Statement to the Congress

Federal Reserve Bulletin, Jan, 2000

Statement by Richard A. Small, Assistant Director, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System, before the Permanent Subcommittee on Investigations of the Committee on Governmental Affairs, U.S. Senate, November 10, 1999

I am pleased to appear before the Permanent Subcommittee on Investigations to discuss the Federal Reserve's role in the government's efforts to detect and deter money laundering and other financial crimes, particularly as these issues relate to the private banking operations of financial institutions.

You have asked the Federal Reserve to address several matters, including the Federal Reserve's review of private banking activities; the extent to which private banking is vulnerable to money laundering and what private banking activities raise concerns in this regard; the Federal Reserve's experience in obtaining information from U.S. banks that conduct private banking activities outside the United States; and any recommendations or comments the Federal Reserve may have with regard to the strengthening of anti-money-laundering controls for private banking or on pending legislation. You have also asked us to comment on the operations of a specific banking organization. I will address each of these matters; however, I am not at liberty to discuss the activities of any one organization because of the confidentiality of examination findings that must be maintained.

In order to better understand the money laundering issues related to private banking, it would be very useful to first provide you with some background information on what we consider to be private banking and the way in which private banks operate. But first, let me start by stating that, as a bank supervisor, of primary interest to the Federal Reserve is the need to ensure that banking organizations operate in a safe and sound manner and have proper internal control and audit infrastructures to support effective compliance with necessary laws and regulations. A key component of internal controls and procedures is effective anti-money-laundering procedures. Moreover, as part of our examination process, we review the anti-money-laundering policies and procedures adopted by financial institutions to ensure their continued adequacy.

The Federal Reserve places a high priority on participating in the government's efforts designed to attack the laundering of proceeds of illegal activities through our nations's financial institutions. Over the past several years, the Federal Reserve has been actively engaged in these efforts by, among other things, redesigning the Bank Secrecy Act examination process, developing anti-money-laundering guidance, regularly examining the institutions we supervise for compliance with the Bank Secrecy Act and relevant regulations, conducting money laundering investigations, providing expertise to the U.S. law enforcement community for investigation and training initiatives, and providing training to various foreign central banks and government agencies.

OVERVIEW OF PRIVATE BANKING

Private banking offers the personal and discrete delivery of a wide variety of financial services and products to the affluent market, primarily high net worth individuals and their corporate interests who generally, on average, have minimum investable assets of $1 million. Customers most often seek out the services of a private bank for issues related to privacy, such as security concerns related to public prominence or family considerations or, in some instances, tax considerations. The private banking relationship is usually managed by a "relationship manager," who is responsible for providing a high degree of personalized service to the customer and for developing and maintaining a strong, long-term banking relationship with that customer.

Private banking accounts can typically be opened in the name of an individual, a commercial business, a law firm, an investment adviser, a trust, a personal investment company, or an offshore mutual fund. A private banking operation usually offers its customers an all-inclusive money management relationship that could include investment portfolio management, financial planning advice, custodial services, funds transfer, lending services, overdraft privileges, hold mail, letter-of-credit financing, and bill paying services. These services, some of which I will describe in some further detail in my testimony, may be performed through a specific department of a commercial bank, an Edge corporation, a nonbank subsidiary, or a branch or agency of a foreign banking organization or in multiple areas of the institution, or such services may be the sole business of an institution.

Private banking services almost always involve a high level of confidentiality regarding customer account information. Consequently, it is not unusual for private bankers to assist their customers in achieving their financial planning, estate planning, and confidentiality goals through offshore vehicles such as personal investment corporations, trusts, or more exotic arrangements, such as mutual funds. Through a financial organization's global network of affiliated entities, private banks often form the offshore vehicles for their customers. These shell companies, which are incorporated in such offshore jurisdictions as the Bahamas, the British Virgin Islands, the Cayman Islands, the Netherlands Antilles, and countries in the South Pacific, such as the Cook Islands, Fiji, Nauru, and Vanuatu, are formed to hold the customer's assets, as well as offer confidentiality because the company, rather than the beneficial owner of the assets, becomes the account holder at the private bank.