B a n k i n g in a N e w W o r l d O r d e r ANN B. MATASAR*

Abstract September 11, 2001 is the defining date of a new world order. Like all individuals and commercial activities in the U.S., American banks and other domestic financial institutions were affected by the events of the terrorist attacks and by the subsequent responses of the American government and business community. Some of the effects of the attacks were immediate and fleeting. Others, however, were likely to have altered the environment of the financial services industry, particularly banking, in the U.S. f o r the foreseeable future. This paper is an initial consideration of these more lasting effects. (JEL G20)

Introduction September ii, 2001 was a defining date for the people of the United States and, ultimately, the world. It was the start of the new world order. The business community, particularly its financial services component, was particularly and adversely affected. One might venture so far as to say that financial services as the fulcrum of business and the symbol of American economic power was itself a focal point of the attacks on the Wrorld Trade Center [Lang, 2001, p. 360]. Wall Street was more than the location of the twin towers; it was the financial heartland of the country. No part of the American financial services industry including the banking community escaped the effects of September 1 I. This paper looks at the regulation and role of American banks in the post~September 11 world. In particular, it seeks to determine to what extent and how the regulatory climate for banks operating in the United States has been altered. Additionally, it considers the degree to which the regulatory changes that occurred in American banking at the end of the 20th century aided American banks in meeting the unexpected challenges brought on by the terrorist attacks or exacerbated the negative impact of this national tragedy on the banking industry. The Regulators Historically, banking has been among the most regulated businesses, if not the most regulated business, in the United States. From the vantage point of the number of regulators to whom bankers are responsible and the complexity of the regulatory structure overseeing the industry, banks in the U.S. have no equal among their competitors in the financial services industry either domestic or global. The dual banking system that is an outgrowth of federalism has led to a plethora of banking regulators. National banks are under the supervision of the Office of the Comptroller of the Currency (OCC) in the Department of the Treasury. The Federal Reserve Board (Fed) supervises state-chartered banks that are members of the Federal Reserve System as well as M1 foreign banks operating within the borders of the *Roosevelt Universi~y--U.S.A. 48

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U.S. The Federal Deposit Insurance Corporation (FDIC) oversees the non-member, state. chartered banks that it insures. In addition to these federal regulators, banks must answer to the state regulators in those states in which they are headquartered or do business. At one time state regulators were senior supervisors for state chartered, non-member banks that were uninsured by the FDIC. There are, however, no remaining uninsured domestic banks. The events of September 11 increased the regulatory burden of American banks by expanding the role of a new group of regulators. Prior to September 11, some of these regulators had been involved only tangentially with all domestic banks or occasionally with an individual bank. These new banking regulators were empowered by the federal government's efforts to trace the monetary trail of the terrorists, seize their assets, and prevent money laundering activities that could aid in financing future terrorism. Banks were no longer simply a part of the financial services industry or an integral part of the nation's economic system; they were part of the war on terrorism. The position of banks in protecting the nation was altered from that of an essential, regulated industry to an essential tool of government policy. This change in perspective brought to the fore the new set of banking regulators. One must now include among the regulators of American banks: 1) The State Department The money trail that financed the terrorists and provides the economic underpinnings of the At Qaeda network is global in reach and follows many paths, several of which wind through the internationM banking community. The State Department's efforts to find and eradicate terrorists, therefore, has made it attentive to the activities of American banks, particularly those with an overseas presence and also to the activities of foreign banks with representation in the U.S. 2) The Justice Department Previously involved with banks largely through its anti-trust, criminal and civil rights divisions, it is now intimately involved through its subsidiary arm, the Federat Bureau of Investigation (FBI) in the enforcement of the heightened money laundering and asset seizure requirements. 3) The Department of the Treasury Through the OCC and because of the significance of banking in the overall economy, the Treasury Department had daily concern for banks prior to September 11. Nonetheless, the breadth as well as depth of involvement has expanded since that date. Treasury's Office of Foreign Assets Control directs the effort to seize and freeze assets by domestic banks. Additionally, the Treasury Department represents the U.S. with the Financial Action Task Force on Money Laundering (FATF). This international and multi-disciplinary group established in Paris in 1989 by the G-7 includes 29 nations, the European Union (EU), and the Gulf Cooperation Council. It monitors members' anti-money laundering progress and makes recommendations for improving money laundering policies and activities. As of October 2001, the FATF has concentrated its efforts on combating terrorist financing [Financial Action Task Force on Money Laundering, 200t]. Regulations

Money Laundering The extensive regulation of American banks included a substantial number of laws related to money laundering prior to September 11. The terrorist attack demonstrated their inadequacy while simultaneously increasing their importance and changing their focus. It also overrode bankers' and some politicians' (for example, Senator Phil Gramm) opposition to banning foreign banks from access to the U.S. market if they refused to aid the U.S. government in money laundering investigations.

