Giving Banks the Weapons to Compete in a Tough World : But Congress needs to craft restructuring legislation very carefully

Stung badly by the savings-and-loan mess, will Congress take up the challenge of bank reform? It should, because Washington owes every taxpayer the best assurances that banks continue to be safe and sound places for their money. The consequence of an erosion of public confidence in the banks would be too gruesome to contemplate. The federal government, which completely botched its oversight of the S&Ls;, must not fall down on this one.

Banks certainly are not in as bad shape as S&Ls;, but they are long overdue for change in order to be more competitive. If banks fail to be competitive, it wouldn’t take long for the average depositor to feel the effects: More reliance on automatic tellers, more extra charges, even less personal service, less ability for the local bank to make small loans--and on and on.

There’s less objection today to extending new powers to banks than ever before. The Federal Reserve Board recently chipped away at the traditional separation between commercial and investment banking. Bank competitors no longer espouse vociferous opposition to the idea. But any and all change needs to be the result of carefully crafted legislation. Restructuring banks might promote much-needed diversification, but it must be accompanied by new safeguards and minimum risks to insured deposits--and taxpayers. This would require modification of the Glass-Steagall Act and other changes in banking legislation, as well in the Federal Deposit Insurance Corp.

By contrast, all the piecemeal legislation to date has helped almost everyone but the banks. For instance, when companies found it less expensive to raise money by selling commercial paper than borrowing from banks, they turned to investment bankers--not banks. When brokerages provided uninsured but higher-yielding mutual funds, banks were stuck with traditional bank accounts. Banks insist they need to diversify to raise new capital.

They’re right, but what sort of trade-offs would they propose in order to be permitted to enter new ventures? And what safeguards should they agree to that would bar banks from using insured deposits to enter new businesses? One new idea floating about is to control or narrow the range of insured bank activities--”fire wall” them off--in order to significantly reduce risk to the FDIC, the fund that insures bank deposits.

One way is to allow commercial banks to diversify--but under the new umbrella of a general holding company. That way a parent company would establish a bank as a separate and distinct subsidiary from affiliates that engage in riskier nonbank and financial services. New regulations would define, protect and separate the use of insured bank deposits.

For instance, banks might only be allowed to put their deposits in the safest investments, such as Treasury bills, and their loan options might be limited. Risky loans for real estate development, for example, might not be allowed at banks but would be permitted at affiliates that are not insured by the FDIC. The idea is to reduce FDIC risks and make bank affiliates responsible for their uninsured activities.

The General Accounting Office rightly recommends that any new structure needs to include appropriate controls over the holding company, comparable to the Fed’s current control over bank holding company operations. Another reform element would be to lift federal regulations prohibiting interstate banking. Some states, including California, soon will lift its ban on banks operating across state lines. Given technology today, this makes sense. Interstate diversification also would help banks ride out regional problems.

Attempts to change bank legislation are likely to unleash a battle royal in Congress. And while restructuring will mostly benefit large banks, it will be necessary to accommodate small ones, too. Congress must take up the challenge of updating Depression-era laws that do banks--and taxpayers--little good.

Problem Real Estate Loans Growing dependence on real estate loans is a problem for commercial banks. Here is a lookat the amount of problem loans from 1982 to 1990 in billions of dollars: ‘82: 9.4 ‘83: 8.1 ‘84: 8.2 ‘85: 10.6 ‘86: 13.9 ‘87: 16.7 ‘88: 16.1 ‘89: 22.2 ‘90*: 27.7 Source: FDIC *Up to June 30