The BIS in Basel & Nazi Germany

In the middle of the Czech gold controversy, Thomas Harrington McKittrick was appointed president of the Bank, with Emil Meyer of the Swiss National Bank as chairman. White-haired, pink-cheeked, smooth and soft-spoken, McKittrick was a perfect front man for The Fraternity, an associate of the Morgans and an able member of the Wall Street establishment. Born in St. Louis, he went to Harvard, where he edited the Crimson, graduating as bachelor of arts in 1911. He worked his way up to become chairman of the British-American Chamber of Commerce, which numbered among its members several Nazi sympathizers. He was a director of Lee, Higginson and Co., and made substantial loans to Germany. He was fluent in German, French and Italian. Though he spent all of his career inland, he wrote learned papers on the life and habits of seabirds. His wife, Marjorie, and his four pretty daughters, one of whom was at Vassar and a liberal enemy of the BIS, were popular on both sides of the Atlantic.

Early in 1940, McKittrick traveled to Berlin and held a meeting at the Reichsbank with Kurt von Schröder of the BIS and the Gestapo. They discussed doing business with each other's countries if war between them should come.

Morgenthau grew more aggravated by McKittrick and the BIS as the war in Europe continued, but did not insist he be withdrawn. He was forced to reply upon Treasury Secret Service reports rather than upon Cochran for information on the BIS's doings. He learned that in June 1940, Belgian BIS director Alexandre Galopin had intercepted £228 million in gold sent by the Belgian government to the Bank of France and had shifted it to Dakar in North Africa and thence the Reichsbank and Emil Puhl.

The Bank of Belgium's exiled representatives in New York sued the Bank of France, represented by New York State Senator Frederic Coudert, to recover their gold. Ironically, they were represented by John Foster Dulles, whose law firm, Sullivan and Cromwell, had represented I.G. Farber. The Supreme Court ruled in favor of the Bank of Belgium, ordering the Bank of France to pay out from its holdings in the Federal Reserve Bank.

But when Hitler occupied all of France in November 1942, State Senator Coudert stepped in with the excuse that since Germany had absorbed the Bank of France, that bank no longer had any power of appeal against the verdict. He pretended that contact with France was no longer possible, while fully aware of the fact that he himself was still retained by the Bank of France. He claimed that only a Bank of France representative could allow the release of funds from the Federal Reserve Bank. As a result, the gold remained in Nazi hands.

On May 27, 1941, Secretary of State Cordell Hull, at Morgenthau's suggestion, telegraphed U.S. Ambassador John G. Winant in London asking for a report on the continuing relationship between the BIS and the British government. It infuriated Morgenthau that Britain remained a member of a Nazi-controlled financial institution: Montagu Norman and Sir Otto Niemeyer of the Bank of England were still firmly on the board. Winant had lunch with Niemeyer of the Bank He gave an approving report of the meeting on June 1.

Niemeyer had said that the BIS, "guaranteed immunity from constraint in time of war" , was still "legal and intact." He admitted that Britain retained an interest in the Bank through McKittrick twenty-one months after war had broken out. He said that he was in touch with the Bank through the British Treasury and that British Censorship examined all of the mail by his own wish. Asked about the issue of the Czechoslovakian gold, Niemeyer admitted, "Yes, it had a bad public press. However, that was due to the mishandling of the question in Parliament." He further admitted that the government of Great Britain was still a client of the Bank and had accepted a dividend from it. The dividend, it scarcely needs adding, came largely from Nazi sources. Niemeyer said that he believed the British should continue the association for the duration as well as lend the Bank their tacit approval, "If only for the reason that a useful role in post-war settlements might later have an effect."

Niemeyer went on, "It would be of no use at this time of raise difficult legal questions with respect to the relationship of the various countries overrun by the Germans.... McKittrick should stay in Switzerland because he is ... guardian of the Bank against any danger that might occur... McKittrick might want to get in touch with the American Minister in Switzerland and explain his problem to him."

On July 13, 1941, Ivar Rooth, governor of the Bank of Sweden, wrote to his friend Merle Cochran- who had returned to Washington- about the latest general meeting of the Bank and the luncheon at the Basle restaurant Les Trois Rois afterward. He said that it was agreed at lunch that McKittrick should soon travel to the United State to explain BIS's position to "your American friends ...[in the] very correct and neutral way." Rooth continued, "I hope that our friends abroad will understand the political necessity of committing the Germans to send a division to Finland by railway through Sweden."

On February 5, 1942, almost two months after Pearl Harbour, the Reichsbank and the German and Italian governments approved the orders that permitted Thomas H. McKittrick to remain in charge of the BIS until the end of the war. One document of authorisation included the significant statement, "McKittrick's opinions are safely known to us." McKittrick gratefully arranged a loan of several million Swiss gold francs to the Nazi government of Poland and the collaborative government of Hungary. Most of the board's members travelled freely across frontiers throughout the war for meetings in Paris, Berlin, Rome or (though this was denied) Basle. Hjalmar Schacht spent much of the war in Geneva and Basle pulling strings behind the scenes. However, Hitler correctly suspected him of intriguing for the overthrow of the present regime in favour of the Fraternity imprisoned him late in the war. From Pearl Harbour on, the BIS remained listed in Rand McNally's directory as Correspondent Bank for the Federal Reserve Bank in Washington.

