Bank Loan Denial for Nuclear Proliferation under Section 102(b) of the Arms Export Control Act as Applicable to India and Pakistan

98-537 A

Updated December 16, 1998

CRS Report for Congress

Received through the CRS Web

Bank Loan Denial for Nuclear Proliferation under

Section 102(b) of the Arms Export Control Act as

Applicable to India and Pakistan

M. Maureen Murphy

Legislative Attorney

American Law Division

Summary

After the President has determined that a "non-nuclear-weapon state" has detonated

a "nuclear explosive device," section 102(b) of the Arms Export Control Act requires

that a number of sanctions be placed on that state including the prohibition of private

bank loans to the government of the country concerned. When the President responded

to the nuclear tests of India and Pakistan by invoking sanctions on May 13 and 28,

immediate questions arose as to how the banking aspects of the sanctions would be

configured. There is a strong U.S. banking presence in India involving many levels of

interactions with Indian banking, trading, and development companies that are

intertwined with the Indian government. This situation raises issues as to whether

sanctions would extend to governmentally owned and controlled institutions. Section

102(b) has never before been invoked. Its language is sparse; and no regulations have

been promulgated explicating its terms. The Department of the Treasury, in the process

of evaluating the requirements of the law, faced pleas from the banking community to

take into consideration the complex interrelationships of banking and government in

India and Pakistan and proceed cautiously lest operations of U.S. bank branches in those

countries be jeopardized. Using authority of the India-Pakistan Relief Act of 1998, P.L.

105-277, Tit.IX, § 901, enacted as part of the omnibus appropriations measure of

October 19, 1998, the President has waived the India-Pakistan sanctions until October

21, 1999. For a description of the requirements of section 102(b), see Jeanne

J.Grimmett, "Nuclear Sanctions: Section 102(b) of the Arms Export Control Act and Its

Application to India and Pakistan, CRS Report 98-486. This report may be updated.

This report discusses one of the sanctions, denial of bank loans, under section 102(b)

of the Arms Export Control Act (AECA), 22 U.S.C. § 2799aa-1(b), enacted in the Nuclear

Proliferation Prevention Act of 1994. Section 102(b) requires the President to impose

economic and military sanctions against countries that have engaged in certain kinds of

Congressional Research Service ˜ The Library of Congress

CRS-2

nuclear proliferation. After India, on May 11 and 13,1 and Pakistan,2 on May 28,

detonated nuclear devices, President Clinton invoked sanctions against those countries.3

Among the sanctions are prohibitions on foreign assistance; sales and licenses under the

AECA; U.S. government credits, credit guarantees, and financial assistance; U.S. support

for multilateral financial assistance; private bank lending to the affected government; and

exports of certain specific controlled goods and technology. On December 1, 1998, under

Presidential determination No. 99-7, the sanctions were waived until October 21, 1999,

pursuant to the India-Pakistan Relief Act of 1998, P.L. 105-277, Tit. IX, § 901.

U.S. Banking in India and Pakistan

U.S. commercial banking concerns, including Bank of America, Bank of New York,

Chase Manhattan Bank, and Citibank have branch operations in India, conducting a full

range of banking services for individual and corporate clients, supporting international

trade and Indian domestic transactions. Although Federal Reserve Board approval must

be secured before a U.S. bank may establish a foreign branch, the foreign branch operates

under the laws of the host country and may engage in some activities that would not be

permitted in the United States.4

The Indian government imposes certain requirements on banks operating within the

country that make the process of drafting the sanction regulations a balancing exercise.

What must be balanced is the need to actualize the intent of the legislation and the

preservation of U.S. banking operations within India.

In order to obtain approval to operate a foreign bank branch in India, a U.S. bank

must maintain cash deposits at the central bank, which is controlled by the state. It must

also hold a 25% reserve ratio in Indian treasury bills or bonds of state-owned companies.

In addition, since the state holds 51% ownership in each bank, correspondent banking

1

See CRS Issue Brief 93097, India-U.S. Relations.

2

See CRS Issue Brief 94041, Pakistan-U.S. Relations.

3

The India directive, Presidential Determination No. 98-22, 63 Federal Register 27665

(May 20, 1998), ordered the "relevant agencies and instrumentalities of the United States

Government...to take the necessary steps to impose the sanctions described in section 102(b)."

In addition to the Department of the Treasury, which will administer the banking sanctions in

the Office of Foreign Assets Control, the Departments of State and Commerce have responsibility

for administering the AECA and the Export Administration Act licensing systems. The

Department of State has already issued a notice revoking munitions exports licenses for India,

63 Federal Register 27781 (May 20, 1998). On May 28, the Department of Commerce issued

"Interim Guidance for Exporters. ( See <www.BXA.DOC.GOV>.)