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Money laundering refers to the process by which gains or profits earned on criminal proceeds are disguised so that the illegal origins of the money goes undetected and is not known. Succinctly it seeks to legitimize ill-gotten gains while maintaining the confidentiality of the criminal's identity [McDowell and Novis, 2001]. There are three distinct steps in a money laundering process: placement, layering, and integration. Placement is the stage in which unlawful proceeds are put into financial institutions. This is accomplished by dividing the money into small amounts that can be introduced into the financial system through a variety of financial instruments or services such as deposits in bank accounts or the purchase of money orders that do not arouse suspicion. Layering occurs through the separation of the proceeds of criminal activity from their origin through the use of layers of complex financial transactions that frequently includes converting or moving the money in order to distance it from the source. Finally, integration occurs when the funds re-enter the legitimate economy through investments in tangible assets or business ventures. This provides the ultimate legitimate explanation for the illicit proceeds. The key to successful money laundering is to leave no paper trail linking any of these three steps [U.S. Department of the Treasury, 2001; Bauer and Ullman, 2001] The goal of anti-money laundering legislation, therefore, is to establish a paper trail. In order to accomplish this, U.S. anti-money laundering laws have concentrated on the placement stage of the process and have envisioned financial institutions, especially banks and other depository institutions, as the first line of defense. Although most of the anti-money laundering legislation existed well before September 11, there are two major differences since the terrorist attack in regard to these laws. First, the focus of attention has shifted from drug traffickers to terrorists and secondly, the enforcement of the laws has taken on a new

urgency [Bauer and Ullman, 2001]. The most important portions of the pre-September ii anti-money laundering regulations include: 1) The Bank Secrecy Act (1970) Primarily concerned with deterring the establishment of secret foreign bank accounts, this groundbreaking taw did not criminalize money laundering per se. Nevertheless, for the first time it did require banks to report large currency transactions and provided penalties for non-compliance. Thus, the concept of a paper trail was developed [U.S. Department of the Treasury, 2001]. 2) The Money Laundering Control Act (1986) Part of the Anti-Drug Abuse Act of 1986, this iaw represented the first time that money laundering was declared a federal crime whether done by, through, or to a financial institution. It established a $10,000 ceiling for transactions that did not require a report and increased the penalties for avoidance of the Bank Secrecy Act to include up to 20 years imprisonment, fines of $500,000 or twice the value of the laundered funds, and forfeiture of the assets [U.S. Department of the Treasury, 2001]. 3) The Anti-Drug Abuse Act (1988) This legislation increased sanctions for violating the Bank Secrecy Act or the Money Laundering Control Act, and expanded the reporting and recording requirements to cover cash transactions that emanated from a single geographic area. Most importantly, this law no longer assumed that the money laundering problem was largely domestic [Joseph, 2001]. For the first time, it gave the~Treasury Department the authority to sign bi-lateral international agreements to cover U.S. currency transactions and to share information [U.S. Department of the Treasury, 2001]. 4) Section 2532 of the Crime Control Act (1990_)_ The fact that money laundering was a problem of global dimensions gained further recognition. This legislation permitted all federal banking regulators, as well as the