In London, Labour Member of Parliament George Strauss kept hammering away at the BIS. In May 1942 he challenged Sir John Simon's successor, Chancellor of the Exchequer Sir Kingsley Wood, on the matter. Wood replied, "This country has various rights and interests in the BIS under our international trust agreements between the various governments. It would not be in our best interest to sever connections with the Bank."

George Strauss and other Labour members of Parliament insisted upon Knowing why the Bank's dividend was still being divided equally in wartime among the British, German, Japanese, and America banks. It was not until 1944 that they discovered Germany was receiving most of the dividends.

On September 7, 1942, Thomas H. McKittrick issued the Bank's first annual report after Pearl Harbor. He went through the bizarre procedure of addressing an empty room with the report to be able to say to Washington that none of the Axis directors was present. In fact, all of the Axis directors received the report soon afterward and the mixed executive staff of warring nations discussed it through the rest of the day. The report was purely Nazi in content. It assumed an immediate peace in Germany's favour and a distribution of American gold to stabilise the currencies of the United States and Europe. This was a line peddled by every German leader starting with Schacht. When Strauss told the House of Commons on October 12 that the report had delighted Hitler and Göring, Sir Kingsley asserted that he had not seen it. Strauss went on, "It is clear some form of collaboration between the Nazis and the Allies exists and that appeasement still lives in time of war."

In the summer of 1942, Pierre Pucheu, French Cabinet member and director of the privately owned Worms Bank in Nazi-occupied Paris, had a meeting at the BIS with Yves Bréart de Boisanger. Pucheu told Boisanger that plans were afoot for General Dwight D. Eisenhower to invade North Africa. He had obtained this information through a friend of Robert Murphy, U.S. State Department representative in Vichy. Boisanger contacted Kurt von Schröder. Immediately, Shröder and other German bankers, along with their French correspondents, transferred 9 billion gold francs via the BIS to Algiers. Anticipating German defeat, they were seeking a killing in dollar exchange. The collaborationists boosted their holdings from £350 to £525 million almost overnight. The deal was made with the collusion of Thomas H. McKittrick, Hermann Schmitz, Emil Puhl, and the Japanese directors of the BIS. Another collaborator in the scheme was one of the Vatican's espionage group who leaked the secret to others in the Hitler High Command- according to a statement made under oath by Otto Abetz to American a officials on June 21, 1946.

In the spring of 1943, McKittrick, ignoring the normal restrictions of war, undertook a remarkable journey. Despite the fact he was neither Italian nor diplomat and that Italy was at war with the United States, he was issued an Italian diplomatic visa to travel by train and auto to Rome. At the border he was met by Himmler's special police, who gave him safe conduct. McKittrick proceeded to Lisbon, whence he with immunity with immunity from U-boats by Swedish ship to the United States. In Manhattan in April he had meetings with Leon Fraser, his old friend and BIS predecessor, and with the heads of the Federal Reserve Bank. Then McKittrick travelled to Berlin on a U.S. passport to provide Emil Puhl of the Reichsbank with secret intelligence on financial problems and high-level attitudes in the United States.

On March 26, 1943, liberal Congressman Jerry Voorhis of California entered a resolution in the House of Representatives calling for an investigation of the BIS, including "the reasons why an American retains the position as president of this Bank being used to further the designs and purpose of Axis powers." Randolph Paul, Treasury counsel, sent up the resolution to the Henry Morgenthau on April 1, 1943, saying, "I think you will be interested in reading the attached copy of [it]." Morgenthau was interested, but he made one of his few mistakes and did nothing. The matter was not even considered by Congress.

Washington State Congressman John M. Coffee objected and introduced a similar resolution in January 1944. He shouted, angrily, "The Nazi government has 85 million Swiss gold francs on deposit in the BIS. The majority of the board is made up of Nazi officials. Yet American money is being deposited in the Bank."

Coffee pointed out that the American and British shareholders were receiving dividends from Nazi Germany and Japan and that the Germans and Japanese wre receiving dividends from America. The resolution was tabled.

There the matter might have lain had it not been for an energetic Norwegian economist of part-German origin named Wilhelm Keilhau. He was infuriated by Washington's continuing refusal to break with the Bank and its acceptance of a flagrant alliance with its country's enemies.

Keilhau introduced a resolution at the International Monetary Conference at Bretton Woods, New Hampshire, on July 10, 1944. He called for the BIS to be dissolved "at the earliest possible moment." However, pressure was brought to bear on him to withdraw a second resolution, and he was forced to yield. The second resolution called for an investigation into the books and records of the Bank during the war. Had such an investigation taken place, the Nazi-American connection would undoubtedly have been exposed.

