The Bank of Credit and Commerce International (BCCI) was founded by Aga Hassan Abedi in 1972. Its funds were from the investors of Abu Dhabi. The Bank of America was also an investor with a twenty-five percent share in the bank. BCCI was incorporated through a holding company, BCCI Holdings (Luxembourg) S.A., in Luxembourg. The bank also had offices in London and Abu Dhabi. "From a modest start with only three offices in 1972, BCCI grew within five years to 150 offices in thirty-two countries. Bank of America, which had increased its holdings in BCCI to forty-five percent in 1977, was suspicious of BCCI's exceedingly positive results and audited BCCI's European operations for October and November 1977. The report indicated that BCCI's operations were not in conformity with general banking practices: reserves for bad loans were inadequate, and substantial loans were being made to "insiders." Soon after the report was completed, Bank of America began selling its BCCI shares. This may have been an early indication that BCCI was not as profitable as it appeared to be.
By 1977, BCCI was well established in many countries, but not in the United States. BCCI management considered ownership of an American bank to be the key to international success. In 1978, BCCI attempted a hostile takeover of Financial General Bankshares in Washington, D.C., but the bid was unsuccessful because the Securities and Exchange Commission (SEC) refused to approve the purchase. The SEC requires foreign banks to disclose details about their operations if they plan to own more than five percent of the outstanding shares in an American holding company. BCCI tried to avoid these disclosures by working with several parties to buy the stock. In 1982, BCCI succeeded in gaining control of Financial General, which had been renamed First American Bankshares. BCCI accomplished its goal by loaning the funds to a group of Middle Eastern investors, who then purchased the holding company's stock. Although the Federal Reserve suspected that the investors were really a front for BCCI, First American Chairman and former Secretary of Defense Clark Clifford, assured the agency that BCCI was not involved with the bank. Six years later, in 1988, while federal agents were conducting an investigation of money laundering in Florida, a BCCI official told the agents that BCCI actually owned First American. Through First American, BCCI was able to acquire the National Bank of Georgia and Independence Bank of Encino, California. BCCI was indicted by a federal grand jury for laundering illegal drug money in 1988 and fined $14 million after pleading guilty to the charges in 1990.
Since its inception, BCCI had been viewed with suspicion by the world financial community. Therefore, BCCI's victims were primarily small businesses and individuals rather than the financially sophisticated, who were aware of BCCI's shady reputation. BCCI was, among other things, suspected of being involved in the operation of a "black squad" of criminals who engaged in smuggling, bribery, kidnapping and murder to further the goals of the bank.
No one had any proof of BCCI's illegal activities until the indictment for money laundering in 1988. In 1991, three years after the BCCI official informed investigators of BCCI's ownership of First American, the Department of Justice began investigating the claim that the Middle Eastern investors were merely a front in BCCI's scheme to acquire First American. They discovered that BCCI had acquired control of First American by providing the Middle Eastern investors with the funds to bid on the bank. The Middle Eastern investors subsequently defaulted on the loan and relinquished the stock to BCCI. Regulators ordered BCCI to divest itself of its shares in First American and a California bank.
In 1988, after BCCI was indicted in the United States for money laundering, regulators from Britain, Luxembourg, the Cayman Islands, and France formed a "college of regulators" to coordinate better the supervision of BCCI's multinational operations. However, the college failed to produce results because the regulators were unable to work together effectively.
The Bank of England, the regulatory authority for banks in Great Britain, received an indication of fraud at BCCI after Price Waterhouse, BCCI's auditor, discovered irregularities in the bank's accounting methods. In March 1991, the Bank of England authorized Price Waterhouse to conduct an investigation of BCCI's operations. In June 1991, Price Waterhouse uncovered the evidence of massive fraud that led to BCCI's downfall.
The auditor discovered that BCCI made itself appear profitable by hiding losses. Losses of approximately $849 million from financial market trading were hidden by registering the trades under clients' names instead of in the bank's account. Loans were made to poor credit risks and the resulting losses were hidden by creating fictitious loans to cover these losses. Losses also were hidden by transferring the loans to offshore accounts. These transfers made it more difficult for regulators to assess the true value of BCCI's assets. Offshore financial centers are characterized by lenient regulations and strict secrecy laws. Therefore, even in the unlikely event that these transactions were uncovered, the secrecy laws would have protected BCCI from disclosure. As a result, BCCI appeared to be more profitable than it actually was. BCCI also enhanced its seeming rate of return by not recording approximately $600 million in deposits. It appears that BCCI may have never made a profit in its entire existence.