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Office of Thrift Supervision (OTS) to seek assistance from foreign banking authorities when conducting investigations, exams, or enforcement in anti-money laundering endeavors. Additionally, the OCC was authorized to provide similar reciprocal help if requested by an overseas banking authority [U.S. Department of the Treasury, 2001]. 5) Section 206 of the FDIC Improvement Act(1991) The FDIC Improvement Act was the first of several major revisions of American banking laws during the 1990s. Section 206 reemphasized American recognition of the international dimensions of money laundering. It allowed federal banking regulators to disclose appropriate information discovered during supervisory exams to overseas banking regulators, as long as U.S. interests were not adverseb~affected and the information would retain its confidentiality overseas. American banking regulators, therefore, could voluntarily and proactively provide their foreign counterparts with information rather than remaining passive while awaiting a request [U.S. Department of the Treasury, 2001]. 6) Title X V of the Housing and Community Development Act (.1992) Also known as the Annunzio-Wylie Anti-Money Laundering Act, this law expanded the definition of financial transactions, added a conspiracy provision to money laundering activities, outlawed illegal money transmitting businesses, and initiated the "Death Penalty" for national banks and foreign banks with a U.S. presence. The Death Penalty stated that any bank convicted of money laundering in violation of the Bank Secrecy Act was to have its charter terminated, its assets seized or its federal deposit insurance revoked. Any one or a combination of these actions effectively would serve to eliminate a bank's ability to operate [U.S. Department of the Treasury, 2001]. 7) The Money Laundering Suppression Act (1_994) Its major provisions revised the concept of conspiracy. 8) Terrorism Prevention Act (1996) For the first time, terrorist cremes " were specifically included among money laundering offenses. Prior to this law, the illicit funds from drug trafficking had been virtually the exclusive concern of the anti-money laundering legislation and its enforcement [U.S. Department of the Treasury, 2001]. Despite this plethora of anti-money laundering laws, however, the money needed for underwriting the terrorist activities of September 11 still entered the country. This, in turn, sparked a call for even more regulation to rectify the deficiencies of prior legislation. This reaction resulted in passage of the USA Patriot Act of October 26, 2001 [U.S. Department of State, September 24, 2001]. In keeping with the banking deregulatory trend that commenced in the last years of the 20th century, the USA Patriot Act sought to maintain a level playing field for banks and their competitors throughout the financial services industry by applying its restrictions to all institutions, both financial and non-financial, that could be involved in any of the three stages of money laundering rather than exclusively to banks. This new legislation has the following features [Wayne, 2001]. 1) Financial services firms are expected to conduct more due diligence of account holders, set up anti-laundering programs and policies, and report suspicious activities to the Treasury Department. For the first time, this requirement also includes commodities traders and brokers [Wayne, 2001]. 2) In recognition of the role played by correspondent banking as a conduit for dirty money to enter the U.S., banks are to cease financial transactions and correspondent banking with the following types of institutions [Oustitus et al., 2001; Wayne, 2001]: shell banks--those with no physical presence in any country; offshore banks; and banks that are regulated in jurisdictions with weak money laundering regulations.

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3) Banks are required to get more information about foreign banks with which they do business.

Blockage (Freezing) of Assets: The freezing of assets is not a new concept. It has been a political tool for a substantial period of time. Prior to the post-September 11 changes, however, a president only had authority to block assets from a foreign entity if the Middle East peace process was being threatened. In fact, on at least two modern occasions, presidents did use the blockage, seizure, or freezing of assets as a political tool and required banks to serve as conduits for this policy. President Carter froze Iranian assets when the Ayatollah Homeini deposed Shah Reza Pahlavi. Subsequently, President Clinton froze A[ Qaeda assets in 1998 after the bombings of the American embassies in Kenya and Tanzania [Eichemvald, 2001]. The executive power to freeze the assets of foreigners and the role of banks and other financial institutions in this process, however, has been substantially expanded since September 11 by Executive Order 13224--Blocking Terrorist Property, that went into effect on September 23, 2001 [U.S. Department of State, November 7, 2001; Sanger and Kahn, 2001]. Executive Order 13224--Blocking Terrorist P r o p e r t y has the following principle features. 1) It expands the Treasury Department's authority to block assets and U.S. transactions of persons or institutions associated with terrorists or terrorist organizations. The Office of Foreign Assets Control within the department is responsible for enforcement of this order [Eichenwald, 2001]. 2) It "also established our ability to block the U.S. assets of, and deny access to U.S. markets to, those foreign banks that refuse to cooperate in freezing terrorist assets." 3) The ban on financiM dealings with terrorists applies to U.S. citizens, permanent residents, and any business or organization in the U.S. including their foreign branches. Unlike previous situations in which there was a clear focus on particular owners or types of assets subject to a freeze, the ownership of the assets that have been frozen has been varied under the new executive order. The targets of the asset freeze have included individuals believed to be terrorists or their supporters; terrorist groups or groups that support them; organizations posing as charities that funnel contributions to terrorists; banks that are (reed by the terrorists to launder money or provide avenues for the movement of money across national borders; and corporations that serve as a front for the terrorists and thereby aid in the money laundering activities. As of mid-November, the assets of 150 individuals, organizations including charities, financiM supporters, and corporations considered to be terrorists or underwriters of terrorism had their assets frozen in U.S. or have been the subject of a U.S. request that their-, overseas assets be frozen [U.S. Department of State, November 7, 2001]. As the list of terrorists and terrorist groups expands, so does the number of targets whose assets are subject to being frozen and the burden placed upon the financial community to carry out these actions. Additionally, the role that the government wants banks and other financial institutions to play goes beyond the process of blocking the targeted assets within the institution. In conjunction with two new inter-agency coordinating bodies in the Treasury Department, namely the Foreign Terrorist Asset Tracking Center and Operation Green Quest, banks and financial institutions are being asked to participate in identifying sources of terrorist cash and following their path in order to detect patterns that could provide information to forecast and foil future attacks. The government would like to be able to provide a list of individuals and organizations to be checked daily against the database of bank account holders and transactions. This would allow information to be obtained without delay in real time. There are several problems, however, associated with this endeavor, namely, it eliminates privaey~ the information