Bankers Winthrop Aldrich an Edward E. (Ned) Brown of the American delegation and the Chase and First National banks tried feebly to veto Keilhau's resolution. They were supported by the Dutch delegation and by J.W. Beyen of Holland, the former president of BIS and negotiator of the Czech gold transference, despite the fact that Holland's looted gold had gone to the BIS. Leon Fraser of the First National Bank of New York stood with them. So, alas, did the British delegation, strongly supported by Anthony Eden and the Foreign Office. After initial support, the distinguished economist Lord Keynes was swayed into confirming the British official opposition calling for a postponement of the Bank's dissolution until post-war- when the establishment of an international monetary fund would be completed. Keynes's wife, the former Lydia Lopokova, the great star of the Diaghilev Ballet who had made her debut opposite Nijinsky, was a member of wealthy czarist family who influenced her husband toward delaying the BIS's dissolution and a tabling of all discussion of looted gold- according to Harry Dexter White.

Dean Acheson, representing the State Department in the American delegation, was firmly in Winthrop Aldrich's camp as a former Standard Oil lawyer, smoothly using delaying tactics as the master of compromise he was. The minutes of the meetings between Morgenthau, Edward E. Brown, Acheson, and other members of the delegation on July 18-19, 1944, at the Mount Washington Hotel at Bretton Woods show Acheson arguing for retention of the BIS until after the war. He used the spurious argument that if McKittrick resigned and the Bank was declared illegal by the United States government, all of the gold holdings in it owned by American shareholders would go direct to Berlin, via a Nazi president. Acheson must surely have known that the gold was already deposited for the Axis via the BIS partner, the Swiss National Bank, which shared the same chairman. Acheson also argued that the Bank would help restore Germany post-war. That at least was true.

Senator Charles W. Tobey of New Hampshire emerges with great credit from the minutes of the meetings at the Mound Washington. At the July 18 meeting he said, savagely, to the company in general, "What you're doing by your silence and inaction is aiding and abetting the enemy". Morgenthau agreed. Acheson, rattled, said that the BIS must go on as "a matter of foreign policy." At least there was a degree of honesty in that. Morgenthau felt that the BIS "should be disbanded because to disband it would be good propaganda for the United States".

There were jocular moments during the discussion on July 19. Dr. Mabel Newcomer of Vassar said that she "would not dissolve the Bank." Morgenthau asked her cheerfully whether McKittrick's daughter was one of her students. She replied in the affirmative. Morgenthau said, "She has informed my daughter that she is against the Bank". Dr. Newcormer replied, "She didn't inform me, except that she wanted her father to come home- so she might favour the dissolution!"

Everyone laughed. Morgenthau said, "She is very cute. She has read this article in PM about it, and she said [referring to an attack on the BIS in that liberal publication] ' I think PM is right and father is wrong'." Morgenthau threw back his head and laughed again. "That is what Vassar does to those girls!"

Under pressures form Senator Tobey and form Harry Dexter White, Morgenthau stated that Leon Fraser, McKittrick, and Beyen all had sympathies "that run ther." In other words, in the direction of Germany. He said,

I think in the eyes of the Germans, they would consider this as the king of thing which can go on, and it holds out to them a hope, particularly to people like Dr. Schacht and Dr. Funk, that the same [associations] will continue [between American and Germany] after the war. It strengthens the position of people like Mr. Leon Fraser and some very important people like Mr. Winthrop Aldrich, who have openly opposed this dissolution.

Dean Acheson, fighting hard with Edward E. Brown at his side, said he "would have to take the matter up with Cordell Hull." He was sure Hull would want the BIS retained the since Hull had approved its existence up till now. Morgenthau promised to call Hull, who had become acutely embarrassed by press criticism. After four years of tacitly approving the BIS, Hull told Morgenthau he called for its dissolution Morgenthau telephoned him and said, "What about McKittrick?" Hull replied icily, "Let him read about it in the papers!" Later, he repeated angrily to Acheson, "Let him read about it in the papers!"

Acheson went to see the British delegation on July 20. Closely connected to high-level politicians in England, he was well regarded in Whitehall. Lord Keynes felt that the BIS might be too quickly abolished if Acheson were beaten by the Morgenthau faction. Although Keynes was advanced in years and had a heart condition, he and his wife abruptly left a British summit meeting and, finding the elevator jammed with conferences, ran up three flights of stairs and knocked on the Morgenthaus' door. Elinor Morgenthau was astonished to see the normally imperturbable British economist trembling, red-faced, and sweating with rage.

Keynes repeated, as calmly as he could, that what he was upset about was that he felt that the BIS should be kept going until a new world bank and an international monetary fund were set up. Lady Keynes also urged Morgenthau to let the Bank go on. Finally, Keynes, seeing that Morgenthau was under pressure to dissolve the BIS, shifted his ground and took the position that Britain was in the forefront of those who wanted the BIS to go- but only in good time. Morgenthau insisted the BIS must go "as soon as possible." At midnight an exhausted Keynes said he would go along with the decision.

