroad
Japanese banks operating abroad may engage in securities activities,
when not prohibited from doing so by the host country, through the
establishment of offshore subsidiaries known as "overseas security
subsidiaries" (kaigaishouken genchihoujin).'" However, Japanese banks
are further regulated in their activities abroad by the Three Bureaux
Agreement, a 1974 agreement reached by the three bureaus of the
Ministry of Finance (Banking Division, Security Division, and
International Finance Division)."' The Agreement separates the banking and
securities activities of Japanese bank branches and subsidiaries located in
the same foreign country (i.e., the branch is limited to banking activities,
while the subsidiary is limited to securities activities).' The Agreement
also limits the ability of a foreign subsidiary of a Japanese bank to act as
a lead manager for the issuance of foreign bonds of Japanese
corporations.'3 3 The status of the Three Bureaux Agreement under the New
Banking Law is yet unclear, although it appears that the principles of the
Agreement will gradually be abolished under the New Banking Law. 3 4
III. THE FUNCTION IN THE DOMESTIC ECONOMY OF LAWS
SEPARATING SECURITIES AND COMMERCIAL BANKING ACTIVITIES
A. TraditionalJustificationsfor Imposing a Separation Between Securities and Commercial Banking Activities
1. Conflict of Interest Concerns
A basic reason for separating the performance of securities and
commercial banking activities is to prevent conflicts of interest when
banks have an equity interest in nonbanks. Commentators claim that such
conflicts threaten the safety and soundness of the financial system. 35 Their
concern is that the combination of functions within a single institution
130. Shimojo, supra note 93, at 114; Yamane, supra note 83, at 21.
131. Yamane, supra note 83, at 21.
132. Shimojo, supra note 93, at 114-15.
133. Id. Foreign subsidiaries of U.S. banks are under no similar restrictions. Karihara,
supra note 97, at 82. The restriction, the original purpose of which was to protect Japanese
securities companies from competition with the subsidiaries of Japanese banks operating abroad,
is thought by some commentators to be no longer necessary, in light of the current size and
strength of the securities companies. Id.
134, Shimojo, supranote 93, at 115. See Yamane, supra jnote 83, at 21.
135. OECD, supra note 7, at 14; BR6KER, supra note 2, at 82.
may result in mismanagement and excessive risk-taking. 36 Banks may be
tempted to assist failures arising from their nonbanking activities and
likely would be legally responsible for such failures. 37 The desire to
increase business could induce banks to underwrite and distribute low
quality stocks or to overlend to underwriting clients engaging in risky
offerings. 3 8 Conflicts of interest also could arise in situations where the
bank is both shareholder and lender to a firm.'39 In such a situation, the
bank could attempt to influence the management of the issuer-borrower,
could abuse its access to inside information, or might allow ownership
considerations to influence lender-customer relations. "oPerceived conflicts
of interest could threaten public confidence in a country's financial
markets and make investors hestitant to enter the market.' 4'
2. Safety and Soundness Concerns
A second rationale supporting the separation of banking and securities
activities is the fear that conflicts of interest may lead to mismanagement
and excessive risk-taking; both would threaten customer safety and the
financial system's stability.' 42 This concern is closely related to the general
concern with conflicts of interest; however, it concentrates more on the
necessity of maintaining the stability of the monetary system as a whole. 43
Maintaining different regulatory
systems for banking and securities
institutions reflects the different types of risks involved in each type of
activity as well as the necessity of the consequent protections.'" Under
a combined system the risks of particular activities might not be clear,
resulting in excessive risk taking and unprotected losses. 45
136. BRUKER, supra note 2, at 83.
137. Fisher, supra note 4, at 226.
138. PECCHIOLI, supra note 62, at 58.
139. Id. at 61. An example of such a conflict would be a situation where a bank sells the
securities of an overindebted customer to an unsuspecting public in an effort to recover its
imprudent investment. See Japanese Securities Firms; Bankers' Embrace, ECONOMIST, Nov.
28, 1992, at 88. However, in considering this concern, it is instructive to compare the Japanese
experience. Economists have argued that the ability of Japanese banks to hold equity positions
in firms to whom they are also lenders has lessened monitoring (information) costs to banks,
resulting in lower financing costs to Japanese industry and a lesser likelihood, and cost, of
bankruptcies. Sun Bae Kim, Should Banks Hold Shares in Nonfinancial Firms?,AM. BANKER,
Apr. 24, 1991, at 4. But c.f. Time to Leave; The Convoy Scatters, supra note 22, at 44
(discussing Japanese accounting methods which cause banks to continue lending to overindebted
customers, resulting in huge losses).
140. PECCHIOLI, supra note 62, at 61. See supra note 139.
141. See Fisher, supra note 4, at 226.
142. See BRUKER, supra note 2, at 83.
143. See Fisher, supra note 4, at 215.
144. See OECD, supra note 7, at 13.
145. Furthermore, the combination of functions in a single institution raises difficult issues
concerning the role of federal deposit insurance. See Fisher, supranote 4, at 261-62. If banks
3. Concentration of Power Concerns
Permitting a single institution to engage in both securities and
commercial banking activities could also lead to economically
unacceptable concentrations of power."4 This problem also is related to conflicts
of interest concerns because banks' acquisitions of significant equity
participations in securities firms could provide them with the power
necessary to influence the management of the securities firms.' 47
Furthermore, a government may fear the economic implications of the
concentration of financial power in a few large institutions.1'4
4. Concerns Related to the "Specialized"
Nature of the Banking Industry
Because of the important economic role of banks in effective monetary
policy, most governments believe it is necessary that they assume a central
role in protecting the banking system. 149 Some governments believe this
protection can best be achieved by separating banking and securities
activities in order to focus government control and safeguards on the
banking system. 0 Proponents of this view distinguish securities activities
in this regard because such activities are perceived as involving voluntary
risks which the informed investor may assume at his or her discretion.,
This rationale for the separation of banking and securities functions is also
related to safety and soundness concerns because preserving the safety and
soundness of the banking system is essential for effective monetary policy.
were permitted to engage in a wide range of activities, it is unclear the extent (if any) to which
a government should assume the risks of those activities. Also unclear is the feasibility of
separating the risks of activities if differential assumption of risk is desired.
146. Id. at 215.
147. PECCHIOLI, supra note 62, at 61. See supra text accompanying notes 139-40. See also
supra note 139.
148. Fisher, supranote 4, at 215.
149. OECD, supra note 7, at 13. The U.S. Federal Reserve implements monetary policy
through the use of open market operations, the setting of the rediscount rate, and the setting of
reserve requirements. See ROBERT J. GORDON, MACROECONOMICS 416-20 (4th ed. 1987).