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obtained could be used for purposes for which it was not originally intended; it furthers the appearance that banks are not freestanding enterprises subject to regulation but rather are parties to governmental policy; and it substantially increases the administrative burden and cost placed upon banks. T h e Effects o f D e r e g u l a t i o n To view the world of American banking as having changed only after September 11, 2001, however, is myopic. Revolutionary and inexorable deregulatory changes had been occurring throughout the final decade of the 20th century. Most prominent among these were the RiegteNeal Interstate Banking and Branching Act of 1996 and the Gramm-Leach-Blitey Financial Services Modernization Act of 1999. There is no doubt that the new banking environment created by these two laws affected the ability of banks to operate successfully in the new world order. Tile question, however, is whether these reforms aided or adversely affected banks in this new and totally unanticipated era.

Riegle-Neal Interstate Banking and Branching Act of 1996 Riegle-Neal eliminated the McFadden Act's (1927) restrictions on interstate branching and the Bank Holding Company Act's (1956) prohibitions on interstate banking. In so doing, it provided banks and bank holding companies with the opportunity to diversify geographically throughout the U.S. Although it is too early to be certain, it is likely that this diversification assisted banks, particularly those headquartered in New York, to withstand the local shocks associated with the terrorist attacks [Fonst, 2002]. Additionally, the destruction of geographic constraints has created a climate for mergers and acquisitions that, in turn, has diversified and decentralized the hubs of American baI~king power. Although New York remains a dominant force and central location for banking and financial services, it is now rivaled by banking powerhouses headquartered in several other states such as California, North Carolina, and Texas.

G~'amm-Leach-Bliley Financial Services Modernization Act of 1999 By repeMing the Banking Act of 1933's (Glass-Steagall) Chinese Wall separating investment and commercial banking as well as other prohibitions on banking activity, GrammLeach-Bliley paved the way for banks and bank holding companies to diversify their products and services and to compete more effectively with other financial service firms both domestical!y and internationaUy. The inc[nsion of all financial services in the provisions of the USA Patriot Act attests to the importance of Gramm-Leach-Bliley on the banking industry in a post-September l l t h world. Among the non-banking subsidiaries that banks and bank holding companies now are permitted to acquire are insurance companies. In light of the enormous impact of the terrorist attack on the insurance industry, it is informative, therefore, to review the potential impact on the banking community from the vantage point of its new opportunity for diversification into the world of insurance thanks to Gramm-Leach-Bliley. Prior to September 11, one of the great attractions of the insurance industry was the fact that it had no national regulation. Insurance regulation was exclusively the purview of the state regulators in the state in which the insurance firm was headquartered or in which it conducted business. This advantage is likely to be eliminated or at least abridged. By seeking federal assistance to pay the claims associated with the terrorist attack, the insurance industry paved the way for consideration of federal regulation. Although the political parties and their competing legislation have differed on limiting damage awards, capping attorney's fees, the size of the ceiling preceding federal assistance, whether the federal assistance should be in the form of a loan to the insurance industry or an outright supplemental payout and a host