Keynes returned to his rooms and contacted his fellow delegates from the Foreign Office. The result of this late-night meeting was that he largely compromised his original agreement and at 2 A.M. sent a letter by hand to the Morgenthaus' suite again calling for the BIS to go on for the duration.

Next day, over the objections of Edward E. Brown and the great irritation of Dean Acheson, Morgenthau's delegation approved the disposal of the BIS.

Immediately after the liquidation of the BIS was voted, McKittrick did everything possible to combat it. He sent letters to Morgenthau and the Chancellor of the Exchequer, Sir John Anderson in London. He stated that when the war ended, huge sums would have to be paid to Germany by the Allies and the BIS would have to siphon these through. There was no mention of the millions owed by Germany to the Allies and the conquered nations. Harry Dexter White sent a memorandum to Morgenthau dated March 22, 1945, saying, "McKittrick's letters are part of an obvious effort to stake out a claim for the BIS in the postwar world. As such, they are, in effect, a challenge to Bretton Woods....The other signatories to the Bretton Woods Act should be advised of the BIS action, should be reminded of Bretton Woods' resolution Number Five, and should be advised that we are not answering the letters."

The same day, Treasury's indispensable Orvis A. Schimdt held a meeting with McKittrick in Basle. His comment on McKittrick's remarks was sharp: "I was surprised that a voluntary recital intended as a defense of the BIS could be such an indictment of that institution." When Schmidt asked McKittrick the Germans had been willing to allow the BIS to be run as it had and had continued to make payments to the BIS, McKittrick replied, "In order to understand, one must first understand the strength of the confidence and trust that the central bankers had had in each other and the strength of their determination to play the game squarely. Secondly, one must realise that in the complicated German financial setup, certain men who have their central bankers' point of view are in very strategic positions and can influence the conduct of the German Government with respect to these matters."

McKittrick went on to say that there was a little group of financiers who had felt from the beginning that Germany would lose the war; that after defeat they might emerge to shape Germany's destiny. That they would "maintain their contracts and trust with other important banking elements so that they would be in a stronger position in the postwar period to negotiate loans for reconstruction of Germany."

McKittrick declined to name all save one of the little group, taking particular care to hide the name of Kurt von Schröder. Since he had to name someone, he selected Emil Puhl. Nevertheless, he pretended that Puhl "does not share the Nazi point of view." Orvis Schmidt was not deceived by this. He knew perfectly well that it was Puhl who had authorized the looting of Allied gold and its transferral to Switzerland and who had been talking to McKittrick the day before in Basle about that very subject.

Schmidt closed in. He asked McKittrick whether he Knew what had happened to the Belgian gold deposited in the Bank of France McKittrick replied: "I know where it is. I will tell you. But it is extremely important world does not leak out. It is in the vaults of the Reichsbank." Evidently he realized he had said too much: that he had let slip his own role in the transaction. He added hastily: "I'm sure it will be in Berlin when you get there. Puhl is holding it for return to the Belgians after the war." This barefaced lie scarcely impressed Schmidt. The gold was already in Switzerland.

McKittrick did not end there. He admitted that the Germans had sent gold to the BIS and said, "When the war is over you'll find it all carefully segregated and documented. Anything that' s been looted can be identified. When gold was offered to us, I thought it would be better to take it and hold it rather than to refuse it and let the Germans Keep it for other uses."

McKittrick continued, "I'm so sorry I can't ask you to take a look at the books and records of the Bank. When you do see them at the end of the war, you will appreciate and approve of the role that I and the BIS have played during the war." They were, of course, never released.

Orvis Schmidt went on to see the executives of the Swiss National Bank, which maintained its partnership in the BIS and shared the same chairman, Ernst Weber. Schmidt raised the question of the looted gold: the $378 million in gold of Belgium, Czechoslovakia, Holland, and other occupied countries, including the treasure of the Jews. He knew that by a technicality the BIS no longer siphoned the gold through directly but sent it to its associated earmarked account at the Swiss National Bank.

The Swiss National Bank officials told Schmidt that in order to be sure they were not obtaining looted gold, they had requested a member of the Reichsbank, whom they "regarded to be trustworthy," to certify that each parcel of gold that they purchased had not been prised when the directors of the Swiss National Bank informed him that that personage was none other than Emil Puhl, who had just left ahead of his arrival . At the Nuremberg Trials in May 1946, Walther Funk, still listed as a BIS director, testified that Puhl had American connections and had been offered a major post at Chase in New York shortly before Pearl Harbor. Funk admitted that Puhl was in charge of gold shipments. He admitted receiving the gold reserve of the Czech National Bank and the Belgian gold, and he added, "It was very difficult to pay [in foreign exchange] in gold .... Only in Switzerland could we still do business through changing gold into foreign currency." Funk said that Puhl had informed him in 1942 that the Gestapo had deposited gold coins, and other gold, from the concentration camps, in the Reichsbank. Puhl had been in charge of this. Jewels, monocles, spectacle frames, watches, cigarette cases, and gold dentures had flowed into the Reichsbank, supplied by Puhl from Heinrich Himmler's resources. They were melted down into gold bars; he did not add how many bars were marked for shipment to Switzerland. Each gold bar weighed 20 kilograms. An affidavit was read to Funk, signed by Puhl, confirming the facts. Puhl stated that Funk had made arrangements with Himmler to receive the gold.