Financial deregulation and the proliferation of types of financial instruments have complicated
monetary policy planning, both in the United States and internationally. See id. at 392-93; Bruce
W. Morgan, FinancialServices After the Decline of Deposit Banking, BANKING POL'Y REP.,
Oct. 21, 1991, at 1.See generally T.R.G. BINGHAM, BANKING AND MONETARY POLICY (1985).
150. See OECD, supra note 7, at 13. For instance, U.S. safeguards particular to the banking
system include the access of banks to FDIC insurance, discount window funds, preferential tax
treatment, and special rules for loss carryovers. Fisher, supra note 4, at 215 (citing GENERAL
ACCOUNTING OFFICE, BANK POWERS: INSULATING BANKS FROM THE POTENTIAL RISKS OF
EXPANDED ACTIVITIES, GAO Doc. No. 87-35, at 11-12 (1987)).
151. OECD, supra note 7, at 13.
B. Arguments For PermittingBanks to Engage in both Commercial Banking and Securities Activities
1. Questionable Motives for the Retention of Laws Separating
Commercial Banking and Securities Activities
Although supporters of a financial system separating banking and
securities activities will always offer some combination of the
justifications discussed above, to some extent their motives may be less laudable.
For instance, some commentators have partly attributed the United States'
retention of the Glass-Steagall Act to successful lobbying efforts by the
U.S. investment banking industry.152 If U.S. commercial banks were
permitted to engage in securities activities, the investment banking
industry might lose the profitable and exclusive niche it currently occupies
in the U.S. economy.
Another ulterior motive for retaining laws separating banking and
securities activities is to protect domestic financial institutions from
foreign competition.153 Protectionism may be difficult to distinguish from
legitimate national prudential regulation, especially where such regulation,
on its face, treats foreign financial institutions in exactly the same manner
as domestic institutions." 54 Regardless, in such a situation the effect of the
regulation is to discriminate against foreign institutions and place them
at a competitive disadvantage, with harmful economic consequences
similar to those resulting from true protectionism."'
2. Harm to Domestic Economies by Laws Separating
Securities and Commercial Banking Activities
Laws separating commercial banking and securities activities impose
significant costs on domestic economies. These costs include the financial
burden of compliance placed on banking institutions, a cost which may
influence their choice of jurisdiction in which to locate. 156 Such laws also
reduce the variety of financial services a bank may offer, thus potentially
reducing bank efficiency and decreasing competition among financial
institutions, ultimately resulting in increased prices for services offered."'
As is the trend in the United States, commercial banks may further find
themselves at a competitive disadvantage where the range of activities in
which they may engage is limited, while nonbanks are permitted to engage
in a greater number of traditional banking activities. 5 1 Such laws
separating securities and banking activities may actually increase the risk of bank
failure because the laws prevent banks from efficiently diversifying their
Imposing a separation in a financial system between securities and
banking activities may result in economic harm resonating far beyond the
banking sector. U.S. bank regulators have expressed concern that the
Glass-Steagall Act raises the cost of capital for banks because the Act
prevents banks from offering an efficient variety of services.1? However,
increasing the cost of capital for banks has repercussions far beyond the
banking industry. Firms, especially those of small and medium size, rely
primarily on banks for their capital needs. In countries with laws
separating securities and banking activities, domestic industries are forced to pay
a higher price for banking services, a cost which is passed on to
consumers in the form of more expensive goods and services. 161 This increased
cost of capital ultimately puts domestic producers of goods and services
at a competitive disadvantage in the world market. Intermediate purchases
by domestic firms may account for a substantial amount of bank business.
Thus, these cost-increasing effects may be significant. For instance, for
the European Union as a whole, more than half of the total output of
credit and insurance institutions consists of intermediate purchases by
other industries.' 62
IV. THE EFFECTS IN THE INTERNATIONAL MARKET FOR
FINANCIAL SERVICES OF LAWS SEPARATING SECURITIES
AND COMMERCIAL BANKING ACTIVITIES
A. Is Increased InternationalCompetition
in FinancialServices Desirable?
Before discussing the distortions in international trade of financial
services caused by laws separating banking and securities activities, it is
useful to briefly examine whether increased competition in the financial
services sector is desirable. There are many advantages to increased
competition in financial services, including dynamic gains as domestic
producers respond to competitive pressures by becoming more efficient
and consumers gain by being able to obtain a greater variety of financial
services at lower cost. 63 However, increased international competition in
financial services creates pressures for deregulation; thus, one's view
concerning the desirability of increased trade in financial services is likely
to be related to views about the desirability of deregulation." 6
Commentators who predict a high degree of deregulation resulting from increased
competition in financial services cite fears such as excessive risk taking,
insolvencies, and bank crises of major proportions. 65
B. Distortions in InternationalTrade Flows Resultingfrom
Laws Separating Securities and Banking Activities
1. Differential Regulation and the Use of Reciprocity
in International Trade in Financial Services
In order to understand the remaining impediments to the free flow of
international trade in financial services and, specifically, those
impediments which are related to laws separating securities and commercial
banking activities, it is useful to examine certain provisions of the
proposed General Agreement on Trade in Services (GATS), an annex to
the Dunkel Draft. 6 The Dunkel Draft is a draft agreement of the Uruguay
Round of multilateral trade negotiations drafted in 1991 by Arthur Dunkel,
the Secretary General of the General Agreement on Tariffs and Trade
(GATT). 67 A subannex of GATS, the Annex on Financial Services,
defines the scope and treatment of financial services in the multilateral
context.16 Although the Financial Services Annex does not adopt a
specific financial services model, some commentators have viewed it, by
focusing on the issues which currently impede successful agreement on
financial services, as putting pressure on the United States to reform its
banking laws." These issues are discussed below.