Acting on the information provided by Price Waterhouse, the seven members of the college of regulators seized BCCI's assets in their respective countries on July 5, 1991. This led to the seizure of assets in the sixty-two other countries where BCCI had offices.
The extent of the loss due to BCCI's actions is still being determined. However, up to $15 billion could have been lost. Most of this loss will be absorbed by depositors and investors in Asia, Africa, and Latin America, where BCCI had most of its branches. The governments in some of these countries may also face the loss of reserves deposited in the bank. For example, Cameroon could have had one-third of all its foreign exchange reserves deposited with BCCI.
Overall, depositors are expected to recover between thirty percent and forty percent of their deposits. The amount of funds recovered will depend on the regulatory policy of each nation. Many governments have a deposit insurance system in place to compensate depositors upon a bank failure. However, the extent of coverage and the conditions for payment of funds varies. For example, the British government will compensate depositors for seventy-five percent of their deposit, with a maximum payback of [pounds] 10,000. On the other hand, Italian depositors will recover 100% of their deposits, up to approximately $50, 000. British regulators are trying to obtain funds from the Abu Dhabi government to further compensate depositors. Depositors are protected only to the extent of their national insurance system, and the thirty percent to forty percent estimate is not indicative of what depositors in some countries will receive.
The amount of American assets at risk is $500 million which is relatively small compared to other countries. Generally, foreign banks operating in the United States may choose to open either a branch or subsidiary of the parent bank. Branches of foreign banks can avoid Federal Deposit Insurance Corporation (FDIC) mandatory insurance assessments and other federal requirements by accepting only commercial deposits in excess of $100,000. Since many commercial depositors knew enough not to use the bank, the losses in the United States were smaller than in other countries. The deposits of private citizens placed in First American and the Independence Bank of Encino were protected because these banks were operating under a separate charter and were federally insured. These banks are still in operation and the customers' deposits are not part of the BCCI losses.
In both the United States and the United Kingdom, the political repercussions of the BCCI scandal may be as important as the financial repercussions. Questions have been raised in the United States about the method by which BCCI obtained covert control of First American Bankshares in 1982 despite the Federal Reserve's suspicion that the Middle Eastern group of investors was a front for BCCI. The Federal Reserve is in the process of conducting an investigation into the circumstances surrounding that purchase. One explanation offered is that Clark Clifford may have lied to federal regulators about BCCI's role in First American. Another explanation offered is that BCCI gained control of the bank by bribing government officials. Some commentators believe that the Department of Justice will never find the answers to these questions because of the high level of corruption involved and BCCI's link to sensitive Central Intelligence Agency activities.
The British Government has been criticized for being too slow to act. The Bank of England did not order the investigation of BCCI until 1991, despite indications of mismanagement as early as 1990. In April 1990, BCCI's auditor informed the Bank of England that BCCI's accounting practices were deceptive, and the Bank of England ordered BCCI to remove several top managers. However, no investigation was conducted at that time to determine the extent of BCCI's deceptive practice. The Bank of England has the power to revoke a bank's license on the mere suspicion of mismanagement. The bank of England has been criticized for inaction; given BCCI's poor reputation and rumors of fraud, the British regulators could have closed the bank before March 1991. The Bank of England has responded by stating that it was waiting for actual proof of mismanagement before taking action.
The failure of BCCI is a dramatic reminder of the importance of multinational banks in a global economy. BCCI's illegal activities and subsequent failure affected interests around the world. Although there are many issues raised by BCCI's failure, this focuses on the deficiencies of multinational bank regulations which enabled BCCI to deceive regulators into believing that its operations were profitable. The home country regulator refers to the national authority responsible for monitoring the foreign parent bank's operations.
Amidst allegations of fraud, the Bank of England belatedly closed down the Bank of Credit & Commerce International (BCCI) in July 1991. It was the biggest banking fraud of the twentieth century. The losses are estimated to be more than $10 billion. Rather than directly employing a force of government auditors to regulate banks, the Bank of England had regulated BCCI by relying upon audits conducted by 'global' accountancy firms who owed a 'duty of care' neither to the Bank of England nor to any bank depositor.