Funk unsuccessfully sought to disclaim responsibility for the scheme. He dismissed Puhl's charges that the gold was plowed into a revolving fund. Faced with a film showing as many as seventy-seven shipments of gold teeth, wedding rings, and other loot at one time, he stuck his story. At one stage he said that the loot was brought to the Reichsbank by mistake! His lies became so absurd that they were laughable. When prosecutor Thomas E. Dodd said to him, "There was blood on this gold, was there not, and you knew this since 1942?" Funk replied weakly, "I did not understand."

On May 15, 1946, Puhl took the witness stank. Puhl claimed that he had objected to the shipments as "inconvenient" and "uncomfortable"- a curious description. He admitted that his "objections" were subordinated to the broader consideration of assisting the SS, all the more-and this must be emphasized- because these things were for the account of the Reich."

The prosecuting counsel read items from a report that included the statement, "One of the first hints of the sources of [the gold] occurred when it was noticed that a packet of bills was stamped with a rubber stamp, 'Lublin.' This occurred some time early in 1943. Another hint came when some items bore the stamp, 'Auschwitz.' We all knew that these places were the sites of concentrations camps. It was in the tenth delivery, in November 1942, that dental gold appeared. The quantity of the dental gold became unusually great."

In October 1945 the Senate Committee on Military Affairs produced further evidence of Puhl's activities. His letters to Funk from Switzerland in March 1945 were read out. They showed his desperate and successful efforts to overcome the effects of the mission that month headed by Lauchlin Currie and Orvis Schmidt. Puhl had constantly hammered away at McKittrick and the Swiss National Bank in order to secure the flow of the looted gold of Europe. McKittrick, brutally exposed by the Bretton Woods Conference's Norwegian delegation, had- the letters showed- panicked, seeking to avoid direct receipt of the gold. Instead, the Swiss National Bank, as BIB shareholder, would take it into its vaults. But in order to camouflage the receipt of it, since the Swiss National Bank had promised the Americans they would not receive it, the Swiss National Bank had disguised it as payments to the American Red Cross and the German legations in Switzerland. There was a starkly ironical humour in this. General Robert C. Davis, head of the New York chapter of the American Red Cross, was also chairman of the part- Nazi network Transradio. As late as 1943, the German Legation in Berne was buying Standard Oil for its heating and automobiles, which were supplied and repaired by U.S subsidiaries. Tons of gold, thus laundered, poured into the Swiss National Bank in those last months of the war.

In 1948, under great pressure from Treasury, the Bank for International Settlements was compelled to hand over a mere £4 million in looted gold to the Allies.

Despite the fact that the evidence of the Puhl-McKittrick conspiracy was overwhelming, McKittrick was given an important post by the Rockefellers and Winthrop Aldrich: vice-president of the Chase National Bank, a position he occupied successfully for several years after the war. In 1950 he invited Emil Puhl to the United States as his honoured guest. And the Bank for International Settlements, despite the Bretton Woods Resolutions, was not dissolved.

Chapter 1 - A Bank for All Reasons
From: 'Trading With The Enemy, How the Allied multinationals supplied Nazi Germany throughout World War Two' - By Charles Higham - pub. Robert Hale, London - 1983 - ISBN 0 7090 10230

By Smithy (e-mail: smithy@mindspring.com)

from http://www.wizardsofmoney.org

Table of Contents

1. Introduction

The Basel Committee on Banking Supervision (BCBS) is a committee of bank supervisory authorities from the G10 (i.e. the wealthiest 10 nations). They meet regularly at the Bank for International Settlements in Switzerland and are in the process of putting together the international agreement known as the Basel Capital Accord (BCA). This sets bank supervision, risk-based capital and disclosure requirements for banks operating internationally. These concepts are described more fully in Sections 2 and 3. The new BCA will effect the activities of all large international banks, and will probably be adopted by more than 100 countries.

While such an Accord might seem rather obscure and irrelevant to the general public, this is perhaps more a feature of the general ignorance, secrecy and complexity surrounding the operations of the international banking and monetary systems than anything else. The purpose of this paper is to act as a discussion document to start gathering concerns from various NGOs working on monetary/finance system issues so that more comments representing public interest issues can be submitted to the BCBS for its next comment period in 2002.