Two provisions of the GATS are particularly relevant in the context
of discussing the effects of laws separating securities and banking
activities. The national treatment provision of the draft, article XVIJ,
requires that "each [Party to the agreement] shall accord to services and
service providers of any other Party, in respect of all measures affecting
the supply of services, treatment no less favorable than it accords to its
own like services Ad service providers."' 7 ? However, there are several
caveats to this standard of national treatment. Article XVII goes on to
provide that "[c]ommitments assumed under this Article shall not be
construed to require any Party to compensate for any inherent competitive
disadvantages which result from the foreign character of the relevant
services or service providers...' Allowance for differences in national
regulations is recognized further in the Annex on Financial Services,
which provides that Parties may take measures for prudential reasons,
including the protection of the integrity and stability of national financial
systems, provided that the Party does not use such measures to avoid its
obligations under the agreement.'72
These provisions raise an important, recurrent issue in discussions of
international trade in financial services: when a country maintains a
prudential regulation (such as a law separating securities and banking
activities) that is not protectionist on its face, yet limits the ability of
foreign service providers in that country to act with the degree of freedom
permitted in their home country, how is this resulting discrepancy in
treatment to be addressed in international trade relations? This question
is commonly addressed under the label of reciprocity, of which there are
two basic types. Mirror image reciprocity is an approach under which
a country denies certain legal rights to nationals of another country, if that
country does not grant the same rights to its own nationals. 174 Reciprocal
national treatment is an approach under which a country treats nationals
of a foreign country as it treats its own nationals, provided that the foreign
country treats the home country's nationals, when located in the foreign
country, as its own nationals. 75
Reciprocity issues recently have been prominent in both multilateral
and bilateral negotiations of international trade in financial services.176 The
problem with adopting either reciprocity approach is that both result in
a distorted flow of international trade. For example, if the United States
and the European Union were to adopt a mirror image reciprocity standard
of treatment between them, U.S. banks, acting under the Second Banking
Directive, could engage in universal banking in the European Union (as
they are currently able to do under certain circumstances).'" Under this
standard, however, the United States would be obligated to permit E.U.
banks to engage in universal banking in the United States.178 Clearly, this
would violate the Glass-Steagall Act, among other U.S. laws, and
generally would be an untenable result. At a broader level, mirror image
reciprocity fails to acknowledge a country's right to subject all financial
service providers within its borders to national prudential regulations.
Reciprocal national treatment may also result in distorted trade flows
where countries have differentially liberal regulations with respect to bank
activities. Under reciprocal national treatment, a financial institution from
a country which separates securities and banking activities (such as the
United States) can engage in both activities in a country which has a
universal banking system (such as the European Union). 79 However, a
financial institution from a universal banking country cannot engage in
securities activities in the country which maintains a separation between
securities and banking activities. 8 ' In countries which maintain a
separation between functions, the real effect of this discrepancy is to
substantially limit competition from institutions based in countries with more liberal
banking laws and to capture a greater share of trade benefits than would
occur under a more competitive regime.' 8' Although this result is clearly
beneficial to the country which limits competition, more permissive
countries are likely to notice its protectionist implications. 82 Indeed, the
European Union in its trade relations with the United States and Japan has
noticed these implications and has adopted potentially retaliatory
safeguards, as discussed below.
2. The E.U. Approach to Reciprocity Under
the Second Banking Directive
Article 9 of the Second Banking Directive combines reciprocal
national treatment with effective market access.183 The provision ties the
ability of a non-Member State financial institution to obtain or maintain
a single banking license and engage throughout the European Union in
the full range of activities permitted under the Second Banking Directive,
to the non-Member State's treatment of E.U. financial institutions and its
179. OECD, supra note 7, at 43.
181. Id.; FEKETEKUTY, supra note 163, at 107.
182. FEKETEKUTY, supra note 163, at 107. This result is analogous to a one-sided removal
of tariffs in the case of trade in goods. Id.
183. Second Banking Directive, supra note 65, art. 9. See Mitsuo Matsushita, A Japanese
View on the European Integrationof 1992, in A NEW GAT FOR THE NINETIES AND EUROPE
'92, supra note 176, at 291, 298; Gary C. Hufbauer & Claudia Schmitz, The NorthAmerican
Argument abouta "FortressEurope," in A NEW GATr FOR THE NINETIES AND EUROPE '92,
supra note 176, at 307, 314.
willingness to provide E.U. institutions "effective market access."'1' It yet
unclear how the European Union will choose to interpret this provision."
U.S. and Japanese commentators have expressed concern that the
European Union could use the ambiguous concepts of effective market access
and equivalent treatment as retaliatory tools to negotiate increased access
to the U.S. and Japanese financial markets, both in terms of market share
and permissible activities.186 Indeed, the European Union has already used
the provision to threaten the Japanese
with restrictions in the E.U.
financial market if they fail to increase European access to the Japanese
financial market. 187 The provision could also become a powerful tool by
which the European Union could exert pressure on the United States to
effect deregulatory reform. 8
European Union use of the provision as
light of existing E.U. pressure for reform of the U.S. law.' 9
leverage in lobbying for reform of the Glass-Steagall Act seems likely in
184. Reform Needed to Help U.S. Banks Compete Here and Abroad, Clarke Says, supra
note 52, at 521 (Statement of Sir Leon Brittan, Commissioner of the European Union).
Specifically, article 9 provides, in relevant part, that:
Whenever it appears to the Commission ...that a third country is not granting
Community credit institutions effective market access comparable to that granted by
the Community to credit institutions from that third country, the Commission may
submit proposals to the Council for the appropriate mandate for negotiation with a
view to obtaining comparable competitive opportunities for Community credit
institutions ....Whenever it appears to the Commission... that Community credit
institutions in a third country do not receive national treatment offering the same
competitive opportunities as are available to domestic credit institutions and the
conditions of effective market access are not fulfilled, the Commission may initiate
negotiations in order to remedy the situation.
Second Banking Directive, supra note 65, art. 9(3), (4) (emphasis added). The current version
of article 9 stands in contrast with a prior version, which also required both market access and
reciprocal national treatment but premised the initial authorization for foreign financial
institutions to obtain a banking license on meeting these conditions. Hymas, supra note 41, at
1673. In contrast, under the current version of article 9, the Commission may find at any time
that reciprocity and effective market access are lacking. Id.
Matsushita, supra note 183, at 298.
186. Matsushita, supra note 183, at 297; Golembe & Holland, supra note 29, at 94; Hale,
supra note 93, at 153.
The United States has responded to the European stance under article 9 by adopting a
similar policy of reciprocity conditioned on national treatment, with the goal of ensuring market
access for U.S. institutions in foreign markets. See U.S. to Seek Bilateral Deals in Asia for
Financial Services, Bentsen Says, Int'l Trade Daily (BNA), Jan. 24, 1994, available in LEXIS,
BNA Library, BNAITD File. Recently, the United States formalized this stance in the proposed
"Fair Trade in Financial Services Act," which was approved by the U.S. Senate on February
10, 1994. S.1527, 103d Cong., 2d Sess. (1994). See Senate Banking Panel Affirms Fair Trade
Financial Services Bill, 11 Int'l Trade Rep. (BNA), at 247 (Feb. 16, 1994).