4

The Board has authority to authorize activities that it determines to be usual in connection

with the business of banking in the host country. 12 C.F.R. § 211.3(b)(10). Among the powers

authorized foreign banks that are pertinent to the question of application of the sanctions are

some that appear to be essential to the operation of foreign bank branches in India. Under

Federal Reserve Board regulations, a foreign branch may issue buy, sell, and hold the obligations

of the host country's national government and its political subdivisions; invest in the securities

of the host country's central bank and other securities needed to meet reserve requirements; and

it may invest in government-sponsored development banks of its host country and in securities

needed to meet reserve requirements. 12 C.F.R. § 211.3(b).

CRS-3

relations by which banks maintain deposits with one another to clear checks and other

forms of negotiable instruments, may be routine between Indian state-owned banks and

Indian branches of U.S. banks. 5

The banking situation in Pakistan is distinguishable from that of India, although

some of the same large banking organizations as are operating branches in India also have

branches in Pakistan. Banks with Pakistani branches include Citibank, Chase Manhattan

Bank, American Express Bank, and Bank of America. There are requirements similar to

those in India. Pakistan requires 10% of demand and time liabilities be placed with the

central bank, and banks must hold an additonal 25% in government securities.6 On the

other hand the central bank in Pakistan, the State Bank of Pakistan since 1993 is subject

to reduced government control but is not completely autonomous. Until a new liberalized

investment policy was announced in November 1997, Pakistan restricted foreign bank

branching and business with state-owned corporations.7

Lack of Definitions in Section 102(b) Prohibition on Bank Loans

The language in section 102(b) respecting bank loans is unadorned.8 As recently

amended, it reads:

The United States Government shall prohibit any United States bank from

making any loan or providing any credit to the government of that country,

except for loans or credits for the purpose of purchasing food or other

agricultural commodities, which includes fertilizer.

Although this provision was enacted in 1994, Treasury has not issued any

implementing regulations. It apparently has adopted a policy of waiting until the

President invokes sanctions against a particular country to address each country's

individual situation9 as is customary when economic sanctions are invoked under the

5

See Michael M. Phillips, "Banks Lobby Washington for Slack in Indian Sanctions," Wall

Street Journal A-15 (May 22, 1998) and "Business Groups Face Uphill Battle in Effort to Limit

Indian Sanctions," Inside US Trade (May 22, 1998). Krisan S. Nehra, Specialist in Indian and

Pakistani Law, Library of Congress Law Library, was consulted on the material relating to legal

requirements in India and Pakistan.

6

Department of the Treasury, National Treatment Study 06 (1994).

7

Federal Research Division, Library of Congress, Pakistan: A Country Study 161-165

(April 1994).

8

The legislative history has no further elaboration. See: 140 Cong. Rec. S411-S413 (daily

ed. January 31, 1994); H.Rept. 103-482 , 103d Cong. 2d Sess. 261-266(1994). The language

specifically including fertilizer within the agricultural exception to the bank loan sanction was

added by P. L. 105-194, enacted July 14, 1998. On July 15, the Senate approved by a voice vote

an amendment to the FY1999 agriculture appropriations bill (S. 2159), which would authorize

the President to waive certain of the sanctions, including the bank loan sanction. See S. Amdt.

3155, 144 Cong. Rec. S8183-85 (daily ed. July 15, 1998). On July 16, the Senate passed H.R.

4101, the FY1999 agricultural appropriations measure, inserting the language of S. 2159 for the

text passed by the House. See 144 Cong. Rec. S8329 (daily ed. July 15, 1998).

9

In testimony before the House International Relations Committee June 3, 1998, Hearing

(continued...)

CRS-4

International Emergency Economic Powers Act (IEEPA).10 In that case, after the

President's order, Treasury issues regulations, to be administered by the Office of Foreign

Assets Control. These regulations specifically apply the sanction to the institutional

structure of the targeted country.11

To illustrate the process by which an order is refined into regulations, one might

examine the sanctions against Iraq. When, on August 9, 1990, President Bush invoked

IEEPA to sanction Iraq, the directive, Executive Order 12724, generally prohibited "any

commitment or transfer, direct or indirect, of funds or other financial or economic

resources by any United States person to the Government of Iraq or any other person in

Iraq."12 The President, therefore, had decided to impose broad economic sanctions against

not only the government of Iraq, but also any person in Iraq. This, of course, is

distinguishable from the present situation where the law, itself, mandates a broad

prohibition on bank loans to a "government."