This Accord is of particular interest because of:

• Increasing Power of International Creditors over Debtors. International banks affected by BCA create the bulk of the money we all use in day-to-day living, especially the US currency which is the backbone of the international monetary system. The power of international creditors, particularly those responsible for money creation in the US Dollar, over debtors is increasing. This, in combination with the collapse of the gold standard and the original Bretton Woods structure in 1971, as well as the trend for western corporations to seek financing outside the banking sector, has lead to increasingly reckless behavior of these bank creditors. This is especially true where they can exercise their "powers" to access "collateral" (real assets) crucial to less powerful debtors - e.g. through IMF Structural Adjustment Programs internationally, and through predatory lending and foreclosures domestically. Such activities are increasing income and wealth gaps globally. Good supervision of, and appropriate capital standards for, powerful creditors can help curtail this recklessness.
• Increasing Financial Consolidation: Both domestic and cross-border consolidation of financial services companies is continuing to escalate in the wake of global financial deregulation and the collapse of banks in various countries after financial crises. This is leading to the emergence of huge global "financial empires" domiciled in the same G10 countries that create the "hard currency", dominate institutions such as the IMF and set the rules for international banking. Also, the bigger a financial corporation becomes the more it becomes "too-big-to- fail". Big creditors at the heart of the international financial system are very likely to get bailed out no matter what they do, for their collapse could collapse the entire global financial system. This creates a tremendous "moral hazard" proportional to size and global reach. This further increases the powers of large western creditors over sovereign nations.
• Trends in Bank Supervision and Financial Convergence. The new BCA comes at a time of significant changes in the supervision of large banking operations. In the Western nations, over the past decade or so, we have seen insurance, banking and brokerage operations all merge together. One of the last countries to jump on this bandwagon was the United States with the Gramm-Leach-Bliley act of 1999. This made the Federal Reserve, the central bank of the United States, the new umbrella supervisor of financial conglomerates. The potential for conflicts of interest arising from the driver of monetary policy for the linchpin currency also regulating and supervising large financial players are enormous. Most other countries employ a fully separate government body for this regulatory role and one under democratic control. This strange move in the US could have significant worldwide impacts.
• Moral Hazard Created by the IMF. The larger international banks affected by BCA also seem to be the primary beneficiaries of the IMF bailouts associated with many recent financial crises. IMF bailouts are the insurance provided by the general public if the risk-management strategies of large creditors (including the holding of risk-based capital) fail. In one sense strong risk-based capital requirements can provide an antidote to the increasing "moral hazard" created by the IMF bailouts. Risk-based capital can be used to prevent crises by forcing international creditors to take more responsibility for the risks they assume and this will help prevent the need for severe "cures". It forms a "capital charge" on banking institutions, similar in effect to what the Tobin Tax would do to international speculators in general. A charge on the banking sector is most crucial because they are the most likely to get bailouts.
• Increasing Complexity of Financial Instruments. Convergence of financial players, increasing consolidation of wealth in fewer hands, hedging strategies and innovative regulatory avoidance have created whole new worlds of complex financial instruments. The regulators themselves are admitting that this makes it increasingly difficult to really understand what is going on at these financial conglomerates and, in fact, to regulate them. As we shall see, this is reflected extensively throughout the new BCA with the development that "sophisticated" banking operations will be able to set their own capital requirements to a very large extent. This may be the first step toward "self-supervision" of banks, which is especially dangerous as "too-big-to-fail" risks and dependence on IMF "cures" increase.
• Domestic Predatory Lending and Credit Access for Low/Middle Income: Within the US, in the sub-prime market, banks have been incented to assess good credit risks (that should get a prime rate) as sub-prime because they could charge a higher interest rate without having to hold higher capital. Presently in the US extensive problems have emerged with respect to bank's activities in low and middle-income groups. Bank capital requirements should address such exploitation of the poor, and supervision requirements in general should address the whole issue of credit access on reasonable terms for low/middle income groups. These issues are not presently addressed at all in the existing BCA.

In the following sections I wish to unravel some of the main features of the Basel Capital Accord and highlight what I perceive as some of the issues that the general public should be concerned about. In doing so I will attempt to relate the significance of BCA to these above-mentioned issues of global finance sector deregulation, mergers and acquisitions, IMF bailouts, low income credit access, bank supervision trends, and the general imbalance in creditor/debtor relations.

However it should be noted that I am making these observations and drawing conclusions based on public information analyzed using skills acquired in my own training as an actuary who has been primarily concerned with the insurance industry throughout my career. In looking at the banking sector extensive information about exactly what is going on underneath is not easy to find in the public domain.

Based on public information it is not easy to fully understand a bank's risk exposures and it has been widely acknowledged by many bank industry watchers that this is a key part of the success of the monetary system. For the monetary system is no more than a confidence game and this requires confidence in the banks at all times, especially those responsible for the creation of the linchpin currency - the US Dollar.

This necessary "secrecy" surrounding the monetary system in order to keep confidence in the ($US driven) financial system probably has a lot to do with the secrecy that surrounds institutions like the IMF. Public information from the IMF does not reveal how bailout sums are determined or what creditors are at the other end of the bailout packages. Nor do public bank financial statements reveal such details. It is highly likely that the main beneficiaries of IMF bailouts are large western creditors with banking licenses (and therefore those "regulated" under BCA standards) since these institutions sit closest to the heart of the international monetary system. Any large hit to their balance sheet is most likely to threaten global financial stability.

