Bottom Line on Reform: Care and Comprehensiveness : Treasury proposes a major makeover for nation’s commercial banks

For years, Washington ducked the pleas of American bankers to modernize the nation’s banking system. Small wonder. The job was fiendishly complicated and politically risky.

So why bother? But now, with the economy reeling and the aftertaste of the savings and loan crisis still bitter throughout the nation, the Treasury Department is offering a blueprint for long-overdue reform of banking.

The proposals deserve serious consideration.

THE PLAN: The Treasury’s plan targets structural problems in banks that have plunged the industry into its worst crisis since the Depression. It would dismantle outdated laws so banks can serve customers across state lines and diversify into new businesses. The package also includes a mandatory intervention system to replace the arbitrary measures now used to rescue troubled banks. And it sets limits on accounts insured by the Federal Deposit Insurance Corp. The goal is to make banks safer and better.

But will it? Little quarrel here with the fact that banks are hungry for capital and new enterprises (known as diversification). Until recently the debate has mostly focused on helping the banks in both areas. Fine, but now it’s time to ask how far bank reform should go. The Treasury proposes that well-capitalized banks be allowed to affiliate with insurance and securities firms and mutual funds under the structure of a financial services holding company that even a commercial firm could own. That would break down the separation between commerce and banking.

One major legislative challenge for Congress will be to create the necessary fire walls to protect insured bank deposits from risks and possible abuses of the banks’ affiliated operations. Remember that an angry Congress slapped restrictions on banks after the 1929 stock market crash because of unfair and manipulative market practices by risky investment syndicates created by banks. Opening up banking too fast, without adequate safeguards, could create new problems.

A second concern is the conspicuous absence in the Treasury’s report of a detailed plan to shore up the FDIC’s bank insurance fund, which could run out of money by year’s end. The fund is under pressure partly because the FDIC’s original mandate to protect small savers has evolved instead into a system that protects banks.

To get back on track, it makes sense to limit the number and type of insured accounts. The Treasury’s proposal to limit an individual to two insured accounts of $100,000 each at one institution is a step in the right direction but it needs further refining to take into consideration special needs like individual retirees living off of sizable nest eggs. At present, about 99% of all bank accounts are in the under-$100,000 category, so relatively few individual savers would be affected. It makes sense to eliminate federal insurance for big institutional investors--pension funds and securities firms--which break down deposits into amounts of $100,000 or less in order to qualify for the insurance.

THE BIG WORRY: Congressional attention will focus on the fragility of the bank insurance fund, which covers $2 trillion in deposits. “The Administration makes a mistake in proposing new and risky activities for banks before the supervisory and insurance reforms are in place and working,” complains Henry B. Gonzalez (D-Tex), chairman of the House Banking, Finance and Urban Affairs Committee. “Let’s set the speed limits and train the policemen before we open a super new expressway for financial institutions.”

Such caution is probably necessary, and the FDIC fund should be a top priority precisely because it is critical to any overhaul of banking. But Washington should not mistakenly assume that that alone will solve the problem: The insurance fund is under stress precisely because of outdated laws, as the Treasury report rightly points out. Bank reform makes economic sense. Now it will take political sense--and courage.

SIZING UP THE ACCOUNTS AVERAGE ACCOUNT SIZE As of June 30, 1990 COMMERCIAL BANKS: $8,142 % of deposits over $100,000: 1% % of deposits under $100,000: 99% STATE SAVINGS BANKS: $7,204 % of deposits over $100,000: 1% % of deposits under $100,000: 99% FEDERAL SAVINGS BANKS: $8,453 % of deposits over $100,000: 1% % of deposits under $100,000: 99% Source: Federal Deposit Insurance Corp.