Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, November 2 7, 1995
I appreciate the opportunity to discuss with you today the issues raised by the recent events relating to the U.S. operations of Daiwa Bank and to provide you with our preliminary conclusions on these issues. I believe the basic facts are known and need not be recounted in detail. A short chronology is provided in an attachment, and I will briefly summarize the key events.(1) Of course, I would be pleased to answer, to the extent that I can, any questions that you might wish to ask regarding these events.
Very briefly, as background, on September 18, 1995, Daiwa Bank met with a Federal Reserve representative and reported that Daiwa's New York branch had incurred losses of $1.1 billion from trading activities undertaken by Toshihide Iguchi, a branch official, over a period of eleven years. These losses were not reflected in the books and records of the bank or in its financial statements, and their existence was concealed through liquidations of securities held in the bank's custody accounts and falsification of its custody records. Although Daiwa indicates that its senior management learned about these trading losses in July, they concealed the losses from U.S. banking regulators for almost two months thereafter. Moreover, they directed Mr. Iguchi to continue transactions during the two-month period that avoided the disclosure of the losses.
We understand that some officials at the Japanese Ministry of Finance were informed in early August about Daiwa's losses. They did not instruct Daiwa to inform the U.S. authorities; nor did they themselves do so. This lapse on the part of the Ministry of Finance is regrettable because open communication and close cooperation among supervisory authorities are essential to the maintenance of the integrity of the international financial system. Finance Minister Takemura has acknowledged the ministry's failure in this regard and has pledged that in the future the ministry will promptly and appropriately contact U.S. authorities on such matters of U.S. interest. We have been assured that the ministry is taking steps to implement this pledge. In addition, we have been pleased that once the Daiwa problem was disclosed, the Japanese authorities have fully cooperated with US. supervisors in dealing with the consequences.
On October 9, Daiwa also announced that its separate federally insured bank subsidiary in New York had incurred losses of approximately $97 million as a result of trading activities, at least some of them unauthorized, between 1984 and 1987. These losses should have been reflected in the books and records and financial statements of the subsidiary but were not. Instead, the losses were concealed from federal and state regulatory authorities through a device that transferred the losses to offshore affiliates, apparently with the knowledge of senior management.
On October 2, 1995, the New York Superintendent of Banks and the Federal Deposit Insurance Corporation (FDIC), together with the Federal Reserve Board, issued cease-and-desist orders against Daiwa requiring a virtual cessation of trading activities in the United States. On November 2, Daiwa was indicted on federal criminal charges. At the same time, the Federal Reserve, the FDIC, the New York Superintendent, and a number of other state banking authorities jointly issued consent orders under which Daiwa must terminate its banking operations in the United States by February 1996.
This matter has troubling implications for supervision and regulation in a world of multinational banking and increasing interrelationships of financial systems. Not only were bank employees able to conceal massive losses over an extended period of time, but senior management of Daiwa also took steps to conceal the events in question from US. regulatory authorities. This is particularly disturbing given that it would obviously have been in the best interest of both the bank and its management to have dealt with the problems openly and in compliance with host country regulations and operational standards.
The action taken by the Federal Reserve and the other regulatory authorities in terminating the U.S. operations of Daiwa was quite stem, particularly given that no US. depositor or U.S. counterparty ultimately lost any money. We, however, were united in the belief that this supervisory response was necessary because actions such as Daiwa's carry the threat of significant damage to a major asset of our nation the integrity of our financial system.
Trust is a principle of central importance to all effective financial systems. Our system is strong and vibrant in large part because we demand that financial institutions participating in our markets operate with integrity and that any information made available to depositors and investors be accurate. When confidence in the integrity of a financial institution is shaken or its commitment to the honest conduct of business is in doubt, public trust erodes and the entire system is weakened.
The need to trust other participants is essential in a complex marketplace. For example, on the basis of trust, counterparties typically trade millions of dollars on an oral commitment that may not be formalized for hours. A breach of that trust by failure to honor such commitments--presumably because markets turn adverse--would inevitably lead to an institution being drummed out of the marketplace. No set of statutes can ensure the effective functioning of a market if a critical mass of financial counterparties is deemed untrustworthy. Any risk that counterparties will not honor their obligations will be reflected in a widening of bid-ask spreads, a reduction in liquidity and, as a consequence, a less efficient financial system. Consequently, actions such as I have recounted in the Daiwa case cannot be tolerated. The potential …