187. EC Threatens Japanese Finance Firms Operating in Europe if Tokyo Stays Restrictive,
THOMSON'S INT'L BANKING REG., Feb. 24, 1992, at 3; Japan Faces EC Stick in Financial
Services Talks, REUTERS, Feb. 17, 1992, available in LEXIS, New Library, Wires File; Reform
Needed to Help U.S. Banks Compete Here and Abroad, Clarke Says, supra note 52, at 521.
188. Hymas, supra note 41, at 1706.
C. The Costs of the Glass-SteagallAct to International
Trade in FinancialServices
1. Costs to the United States
The Glass-Steagall Act places the U.S. banking industry at a
substantial competitive disadvantage to E.U. and Japanese financial
institutions. 19 The Act imposes costs on the U.S. economy, as discussed in Part
III.B above. Even where U.S. financial institutions are able to engage in
universal banking in the European
Union, they are at a competitive
disadvantage to European institutions."r! Although in such cases they are
able to underwrite securities in Europe, the Glass-Steagall Act prevents
them from marketing those securities in the United States, the location of
their principal pool of investors, while most European banks will not face
a similar dilemma.192 Some commentators warn that if the United States
does not reform the Glass-Steagall Act, the U.S. banking industry will be
competitively overtaken in the world market by powerful Japanese and
U.S. commentators, including top
banking regulators, are among the most vocal of those advocating reform
of the Glass-Steagall Act. 94
2. Costs to the United States' Trading Partners
The Glass-Steagall Act also imposes costs on the United States'
trading partners. Some of these costs, which relate to differential gains
from trade, are highlighted in Part IV.B above. Other costs result from the
190. Reform Needed to Help U.S. Banks Compete Here and Abroad, Clarke Says, supra
note 52, at 521; Horwitz, supra note 32, at 10; Rep. LaFalce Calls U.S. Banks Complacent
About Need to Compete in GlobalMarket, Banking Rep. (BNA). Oct. 2, 1989, at 464.
191. Oversight Hearings,supranote 31, at 155-56 (prepared statement of Robert L. Clarke,
former Comptroller of the Currency).
193. 1992 Poses Competitive Threat to U.S. Banks, RegulatorsSay, Banking Rep. (BNA),
Oct. 2, 1989, at 464; OversightHearings,supranote 31, at 5 (statement of Manuel H. Johnson,
former Vice Chairman, Board of Governors of the Federal Reserve); id. at 8 (statement of L.
William Seidman, former Chairman, Federal Deposit Insurance Corporation); id.at 10 (statement
of Robert L. Clarke, former Comptroller of the Currency); Reform Needed to Help U.S. Banks
Compete Here and Abroad, Clarke Says, supra note 52, at 521; Hufbauer & Schmitz, supra
note 183, at 320; Clarotti, supra note 67, at 184.
194. Bacon, supranote 152; 1992 Poses Competitive Threat to U.S. Banks, RegulatorsSay,
Banking Rep. (BNA), Oct. 2, 1989, at 464; OversightHearings,supra note 31, at 5 (statement
of Manuel H. Johnson, former Vice Chairman, Board of Governors of the Federal Reserve);
id. at 8 (statement of L. William Seidman, former Chairman, Federal Deposit Insurance
Corporation); id. at 10 (statement of Robert L. Clarke, former Comptroller of the Currency);
Reform Needed to Help U.S. Banks Compete Here and Abroad, Clarke Says, supra note 52,
at 521; Hufbauer & Schmitz, supranote 183, at 320.
limits the Glass-Steagall Act places on foreign institutions operating in the
United States. Because financial institutions from countries with more
liberal banking laws (such as the European Union and Japan) are not able
to offer in the United States the full range of services they offer in their
home countries, they lose a potential market for these services and may
choose to focus their activities in countries with more liberal banking
laws.195 Therefore, the Glass-Steagall Act has the same effect on these
countries as would a tariff on financial services. The Glass-Steagall Act
also imposes modification costs on foreign financial institutions because
they may have to significantly tailor their U.S. operations to make them
consistent with the Act.
D. PotentialRamifications of U.S. Retention of the Glass-SteagalAct
1. General Trends Resulting from the Internationalization of Financial Services
It is useful to examine the general trends predicted as a result of the
increasing internationalization of financial services in order to understand
how the Glass-Steagall Act will function in the resulting international
market. First, increased competition, both at the national and international
levels, blurs product divisions among different types of financial
institutions.'" In jurisdictions where there is a division between banking and
nonbanking activities, each type of institution seeks to increase its range
of permissible activities in order to increase its competitiveness. 197
Regulatory convergence is a second trend resulting from the
internationalization of the financial services market. 98 As a result of increasing
international competition, national regulatory standards are likely to
converge to some degree.' 99 This trend does not suggest a complete
erosion of prudential supervision; rather, those countries which are most
195. See Fisher, supranote 4, at 140; Hymas, supra note 41, at 1688.
196. PECCHIOLI, supra note 62, at 65.
197. ld. In the United States this trend is visible as nonbanks increasingly are permitted
to engage in traditional banking activities and as banks seek to engage in more nonbanking
activities. Bacon, supra note 152, at A22; Steven Lipin & Kenneth H. Bacon, Rise in Banks'
EarningsIn a Weak Economy Helps Them Rebuild, WALL ST. J., Oct. 30, 1992, at A1, A7. In
the European Union the trend will become apparent at the Member State level as national
regulatory systems converge toward universal banking. See discussion supra part II.B.2. In
Japan, the trend is reflected in the increased securities activities permitted for banks and the
increased banking activities permitted for securities companies under the New Banking Law
and amended article 65 of the Securities and Exchange Law. See discussion suprapart II.C.2.
198. Clarotti, supra note 67, at 184.
efficient in producing financial services, where efficiency includes quality
considerations as well as cost, will experience an inflow of capital.' The
effect of the competition arising from increased international trade in
financial services will be to discipline domestic regulatory regimes and
to force them to eliminate those inefficient regulations which impose costs
on domestic industry that are disproportionate to their social benefits. 2?1
2. The Expected Hierarchy of Financial Service Producers
Under a Liberalized Regime of International
Trade in Financial Services
U.S. and European. commentators speculate that, assuming Japan
continues to liberalize article 65 of its Securities and Exchange Law and
that the United States retains the Glass-Steagall Act in its present form,
a liberalized regime of international trade in financial services will result
in the dominance of European and Japanese financial producers and the
decline of the U.S. financial services industry in the world market. 2' 2 In
the case of Japan, commentators attribute this result to the increasing
strength of Japanese financial institutions resulting from the expansion of
the domestic market for financial services and expected reform of article
65. In the case of the European Union, commentators base this prediction
on the increasing dominance of E.U. financial institutions as a result of
their ability to expand their asset bases and economic power under the
Second Banking Directive.2 3
3. Expected Effects on the U.S. Market of Increased
International Trade in Financial Services
U.S. banks will not avoid competition from European and Japanese
banks in the domestic U.S. market.2" As European and Japanese banks
experience further consolidation and increased financial power, they will
seek new markets for expansion, including the United States. 5 U.S.
multinational banks may choose to take advantage of increased business
opportunities in Europe and Japan by relocating their full operations
abroad, rather than merely establishing branches or subsidiaries, in order
to avoid the restrictions of the Glass-Steagall Act. 206 Such a trend would
only serve to further weaken the U.S. banking industry by causing the
attrition of its strongest players.
