Federal Reserve Grants Banks Power to Sell Corporate Bonds

In a major victory for the banking industry, the Federal Reserve Board announced Wednesday that banks will be allowed to market corporate bonds and other debt securities.

The Fed also said it will decide next year whether to permit banks to enter an even more lucrative enterprise--underwriting and selling corporate stocks.

While Congress has been debating for several years whether to permit banks to expand into more financial activities, the Fed has been moving steadily to remove restrictions by providing more liberal interpretations of current banking laws.

Wednesday’s Fed action gives conditional approval for the new securities activity by five major bank holding companies: Security Pacific Corp. of Los Angeles and four New York firms, Citicorp, Chase Manhattan, Bankers Trust New York and J. P. Morgan & Co.

“Everyone has generally expected them to provide the (bond) powers,” a banking lobbyist said of the Fed. “But it was a pleasant surprise for them to put stock powers on track for fast consideration.”

Before marketing bonds, the banking firms must show that they have the financial strength to take on the comparatively risky securities activity and the expertise to manage their operations.

Debt issues will be handled by separate subsidiaries created to handle securities business. These securities firms, already established by the banks, must obtain substantial capital before winning Fed approval, Michael Bradfield, the agency’s general counsel told reporters.

He refused to specify the level of funds, but said, “as a general matter (the board) will look for more capital” than they have.

Once the Fed is satisfied, approval for new securities activity will be granted “on a fairly automatic basis,” Bradfield said.

Although only five major banks have been granted conditional approval, other banks could seek authorization if they assemble the financial resources.

The banking industry has been lobbying aggressively for permission to enter new businesses, maintaining that they need profits from additional sources to become financially stronger and compete better with massive foreign financial institutions.

Security Pacific said in a statement that it was “extremely pleased” by the Fed announcement. The greater freedom allows the bank “to be more responsive to client needs, more efficient and more competitive in the world economy,” it said.

Securities firms, however, reacted angrily to the decision, which provides them with tough new competition. “It represents piecemeal dismantling of the appropriate separation which exists in the financial services industry,” said Edward I. O’Brien, president of the Securities Industry Assn.

O’Brien said such action should be Congress’ responsibility. Congress is more attuned to “such critical questions as the balancing of expanded powers with appropriate controls, establishment of protective fire walls and the absolute need for prudent regulatory oversight” by the Securities and Exchange Commission, he said.

The Fed’s order will enable the bank subsidiaries to handle any kind of corporate debt, including ordinary bonds and convertible issues that can be transferred into stock. “Junk bonds”--those with high yields but greater risks--also are available to the banks.

As underwriters, banks would compete directly with traditional Wall Street securities firms to help industry raise money. The underwriter prepares the bond issue, supplies the funds to the corporation and then sells the bonds to investors.

The banks’ securities subsidiaries must be efficient and expert in preparing to embark on the new lines of business, the Fed cautioned.

The bank and its securities subsidiary must be separated by so-called fire walls that would prevent the bank’s stability from being jeopardized if bond and stock dealings go awry. No more than 5% of the subsidiary’s revenue can come from the new source of business--corporate debt. The other 95% must come from less risky activities such as dealing in U.S. government securities.

In a further precaution, the parent bank is forbidden from lending money to the securities subsidiary.

The Fed said it will decide in a year whether banks have the “managerial and operational infrastructure” to underwrite corporate stock issues.

The agency said it “places a great emphasis upon the establishment of adequate procedures, accounting and computer systems, and internal risk management controls as a prerequisite to engaging in securities underwriting and dealing activities.”

Security Pacific said it plans to “enter the debt business shortly and equities according to the timetable established by the Federal Reserve Bank.”

It said that “underwriting of corporate debt and equity are extensions of activities which Security Pacific has conducted safely and profitably for years.”