At the time of its closure, BCCI operated from 73 countries and had some 1.4 million depositors. The extent of losses and the folly of relying upon commercial accountancy firms for 'public interest' work should have led to an immediate independent inquiry into the quality, role, efficiency and effectiveness of the BCCI audits. It did not. Successive governments have failed to order any such inquiry. After the closure of BCCI, the government ordered an independent inquiry into the role of the Bank of England by Lord Justice Bingham. The same inquiry considered any scrutiny of BCCI audits to be beyond its terms of reference. Before the closure of BCCI, the Bank of England commissioned a report (Sandstorm Report) into the massive frauds at BCCI. The report had the potential to enable innocent BCCI depositors to secure some redress from regulators and auditors. Yet successive UK governments have suppressed this report even though most of it is freely available in USA. A US Senate inquiry into BCCI noted that there was a deep relationship between BCCI management and auditors who also acted as advisers and consultants to BCCI management. Yet the UK regulators have failed to mount any investigation into this relationship.
Instead of mounting an open and independent inquiry into the real/alleged audit failures at BCCI, successive governments have continued to indulge the auditing industry. They have passed the buck to accountancy trade associations expecting them to mount an investigation. The accountancy trade associations have no independence from the auditing industry and have a history of sweeping things under their dust-laden carpets. They are financed and controlled by the auditing industry and are in no position to call multinational firms to account. The organized cover-up may appease the auditing industry. Its cost is borne by savers, investors, employees and other stakeholders who lost their savings, homes, investments and jobs.
UK capital markets were concerned about the supervision of BCCI and the adequacy of the regulatory system to prevent the collapse of the bank. This interpretation is in line with the Bingham Report commissioned in the UK after BCCI's failure. This report raised several issues in relation to the supervision of BCCI in the UK and offered a number of detailed suggestions to strengthen it, such as: including the need for greater cooperation greater sharing of information strengthening of internal communications more efficient supervision of internationally spread banking groups like BCCI.
The BCCI case arose out of the spectacular collapse of the Bank of Credit and Commerce International in 1991. Its collapse, as is well-known, resulted in it owing massive sums to its creditors, including its depositors. On 24 May 1993 6019 depositors began proceedings arising out of the collapse against the Bank of England. Damages were initially sought for approximately half a billion pounds, plus interest. The basis of the action was the allegation that the depositors' losses arose out of the Bank of England's failure properly to supervise and regulate BCCI by first granting it a license in 1979 and by then not later revoking it. The case was that the Bank ought to have closed it down every day from 1979 until 1991 when it took action which effectively closed it down. The claim was not, as might have been expected, based on negligence, but on an old and rarely used action, that for misfeasance in public office. That was because the courts had previously held that a banking supervisor did not owe a duty of care to depositors or creditors and because the relevant Banking Act provided that the Bank of England would not be liable other than in a case of bad faith.
Stronger supervision of multinational banks will not prevent fraud from occurring or a bank from failing. However, stronger supervision can lead to earlier detection of problems which would serve to reduce the loss to depositors. Supervision would be improved by denying market entry to multinational banks with inadequate home country supervision. Uniform guidelines for the detection of fraudulent activities are also needed.
Multinational banks should be allowed market entry only if there is adequate home country supervision. Currently there is no incentive for the home countries to supervise the banks incorporated in their jurisdictions. Stronger supervision may result in fewer banks choosing to incorporate in these countries; therefore, it is beneficial from their perspective to not supervise the bank. Host countries can provide the incentive for stronger supervision by denying market access to banks incorporated in countries where supervision is lax. Host countries must also weigh the costs and benefits of denying market entry. Denial may mean that unless the bank locates its operations elsewhere, the host country may lose investment capital, taxes, and employment opportunities for its citizens. However, these costs must be weighed against the potential loss to depositors if the banks fail. In addition, the failure of a bank reduces the public's confidence in banks and in the economy. The result is a crisis of confidence that may lead to further bank insolvencies. Given the importance of banks to the country's economy, it is in the best interest of the host country to deny market access to poorly supervised multinational banks.
In cases where the home country does not have the resources or skills to supervise the bank's operations, the home country should be responsible for coordinating supervision with host countries where the bank has a significant presence. Coordinated supervision of BCCI was attempted with the establishment of the college of regulators and met with limited success. The group's efforts were inhibited by a number of factors. When coordinated supervision began in 1988, BCCI's illegal activities had already achieved global proportions. Also, the college of regulators was an informal group functioning without leadership or direction. These flaws can be corrected by coordinating supervision earlier and by having the home regulator assume the leadership role in the group.
The BCCI scandal calls attention to the fact that multinational banks link economies in countries where they maintain a presence. The activities of these banks in one country impact other countries. Therefore, it is critical that multinational banks are supervised and that depositors are protected. BCCI's impact was limited primarily by the fact that it had such a poor reputation. The sobering possibility exists that unless adequate supervision is implemented another scandal of greater magnitude may occur.