The regulations implementing the Iraq sanctions, however, do illustrate the issues

that the drafters of the India regulations will face. The Iraq regulations, issued on January

18, 1991,13 contained an intricate definition of the term "Government of Iraq," which, if

applied to India, would mean closure for U.S. branches operating there. That definition

was:

The term Government of Iraq includes:

(a) The state and the Government of Iraq, as well as any

political subdivision, agency, or instrumentality thereof, including

the Central Bank of Iraq;

(b) Any partnership, association, corporation, or other

organization substantially owned or controlled by the foregoing:

(c) Any person to the extent that such person is, or has been, or

to the extent that there is reasonable cause to believe that such person

is, or has been, since the effective date, acting or purporting to act

directly or indirectly on behalf of any of the foregoing; and

9

(...continued)

on Sanctions in U.S. Policy, Undersecretary of State Stuart Eizenstat referred to section 102(b)

as "in some respects a very vague act." Many of the Committee Members were concerned about

the impact on people in the United States and in the subject countries as well as on the deterrent

effect. The Undersecretary referred to the process of drafting the regulations as involving

mitigating the impact on U.S. business and workers.

10

50 U.S.C. §§ 1701 - 1706.

11

Under IEEPA, the President issues an Executive Order invoking the sanctions and

delegates to the Department of the Treasury implementation authority, with respect to economic

sanctions. At that point regulations are developed. This process may be lengthy. For example,

it was not until May 21, 1998, that final rules were published implementing Executive Order

13047 of May 20, 1997, prohibiting new investment in Burma. 63 Federal Register 27846

(1998).

12

55 Federal Register 33091, 33092 (August 13, 1990).

13

56 Federal Register 2113 (1991).

CRS-5

(d) Any other person or organization determined by the Director

of the Office of Foreign Assets Control to be included within this

section.14

Nowhere in section 102(b) is a definition given for the term "government," with

respect to the country against which the sanctions are to operate. How broadly or

narrowly that term is defined by the implementing regulations is critical. For example,

will the state-controlled central bank be included in the definition? Will banks in which

the state holds 51% equity be covered? How will staate-controlled and owned

development banks be handled? How will state controlled corporations engaged in

international trade be treated? Will Treasury distinguish between governmental entities

acting or performing sovereign functions from government-owned or -controlled entities

performing commercial functions? One approach that has been suggested is to limit

sanctions to Indian or Pakistani governmental operations that are performing sovereign

functions, rather than commercial or proprietary ones. The Foreign Sovereign Immunities

Act, 28 U.S.C § § 1601 - 1611, by which foreign states are subject to U.S. court

jurisdiction for commercial, but not governmental functions, may provide an analytical

framework for making such distinctions.15

Section 102(b) does not define "United States bank." Does it mean only U.S.

commercial banks or does it include development banks? Does it include branches of

Indian banks operating in the United States? Does it include securities firms?

Section 102(b) does not define "making any loan or providing any credit to the

government of [the sanctioned] country." How will Treasury treat the required investment

in Republic of India currency and obligations imposed upon branches of U.S. banks doing

business in India? How will it treat currency swaps involving Indian currency? What will

be the treatment of sales and exchanges of securities that have already been issued by the

Republic of India? What distinctions will be drawn with respect to banking transactions

facilitating India's purchases of exempt commodities, such as food and agricultural

products? What rules will apply to interbank loans, deposits, and clearing of negotiable

instruments? Will there be exceptions for interbank clearances of checks and payment

settlements that may result in overnight debit balances?

Section 102(b) does not designate an agency to enforce the bank loan sanctions. This

raises the question of whether the Office of Foreign Assets Control at Treasury or the

Federal Reserve Board will be designated with that authority. Arguments in favor of the

14

15

31 C.F.R. §§ 575.306.

The Foreign Sovereign Immunities Act applies to foreign states and determines whether

to differentiate an agency or instrumentality of the state as being subject to jurisdiction based on

whether the core functions of that entity are governmental in nature. The statute has an exception

by which jurisdiction is denied over suits "based upon a commercial activity carried on ... by the

foreign state." 28 U.S.C. § 1605(a)(2). In Republic of Argentina v. Weltover, Inc., 504 U.S. 607

(1992), the Supreme Court held Argentina subject to suit to recover on bonds, called Bonads,

issued through its central bank, under a program whereby the government had assumed the risk

associated with cross-border currency transactions. To reach the decision, the Court

distinguished between a government as a market regulator and as a player in the market. The

issuance of the bonds, of public debt instruments, was held to be a commercial activity and was

seen to be similar to issuance of debt instruments by private parties.

CRS-6

latter include its familiarity with the banks involved and its distance from any presidential

administration. There also may be the perception that Federal Reserve Board oversight

would bring more flexibility.

Conclusion

Absent a mechanism in section 102(b) for terminating or suspending a sanction,

legislation appears to be the only way of lifting sanctions, once imposed. In the case of

the sanctions against India and Pakistan, under the Indian-Pakistan Relief Act of 1998,

P. L. 105-277, Tit. IX, § 901, Congress authorized a Presidential waiver for a period of

up to one year. The President used this authority to waive the sanctions until October 21,

1999.