In no way do the opinions expressed herein reflect the views of my employer nor the views of the professional actuarial societies of which I am a member. In fact the International Actuarial Society, representing these organizations, has submitted public comments on BCA that do not overlap at all with the concerns expressed herein. Nevertheless I consider it the duty of any professional to consider the broader public implications of the goings on in their profession. My profession is built around the practice of financial risk management and it is my opinion that the financial and other risks to the broader public of the global financial order are unacceptable, so this is why I write this paper. I do not consider this exercise to be inconsistent with my duty as an actuary to sound alarm bells when risks are getting out of hand.
 

2. Background to Development of Basel Capital Accord (BCA)

The first BCA came into existence in 1988. More information about the original Accord can be found at the web site of the Bank for International Settlements (BIS) at www.bis.org. The BIS is an international bank for central bankers, whose dominant members are the central banks (NOT governments) of the G-10 + Switzerland. More recently other countries' central banks have been able to join the BIS but it is dominated by the G-10. I cannot be certain of all the things the BIS does but I think it is important to note that this is the main place for the meeting of minds of the world's most powerful central bankers. These meetings are conducted in private, as are the Federal Reserve's Open Market Committee and Federal Advisory Council meetings. No doubt, very key decisions about the international monetary system - the same monetary system we all depend on - are made behind these closed doors.

The BCA of 1988, according to the BIS web site, came out of the need to set consistent capital standards for international banks so that one country's banking sector would not have regulatory advantages over another. A "behind-the-scenes look" would reveal that in the late 1980s the US and other bank regulators saw the need to introduce better risk-based capital requirements in the wake of the emerging Savings and Loans Debacle and the Latin American Debt Crisis. In both crises the banks were holding capital way short of what the risk of default of their loans implied and this ultimately led to the need for bailouts (from US public and Latin American public).

The BIS web site also states that the new BCA is coming out of a need to get away from "one size fits all" requirements, and the need to better incorporate operational and market risks (to be discussed in Section 3) into capital requirements. They also state that "sophisticated" banks should be allowed to use their own internal risk management techniques to set their own capital levels. A behind-the-scenes look reveals that the financial crises of the 1990's and subsequent IMF bailouts scared the heck out of those at the helm of the financial system. They found that the old BCA did not have a sufficient capital charge for very risky cross-border loans over that for safer ones. Hence many creditors were incented to engage in very risky cross-border financing which played a large role, not only in triggering the crisis, but also in all the trouble the western creditors found themselves in once the crisis emerged.

The meetings of the Basel Committee on Banking Supervision (BCBS), responsible for the BCA, are hosted by the BIS and are also conducted behind closed doors. Public input into draft BCA documents has been welcomed, however, and this opportunity has certainly been utilized by the global finance sector. So far the major groups of NGOs opposed to the Bretton Woods institutions and the global financial order have not provided input and I am certain the BCBS is not expecting them to. Therefore it would be very nice to give them the big surprise of public input from the members of the public who are not large, powerful financial players. This makes sense especially because this public is called upon to bailout banks whose capital can't cover their risks.

The latest "public" comment period ended on May 31st 2001. Due to the extensive complaints received from the banking sector (who, of course, wish to hold less capital and be less supervised) the BCBS is saying that they will have another round of comments for another (more bank friendly, no doubt) revised draft in 2002. It is important to note that the BCBS is currently chaired by William McDonough, the current President of the Federal Reserve Bank of New York, and who therefore sits on the Federal Open Markets Committee - THE committee that determines monetary policy for the world's linchpin currency.

As noted, the BCBS is composed of central bankers from the G-10. This is a critical observation for several reasons. First, bank supervision standards are being set only by the wealthy countries that create all the "hard currency". Second, bank supervision standards are being set by those responsible for monetary policy, not by separate national government bodies responsible for bank supervision. The domination by central bankers in this process means that most of the input will come directly out of the banking sector, rather than the general public or their elected representatives.

In a better world a large part of the role of bank supervision would be to protect some balance of power between creditors and debtors. Instead the large international banks seem to be moving into a world where they are gaining more ability to "supervise themselves" and this will become more evident as we study BCA. The structure of the BCBS and its role in producing the BCA is consistent with this observation.

In a much better world the actual process of money origination would be democratic, which it is far from today. The reality is that we are stuck with the international monetary system based on the US dollar because that is what people all over the world have placed their confidence and trust in. This is unlikely to change in any hurry, though baby steps are being taken with the emergence of local currencies. In the meantime it makes sense to focus attention on the supervision of those with credit creation powers in the dominant "trusted monetary system", regardless of how unsavory this system and its major players have become.

It is important to note that BCA covers ONLY international banking institutions. It does not cover non-bank financial institutions (NBFI). In one sense it is quite reasonable that banks should have tougher capital requirements and supervision standards on them for the following reasons:

• They have the special privilege of being able to "create money out of thin air", and must use that privilege responsibly else the safety of the whole financial system is put at risk.
• They have various guarantees or bailout mechanisms backing them up such as FDIC funds and, of course, the IMF bailouts that nobody wants to give us too much information on.