4. Expected Effects of Increased International Trade
in Financial Services on the E.U. Market
Increased competition in the European market resulting from
liberalized bank powers under the Second Banking Directive might lead to a
consolidation of financial institutions, increased demand for financial
services (stemming from the economic growth caused by the completion
of the internal market), a fall in prices of financial services of
approximately five to fifteen percent, and innovation of financial products.' As
discussed in Part IV.C.1 above, U.S. banks with subsidiaries in the
European Union will be hampered by the Glass-Steagall Act, which will
prevent them from taking full advantage of increased opportunities there.
Despite substantial evidence that U.S. banks will be at a competitive
disadvantage in the European market, however, some commentators
predict increased opportunities for U.S. banks in Europe as a result of the
Second Banking Directive. These arguments are analyzed below.
Some commentators emphasize that the Second Banking Directive will
greatly expand the European opportunities for banks from all countries,
including the United States, because non-Member State banks will no
longer have to deal with twelve separate sets of national financial
institution regulations and will thus benefit from lower operational costs
of doing business in the Union.' ? This is undoubtedly true. However,
because these benefits will accrue to the United States' trading partners
as well, countries with more liberal banking regimes such as Japan will
realize proportionally greater benefits than the United States, making any
relative U.S. gain negligible.
local car dealers have to compete with Toyota and Volkswagen, U.S. regional and community
banks will soon find themselves competing with Sumitomo and Deutsche Bank." Id.
205. Golembe & Holland, supra note 29, at 109. However, it is important to note that the
impact of increasing European and Japanese power on the U.S. market will be felt over the long
term, rather than the short term. Id. at 87, 93.
206. Id. at 106-08.
207. Celarier, supra note 124, at 72; Clarotti, supra note 67, at 183.
208. Oversight Hearings,supra note 31, at 154 (prepared statement of Robert L. Clarke,
former Comptroller of the Currency); Matsushita, supra note 183, at 298.
Some commentators argue that countries outside the European Union,
including the United States, will benefit from the expansionary and
tradegenerating effects of European integration and that these effects will be
greater than any deflection of economic activity to the European Union."
This argument has some merit. However, it suffers from the same fallacy
as the argument above concerning the benefits of the single banking
license. Because all countries outside the Community will benefit from
these effects and because the United States is already at a competitive
disadvantage due to the restrictions of the Glass-Steagall Act, it follows
that any relative gain by the United States will be negligible. Although
European integration will likely increase demand for financial services,1 0
the United States, because of the Glass-Steagall Act, is not in a favorable
position to take advantage of this increased business, which can easily be
absorbed by financial institutions from countries with more efficient
regulatory systems, such as Japan.
5. Expected Effects of Increased International Trade
in Financial Services on the Japanese Market
There are currently very few foreign financial institutions in Japan.2 1'
Although the Japanese market has been deregulated to some extent 12 and
deregulation continues, this deregulation has favored Japanese financial
institutions over foreign entities."' Furthermore, it is not clear that the
United States would stand to gain from further liberalization of the
Japanese financial markets, even though such deregulation has long been
a U.S. goal.214 U.S. banks in the Japanese market have traditionally
enjoyed specialized niches that Japan created in the mid-1980s to appease
demands for extensive liberalization.21 5 If Japan liberalizes its banking
laws further, the United States may lose these profitable sources of
209. Clarotti, supra note 67, at 183-84.
210. ld. at 184.
211. Semkow, supra note 80, at 101.
212. See supra part II.C.2.
213. Szegt3, supra note 7, at 195.
214. Hale, supra note 93, at 151, 160.
E. Alternatives to the Glass-SteagallAct
1. Proposed Alternatives to a Strict Separation of
Securities and Commercial Banking Activities
The arguments discussed throughout this Note suggest that reform of
the Glass-Steagall Act is necessary if the U.S. banking industry is to
remain competitive in the world market. Although a discussion of specific
alternatives to the Glass Steagall Act is beyond the scope of this Note,
some general observations concerning the possibility of reform that would
be consistent with maintaining the safety and soundness of the financial
system are in order. It is not necessary to completely abolish the
separation of securities and banking activities in order to improve the
competitiveness of U.S. banks.217 Ideally, the goal in deregulatory reform should
be to liberalize the range of activities in which banks may engage, while
retaining those prudential safeguards which are necessary to protect against
the valid concerns which led to the enactment of the Glass-Steagall Act.
A number of different corporate structures could achieve this goal.
Commentators have proposed various types of holding structures which
would maintain a degree of separation between the securities and
commercial banking activities of banks.'
For instance, banks could engage in
securities activities through separately capitalized subsidiaries in a manner
which, if the subsidiary failed, would allow the bank to retain sufficient
capital so that the subsidiary's failure would not cause the bank substantial
harm. 9 Screening could prevent the exchange of information between
banking and securities departments which would otherwise give rise to
217. A complete integration of securities and banking activities, much like the German
universal banking model, may not be feasible in the United States for several reasons. First, such
a regime would not be compatible with the current structure of the U.S. banking system. Reform
Needed to Help U.S. Banks Compete Here and Abroad, Clarke Says, supra note 52, at 521.
Second, it is not clear that, if completely integrated, U.S. banks could successfully blend the
divergent business cultures of commercial and investment banking, at least in the short-run.
Hale, supra note 93, at 162. Finally, the powerful U.S. investment banking industry strongly
opposes further expansion of banks' securities activities, making the adoption of a universal
banking system politically unlikely. Id. But see SAUNDERS & WALTER, supra note 1, at 84-236
(arguing that universal banking is a feasible and advisable alternative to the current U.S. system).
218. See OversightHearings,supra note 31, at 24; TREASURY REPORT, supra note 13, at
55-61; BR6KER, supra note 2, at 84. For a discussion of several recent legislative proposals in
this regard, see Fisher, supra note 4, at 231-58; Isaac & Fein, supra note 4, at 302-10. For
some recent academic proposals, see SAUNDERS & WALTER, supra note 1, at 84-236 (arguing
for universal banking in the United States as an alternative to the Glass-Steagall Act).
