Document Type

Article

Disciplines

International Law

Abstract

When representatives of the United States, Canada, and Mexico signed the North American Free Trade Agreement' (NAFTA) in 1992, they created the largest free trade zone in the world.2 On items ranging from automobile parts to water, from saw logs to beer, the negotiators crafted a workable document that represented compromises by all parties, but which was nevertheless minimally acceptable to all. As might be expected, on the specific issue of trade in financial services the NAFTA fashioned an acceptable, but incomplete compromise.

The promise of increased cross-border trade brings with it the need for cross-border financial services. In 1988, the United States-Canada Free Trade Agreement took the historic step of addressing trade in financial services in addition to trade in merchandise, and the NAFTA followed suit. 3 The willingness of the North American negotiators to address issues of trade in services marked a significant departure from typical trade negotiations where the focus is on the trade of goods rather than the trade of services.

Drafting trade agreements that cover services is always difficult because of issues such as defining what constitutes a service, figuring out where it is performed, and finding equitable treatment for labor-intensive as opposed to capital-intensive services. 5 The challenge of drafting an acceptable document covering trade in financial services in North America was made even more daunting by the very different banking markets in the three signatory countries. 6 The United States and Canada have solid, wellestablished banks and stable currencies, while Mexico's modem banking industry is still in its infancy and the peso is somewhat volatile. Canada and Mexico both have relatively concentrated banking markets in which banking organizations are free to offer a broad range of financial services, while the United States banking industry shares neither of those attributes.

Despite these serious obstacles, the NAFTA negotiators were able to agree on a framework for trade in financial services in the North American free trade zone. Although the NAFTA potentially covers all providers of financial services, this article focuses specifically on the banking industry. The NAFTA gives banks from each of the member nations access to the banking markets of the other member nations. At present, U.S. access to the Mexican and Canadian markets can be accomplished only through the establishment of a new subsidiary. Of course, Mexican and Canadian banks may also expand into the United States by establishing a de novo bank or by acquiring an existing institution. In addition to these methods, however, Mexican and Canadian banks are permitted to branch into the United States, although like all foreign banks they are subject to an extensive system of U.S. regulation as part of the price of expansion through branching. In practice, the foreign branching regulations are so onerous that it often makes more sense for foreign banks to establish a subsidiary rather than a branch. 8 A question left open by the NAFTA, therefore, is whether the banks of the member nations should be permitted to expand across national borders through a true branch as opposed to a subsidiary network or the currently burdensome U.S. branching regulations.

This article examines the issue of cross-border branching. It starts with a brief overview of the banking markets and regulatory approaches in the three countries, then it turns to a discussion of how the NAFTA changed the regulatory landscape. It proceeds to examine the branching question in light of the theoretical considerations of enterprise liability, the moral hazard problem, and public choice. It concludes that in a perfect world, a scheme of cross-border branching would be the preferred approach to bank expansion in North America. However, in the real world the banking regulators of the member countries will be reluctant to give up any authority and the financial services providers in the member countries will do what they can to preserve the non-tariff barriers to trade that already exist, one of which is the restriction on branching. As a result, nothing will change on the NAFTA branching issue until other concessions, perhaps involving securities or insurance, tip the balance.

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