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of other issues, all of the proposed legislation related to federal assistance for the insurance industry has included some type of regulation. If for no other reason, this has been necessary to protect the public from future bailout situations [Schroeder and Oster, 2001]. Government assistance for the insurance industry has additional, multiple significances for the banking industry. First and foremost are the implications for lending. Reinsurance firms announced after September 11 that they would not renew underwriting policies without government protection. In turn, insurance firms said that they would no longer write insurance for businesses in urban areas or for mortgages or real estate, especially trophy properties that were possible terrorist targets. The final stage of this snowballing situation occurred when banks said that without insurance, they would not make loans, thus having a detrimental affect on an already poor economy. More specifically, banks Mso said that without terrorism coverage they might consider some current loans to be in default because they would no longer meet the insurance stipulations in loan agreements [Labaton, 2001; Treaster, 2001; Bray, 2001; Gogoi and McNamee, 2002]. Loan protection is not the only reason that the banking industry is concerned with obtaining federal legislation to assist the insurance industry; the other is product diversification. Even in the absence of government protection, the insurance industry is positioned to thrive, not just survive in a post-September 11th world. It can protect itself through higher deductibles, inclusion of no terrorism coverage clauses, by charging higher premiums, or by making terrorism coverage an expensive option rather than part of basic coverage. Insurance firms defend these options because they say they cannot assess the risk of future attacks in terms of their lil~elihood or extent of damage and thus, must protect themselves. Therefore, it is likely that the insurance industry will get richer rather than poorer because of the September 11th cMamity, because it is one of the few sectors of the economy that has retained strong pricing power, a factor that has made them the darling of buyout firms [Scannell and McGee, 2001]. By giving banks and bank holding companies access to diversification into insurance, Gramm-Leach-Bliley may have opened up an avenue for new profitability. Simultaneously, it may have buffered banks and bank holding companies from the higher premiums that will adversely affect all businesses as well as potentially having a negative impact on loan portfolios and lending income. Summary In the new world order, banks will have more regulators and greater regulation as they alter their economic functions to become participants in the expanding war on terrorism. From a business perspective, however, they have been insulated from many of the negative effects of the events of September 11 because of the geographic and product diversification accorded them through deregulation at the end of the 20th century. References Bauer, Paul; Ultmann, Rhoda. "Understanding the Wash Cycle," U.S. Federal Reserve Bank of Cleveland, , 2001. Bray, Chad. "States May Allow Insurers Exclude Some Terror Coverage," Dow Jones Newswires, , December 18, 2001. Eichenwatd, Kurt. "Terror Money Hard to Block, Officials Find," The New York Times, December 10, 2001, pp. A1, B4. Financial Action Task Force on Money Laundering. "Basic Facts about Money Laundering," , 2001. Foust, Dean. "Still Tightening Those Belts/' Business Week, January 14, 2002, pp. 106-7.

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Gogoi, Pallavi; McNamee, Mike. '~Soaring Rates-And Revenues," Business Week~ January 14, 2002, p. 108. Gustitus, Linda; Bean, Elise; Roach, Robert. "Correspondent Banking: A Gateway for Money Laundering," U.S. Senate, Committee on Government Affairs, Permanent Subcommittee on Investigations, Democratic Staff, , 2001. Joseph, Lester M. "Money Laundering Enforcement: Following the Money," U.S. Department of Justice, , 2001. Labaton, Stephen. "House Committee Approves Measure to Aid Insurance Industry in Terrorist Attacks," The New York Times, November 8, 2001, p. B7. Lang, William W. "The Impact on the Financial and Banking Sector from the U.S. Perspective," Atlantic Economic Journal, 29, 4, 2001, pp. 360-3. McDowell, John; Novis, Gary. "The Consequences of Money Laundering and Financial Crimej' U.S. Department of State, Bureau of International Narcotics and Law Enforcement Affairs, , 2001. Sanger, David E.; Kahn, Joseph. "Banks One Notice," The New York Times, September 25, 2001, pp. A1, B4. Scannell, Kara; McGee, Suzanne. "Buyout Firms Pump Money Into the Insurance Sector," The Wall Street Journal, , December 20, 2001. Schroeder, Michael; Oster, Christopher. "Congress Fails to Approve New Terror-Insurance Bill," The Wall S~reet Journal, , December 21, 2001. Treaster, Joseph B. "Insurance Companies Favor a Plan to Limit Terrorism Losses," The New York Times, November 6, 2001, p. Bh. U.S. Department of State. "Bush Executive Order on Freezing Terrorist Assets," Washington File, September 24, 2001. U.S. Department of State. "Fact Sheet: White House oi1 Halting Financial Flows to Terrorists," Washington File, , November 7, 2001. U.S. Department of the Treasury. "Money Laundering: A Banker's Guide to Avoiding Problems", Office of the Comptroller of the Currency, , 2001. Wayne, Leslie. "Wall St. Faces Rules on Money Laundering," The New York Times, December 11, 2001, p. C2.