219. OversightHearings, supra note 31, at 24 (recommendation of the Federal Deposit
conflicts of interest.2 ' Other prudential measures include, adequate
disclosure requirements, to fully inform clients of financial institutions
about all aspects of the institution's business, and implementation of
detailed and binding codes of conduct for financial institutions in order
to prevent abuses in conflict of interest situations. 22'
2. Reform of the Glass-Steagall Act is Important to
Maintain the Safety and Soundness of
the U.S. Financial System
Reform of the Glass-Steagall Act is not only consistent with
maintaining safety and soundness in the financial system, it is also an important
factor in maintaining the health of the U.S. banking system. 2 The
efficiency and competitiveness of a financial system are fundamentally
related to its safety and soundness.223 As banks lose business from
traditional banking activities to nonbanks, they lose important sources of
capital.2' If the permissible range of bank activities is not expanded, banks
will be unable to attract sufficient amounts of capital, threatening their
safety and soundness. 225 In addition, permitting banks a broader range of
activities allows them to choose efficiently an optimal level of risk and
return, which will further contribute to their continued stablility.2
Reform of the Glass-Steagall Act is important for the continued
strength of the U.S. banking industry, both in the domestic and
international arenas. Liberalizing the range of activities in which U.S.
banks may engage is essential for the U.S. banking industry to meet the
competitive challenges posed by E.U. and Japanese banks in the
increasingly international market for financial services. Liberalization of
permissible bank activities also is consistent with maintaining the
continued safety and soundness of the U.S. banking industry. As bank
profits are threatened by the continuing trend of nonbanks to engage in
traditional banking activities, the need for banks to broaden their activities
in order to maintain healthy levels of capitalization becomes more urgent.
220. BROKER, supra note 2, at 84.
222. TREASURY REPORT, supra note 13, at 29, 55.
223. BR6KER, supra note 2, at 96-97. See supra text accompanying notes 7-24.
224. See Bacon, supra note 152, at A22.
225. BR6KER, supra note 2, at 97-98; Bacon, supra note 152, at A22.
226. Oversight Hearings,supra note 31, at 158 (prepared statement of Robert L. Clarke,
former Comptroller of the Currency).
It is possible to effect reform of the Glass-Steagall Act while maintaining
those safeguards necessary to address safety and soundness concerns;
however, it will be difficult for the U.S. banking industry to maintain its
viability in the long term, in the domestic or international context, if the
United States retains the Act in its current form.
24. Id . at 44.
25. Dufey , supra note 7, at 183.
26. Id .
27. Id .
28. Id . at 174.
29. Carter H. Golembe & David S. Holland, Banking and Securities, in EUROPE 1992: AN AMERICAN PERSPECTIVE 65 , 78 (Gary C. Hufbauer ed., 1990 ).
30. Id .
31. Id . at 66 , 108; Oversight Hearings on European Community's 1992 Program: Hearings Before the Subcommittee on Financial Institutions' Supervision, Regulation and Insurance of the Committee on Banking, Finance and UrbanAffairs, 101st Cong ., 1st Sess . 140 - 41 ( 1989 ) (statement of L. William Seidman, former Chairman, FDIC) [hereinafter Oversight Hearings];Id. at 42 (statement of Sir Jeremy Morse , Chairman, Lloyds Bank PLC , London, England); see Dufey, supra note 7 , at 190- 91 . The perceived advantages for domestic financial institutions in the retail market are attributed to a number of factors, including locational convenience, familiarity with the local market, and ease of establishing business relationships with customers . Id. See INGO WALTER , BARRIERS TO TRADE IN BANKING AND FINANCIAL SERVICES 36- 45 ( 1985 ).
32. Tony Horwitz , Europe's Borders Fade, And People and Goods Can Move More Freely, WALL ST . J., May 18 , 1993 , at Al, A10 .
33. Glass-Steagall Act ?? 16 , 20 , 21 , 32 , 12 U.S.C. ?? 24 (Seventh), 377 , 378 , 78 ( 1988 ).
34. See S. REP . No. 455 , 73d Cong., 2d Sess . 1 ( 1934 ). For a more detailed discussion of the traditional reasons for separating securities and commercial banking activities, see infra part III.A.
35. Glass-Steagall Act ? 16 , 21 .
36. Id . ? 21 .
37. Id . ? 20 . Section 4 of the Bank Holding Company Act imposes similar ownership limitations on bank holding companies . Bank Holding Company Act ? 4(a) , 12 U.S.C. ? 1843(a ) ( 1988 ).
38. Glass-Steagall Act ? 32 ; see id. ? 21 which, in effect, extends the management interlock prohibition of section 32 to all banks.
41. Douglas L. Hymas , The EuropeanCommunity's Second Banking Directive and U.S. Banking Regulation: Preparingfor a MultilateralAgreementfor the Trade of Services, 1990 B.Y.U. L. REV . 1687 , 1690 .
45. International Banking Act of 1978 , ? 8 ( a ), 12 U.S.C. ? 3106 (a) ( 1989 ). Prior to the Act, foreign banks were subject mainly only to state regulation . EDWARD L. SYMONS, JR . &
47. International Banking Act of 1978 ? 8(c ). See INGO WALTER, GLOBAL COMPETITION IN FINANCIAL SERVICES 133-34 ( 1988 ) [hereinafter GLOBAL COMPETITION] .
48. Bank Holding Company Act ? 2(h)(2).
49. Regulation K , 12 C.F.R. ? 211 .23( b ), (f) ( 1991 ).
50. Bank Holding Company Act ? 4(c)(9). The Federal Reserve Board's discretion in granting this exemption is guided by its policy that foreign banks should not enjoy substantially broader powers than are permitted domestic bank holding companies . SYMONS & WHITE, supra note 45 , at 762.
51. EEOC v. Arabian American Oil Company, 111 S. Ct . 1227 ( 1991 ).
52. Reform Needed to Help U.S. Banks Compete Here andAbroad, Clarke Says , Banking Rep ., Mar . 26 , 1990 , at 521.
53. Regulation K , 12 C.F.R. ? 211 .5.
54. Id . In 1990, U.S. banks operating abroad were required to limit any single underwriting commitment to two million dollars or twenty percent of the issuer's capital and surplus or voting shares . Reform Needed to Help U.S. Banks Compete Here and Abroad, Clarke Says, supra note 52.