However the emergence of the NBFIs poses a problem and this is giving the banks a lot of leverage in arguing against tough capital requirements. Basically NBFIs have emerged as a result of huge accumulation of financial capital into few hands and the development of new instruments such as loan-backed securities. This means that large NBFIs without a banking license (who do not create M3 money) can compete with bank financiers, so they may have an advantage if banks have to comply with tougher capital and supervision requirements.

Hence many banks are approaching the BCBS with the complaint that the BCA unfairly penalizes them for being a bank. Rather than ignoring these arguments on the basis that the banking sector has privileged access to various bailout mechanisms that NBFIs don’t, I fear that the BCBS may cave in to such arguments. Hence it is important for the concerned public to remind the BCBS of these things and this makes it even more important to get access to the list of creditors benefiting from the IMF bailouts.

If NBFIs are also benefiting from these bailouts then maybe the solution is that NBFIs also need something similar to the BCA. In any case that would be recommended from the point of view of prevention of crises for tougher capital requirements help curtail speculative activity.

3. (Very Brief) Overview of BCA Standards (see www.bis.org/ )

The BCA contains what are known as the three pillars of bank supervision. These are:

• Pillar 1: Risk-Based Capital Requirements
• Pillar 2: Supervisory Review Process
• Pillar 3: Market Discipline = Reporting and Disclosure Requirements

Each of these are now discussed in turn:

1. Pillar 1: Risk-Based Capital Requirements

Capital is the excess of a bank's assets (mostly loans to the non-bank public, including security holdings) over its liabilities (primarily deposits of the non-bank public).

Risk-based capital requirements demand that a bank's capital (or equity) be at least as large as something specified as minimum capital.

Minimum capital requirements act like a safety net and are set based on the riskiness of a bank's assets. If a bank makes lots of risky loans or holds risky securities, then it must hold more capital -more of a safety net - than a bank that takes less risks. Thus capital requirements act like sort of a charge on risky speculations. This helps to curtail risky speculation (which can often serve to destabilize markets) and provides institutions with a capital buffer big enough to absorb the higher expected losses on the asset. In turn this helps reduce the need for publicly funded bailouts of the banking industry such as what happened with the S&L Debacle and what seems to happen with IMF bailouts.

Advocates of the so-called Tobin Tax should be rather fond of well-crafted capital requirements for banks and also other non-bank speculators. Therefore it would be appropriate for such advocates to have some input into BCA.

To see how banks view capital requirements and to see why they like this charge to be as low as possible (especially since handy public bailouts are often available anyway) it is useful to look at an example.

Example of the "Cost of Capital" Charge:

- Suppose shareholders have 10 units of equity capital to invest in a bank.

- Let's suppose the bank's assets will earn 5% and its liabilities will costs 3%.

- If capital requirements are at 10% assets, then the bank can create a total of 100 units in assets by lending with 90 in liabilities and 10 in capital. Then shareholders Return on Equity (ROE) is:

(100 * 5% - 90 * 3%) / 10 = 23%

- If capital requirements are at 5% assets, then the bank can create a total of 200 units in assets by lending with 190 in liabilities and 10 in capital. Then shareholders Return on Equity (ROE) is:

(200 * 5% - 190 * 3%) / 10 = 43%

Banks refer to the "cost of capital" as the earnings that are given up by holding capital earning whatever the assets are invested in (usually a low risk bond rate) versus the required shareholder return rate, which for banks is normally around 20% after tax. In the case of the example above we might like to calculate the cost of capital of the extra 5 units of capital that had to be held as capital in the 10% requirement, but got to be released and invested in banking business (making loans) for another 100 in loans in the 5% requirement.

The costs of capital of these 5 units is:

Earnings on 5 units in 5% Capital Requirement - Earnings on 5 Units in 10% Capital Requirement

= (100 * 5% - 95 *3%) - 5% * 5 = 1.9

This equates to an ROE cost of 1.9/5 = 38% = 43% - 5%.

So you can see why banks like lower capital requirements on the same set of assets and why good risk-based capital requirements help deter certain risky or speculative activities.

Minimum capital is defined in BCA as:

8% * Risk Weighted Asset Base

The risk weighted asset base brings assets into capital requirements commensurate with the risks associated with them. These risks are:

• Credit Risk = Default risk.
• Market Risk = Risk of loss on market positions in the "Trading Book" (defined later).
• (Note that Interest Rate Risk is NOT explicitly addressed here but rather is addressed under Pillar 2).
• Operational Risk = other risks such as computer failure, mistiming trades, fraud.

In what follows I will focus primarily on Credit Risk requirements because this is the primary risk for banks and is the main culprit in financial crises. Explanation of how this risk is being treated under the new BCA will serve to illustrate the direction things are headed in and will sound most of the necessary alarm bells.