61. OECD, supra note 7, at 14.
62. Id.. See R. M. PECCHIOLI , PRUDENTIAL SUPERVISION IN BANKING 57 ( 1987 ).
63. SAUNDERS & WALTER, supra note 1, at 237.
64. Szeg6, supra note 7, at 190. For more detailed discussions of the particular banking systems of the E .U. Member States, see OECD , supra note 7 , at 15-16; George S , Zavvos, Banking Integration and 1992: Legal Issues & Policy Implications , 31 HARV. INT'L L.J . 463 , 481 ( 1990 ) ; BR6KER, supra note 2 , at 63; Golembe & Holland, supra note 29, at 80.
65. Council Directive 89 /646 of Dec. 15 , 1989 on the Coordination of Laws, Regulations and Administrative Provisions Relating to the Taking Up and Pursuit of the Business of Credit Institutions and Amending Directive 77 /780, 1989 OJ. (L 386) 1 [hereinafter Second Banking Directive]. The Second Banking Directive came into force simultaneously with companion directives on own funds and solvency ratios . Golembe & Holland, supra note 29 , at 75; Zavvos, supra note 64, at 476.
66. See Second Banking Directive, supra note 65 , pmbl.
67. Paolo Clarotti , Harmonization for Banking and Securities Regulations in the European Communities: Its Implications for the Third Countries , in LIBERALIZATION OF SERVICES AND INTELLECTUAL PROPERTY IN THE URUGUAY ROUND OF GATT 177 , 182 (Giorgio Sacerdoti ed., 1990 ).
68. Second Banking Directive, supra note 65, art. 1.
69. Dufey , supra note 7, at 179.
70. Zavvos , supra note 64, at 480.
71. Second Banking Directive, supra note 65, arts. 1-8.
72. Golembe & Holland, supra note 29, at 73.
73. See Second Banking Directive, supra note 65 , art. 18 .
74. Zavvos , supra note 64, at 484. It is possible that this resulting inflow of business to Member States with more liberal regulations may be differential, i .e., banks may find it most profitable to specialize in certain financial services and locate in the Member State with the least restrictive regulatory scheme with respect to that particular service . Szeg6, supra note 7 , at 194. However, under the liberalization of financial services embodied by the Second Banking Directive, it would seem that regulatory convergence would still be the ultimate result .
75. Clarotti , supra note 67, at 178; Zavvos, supra note 64, at 466-67.
76. OversightHearings,supra note 31, at 139 (prepared statement of L. William Seidman, former Chairman, FDIC). The basis of the distinction between subsidiaries and branches is article 58 of the EEC Treaty, which permits foreign companies or firms to enjoy all the freedoms granted to E.U. companies or firms, provided that the company or firm is established in accordance with the law of a Member State and has its registered officer, central administration, or principal place of business in the European Union Clarotti , supra note 67 , at 186. However , Member States are limited to the extent that they are prohibited from giving outside providers of services more favorable treatment than they give E.U. providers (the Most Favored Nation (MFN) principle) . Id. at 187.
77. Golembe & Holland, supranote 29 , at 74. The reciprocity provisions are discussed infra part IV.B.2 .
78. Second Banking Directive, supra note 65 , art. 9 ( 4 ).
79. Id . art. 9 ( 3 ); Giorgio Sacerdoti, The International Regulation of Services: Basic Concepts and Standards of Treatment, in LIBERALIZATION OF SERVICES AND INTELLECTUAL
80. For a summary of the sources of Japanese banking law , see Brian W. Semkow, JapaneseBanking Law: Current Deregulation and Liberalization of Domestic and External FinancialTransactions , 17 LAW & POL'Y INT'L Bus . 81 , 84 - 93 ( 1985 ).
88. Semkow , supra note 80, at 109-10.
89. 1981 Amendment to Securities and Exchange Law (Torihiki-ho no lchibu o Kaisei suru Horitsu) Law No. 62 of 1981, amending the Securities and Exchange Law (Shoken Torihiki Ho) , Law No. 25 of 1948 , art. 28 ( 2 ), in JAPANESE SECURITIES REGULATION , Appendix A ( Louis Loss et al. eds., 1983 ) [hereinafter Amended Securities and Exchange Law]; Semkow, supra note 80, at 110.
90. Semkow , supra note 80, at 110.
91. Id . at 94-95.
92. Id .
93. See David D. Hale , Global Financeand the Retreat to Managed Trade, HARV . Bus. REV., Jan .-Feb. 1990 , at 150 , 156; Masahiro Shimojo , The New Banking Law of Japan: Securities Business by Banks, I UCLA PAC . BASIN L.J. 83 , 85 ( 1982 ).
94. SAUNDERS & WALTER, supra note 1, at 61.
95. Hale , supra note 93, at 156.
96. Id . at 150.
105. Id . at 123.
106. New Banking Law (Ginkoho), Law No. 59 of 1981 , repealing Old Banking Law (Ginkoho), Law No. 21 of 1927 , in JAPANESE SECURITIES REGULATION, supra note 89, at Appendix F [hereinafter New Banking Law].
107. Amended Securities and Exchange Law, supra note 89 , art. 65 .
108. Specifically, the law applies to all institutions that engage in "banking," which is defined as the acceptance of deposits or installment savings, the making of loans or the discounting of notes, and the performance of exchange transactions . Semkow, supra note 80 , at 115.
109. New Banking Law, supra note 106 , arts. 10 , 11 ; Semkow, supra note 80, at 115-16, 123 . The Old Banking Law of 1927 was silent as to securities activities - it merely stated that banks were permitted to engage in "banking related business . " Id. at 118 . However, administrative rulings under the Old Banking Law made clear that "banking related business" included the purchase, sale, and lending of government securities . Id. at 115-16 . Thus, the New Banking Law may be viewed, to some extent, as a codification of practices previously permitted . Id.
110. Amended Securities and Exchange Law, supra note 89 , art. 65; Shimojo, supra note 93, at 111-12.
111. Shimojo , supra note 93, at 111-12.
112. Semkow , supra note 80, at 115-16.
113. Id . at 124.
152. See GLOBAL COMPETITION , supra note 47, at 118; Kenneth H. Bacon , U.S. Comptroller FavorsLetting Banks Sell Insurance ,OtherFinancialServices, WALL ST. J., Sept . 14 , 1993 , at A22.
153. Cf GLOBAL COMPETITION , supra note 47, at 195 ( noting that protectionist measures are often disguised as, for example , antitrust issues).
154. See ld. at 194-95.
155. See Id. at 195.
156. See Dufey, supra note 7 , at 187.
157. Id . A law separating securities and banking activities acts like a government "tax" on production and trade in the industries which purchase financial services. However, unlike a real tax, in which revenue accrues to the government, the increased costs imposed by the law are borne by domestic industry and gained by domestic producers offinancial services . GLOBAL COMPETITION, supra note 47 , at 184.
158. Bacon , supra note 152, at A22 ; Trachtman, supra note 44 at 255. See also Greenspan WarnsAgainst "Unnecessary" Regulation, Reuters , May 26 , 1993 , available in LEXIS, Banks Library , FINRPT File.
159. See Bacon, supra note 152 , at A22 ; MULLINEUX, supra note 100, at 58.
160. Bacon , supra note 152, at A22 ; Reform Needed to Help U.S. Banks Compete Here and Abroad, Clarke Says, supra note 52 , at 521 (statement of Robert L. Clarke, former Comptroller of the Currency) .
161. Reform Needed to Help U.S. Banks Compete Here and Abroad, Clarke Says, supra note 52 , at 521; See GLOBAL COMPETITION , supra note 47, at 119; WALTER, supranote 31 , at 116. For the economic implications of this inefficiency , see supra note 157.
162. MICHAEL EMERSON , ET AL., THE ECONOMICS OF 1992 : THE E.C. COMMISSION'S ASSESSMENT OF THE ECONOMIC EFFECTS OF COMPLETING THE INTERNAL MARKET 98 ( 1988 ).
163. GEZA FEKETEKUTY , INTERNATIONAL TRADE IN SERVICES 96 ( 1988 ) ; See The "Cost of Non-Europe" in FinancialServices, in 9 RESEARCH ON THE "COST OF NON-EUROPE" 174- 75 ( 1988 ) (asserting free trade in capital creates efficiencies for inflow and outflow countries).
164. Rudolf Bosshard , Issues in the Regulation of TransnationalBanking, in LIBERALIZATION OF SERVICES AND INTELLECTUAL PROPERTY IN THE URUGUAY ROUND OF GAIT , supra note 67, at 198.
165. See Too Much Competition?, FIN. REG. REP., Mar . 1992 , available in, LEXIS, News Library , FRR file . These concerns are closely related to the traditional justifications cited for imposing a separation between securities and banking activities. See supra part III.A. For responses to these arguments, see supra part lI . B . 1; infra part IV.D.1; infra part IV .E.I.
166. THE URUGUAY ROUND TRADE NEGOTIATIONS COMMIrrEE, "THE DUNKEL DRAFT" FROM THE GATT SECRETARIAT Annex 11 ( 1991 ) [hereinafter GATS]. Although the Uruguay Round of the General Agreement on Tariffs and Trade (GATT) was formally concluded on December 15, 1993, the Contracting Parties were unable to reach agreement on the liberalization of financial services, and initial commitments in the financial services sector were postponed for further negotiation . See Uruguay Round Agreement is Reached , Clinton Notifies Congress Under Fast Track, 10 Int'l Trade Rep. (BNA) 2103 ( 1993 ).
167. GATS, supra note 166. See Gerhard Wegen, TransnationalFinancialServices - Current Challengesfor an Integrated Europe, 60 FORDHAM L. REV. S91 , S97 ( 1992 ). The Dunkel Draft was intended to be a proposal for compromise among the parties to the GAT'T and covers the various aspects of the Uruguay Round of negotiations. Two draft agreements on financial services preceded the Dunkel Draft: A 1990 Canadian draft and a draft circulated by the SEACEN countries (a combination of the Association of Southeast Asian Nations (ASEAN), Nepal , and Korea). Fisher, supra note 4 , at 139.
168. GATS, supra note 166, Annex on Financial Services.
169. Fisher, supra note 4, at 140.
170. GATS, supra note 166, art . XVII(l).
171. Id .
172. Id . Annex on Financial Services, at (2).
173. Sacerdoti , supra note 79, at 36.
174. Id .
175. Id .
176. See Hale, supra note 93 , at 151-53; R. Brian Woodrow, Sectoral Coverage and Implementation within a Uruguay Round Services Trade Agreement: Paradox and Prognosis, in A NEW GATT FOR THE NINETIES AND EUROPE ' 92 , at 221 ,237 (Thomas Opperman & Josef Molsberger eds., 1991 ); WALTER, supra note 31, at 51-52 ; GLOBAL COMPETITION, supra note 47, at 156-57 , 194 .
177. Sacerdoti , supra note 79, at 37. For a discussion ofpermissible activities of U.S. banks located in the European Union, see supra part II.B.3 .
178. Sacerdoti , supra note 79, at 37. Theoretically, an alternative approach under mirror image reciprocity would be for the country with the less liberal banking law to provide the "mirror," in the sense that the less liberal range of activities would become the standard for both countries' banks when acting in each other's markets. A form ofthis approach has been adopted by the European Union in the form of article 9 of the Second Banking Directive, a retaliatory tool which combines reciprocal national treatment with effective market access. Article 9 is discussed infrapart IV.B.2 .
189. Id . at 1689; see Stokes, Banking Globally, NAT'L J. , May 5 , 1990 , at 1120; EC Would Not Take Action Against US if Banking Laws Not Reformed by 1992 , Banking Rep . (BNA), Apr. 2 , 1990 , at 591.
200. Id .; The "Cost of Non-Europe" in FinancialServices, supra note 163, at 249. Truly efficient production of financial services necessarily involves some degree of prudential supervision because without such regulation the international financial system will be unable to function smoothly . Id. See GLOBAL COMPETITION, supra note 47 , at 34; MARIO A. KAKABADSE, INTERNATIONAL TRADE IN SERVICES: PROSPECTS FOR LIBERALISATION IN THE 199os , at 40 ( 1987 ).
201. Trachtman , supra note 44, at 247.
202. Hufbauer & Schmitz, supranote 183 , at 319-20, 323 . Hufbauer and Schmitz comment that "lilt seems likely that European firms will now join Japanese firms in pushing US-based firms further down the league of ... financial giants." Id. at 319-20.
203. Golembe & Holland, supra note 29, at 96; Hufbauer & Schmitz, supra note 183, at 323; Szeg, supranote 7, at 196; UNITED STATES DEPARTMENT OF THE TREASURY, MODERNIZING THE FINANCIAL SYSTEM: RECOMMENDATIONS FOR SAFER , MORE COMPETITIVE BANKS chapter XVIII , 27 ( 1991 ); Zavvos, supra note 64, at 481.
204. Rep. LaFalceCalls U.S. Banks ComplacentAbout Need to Compete in GlobalMarket, supra note 189, at 721. In 1990, Representative John LaFalce (D-NY ) warned that, "[lust as