Banking Reform Plan Could Offer a Mixed Blessing to Consumers

Congressional leaders are attempting to pass a bill that would launch the most sweeping changes in the financial services industry since the 1930s.

Already both the House and Senate versions of this banking reform legislation have cleared important legislative committees. And leadership in both houses are attempting to push the measures through quickly, with the goal of having a new law by 1992.

The theory behind these proposals is to make the U.S. banking industry stronger and more competitive. Although the House and Senate have taken somewhat different approaches, both bills would allow banks to expand across state lines. When the bills are merged into one law, they are expected to allow banks and thrifts greater latitude to sell securities products through sister companies.

Advocates of the measures maintain that consumers will be big winners if a version of these bills passes. The Senate bill contains a handful of consumer-oriented provisions that would provide for low-cost basic banking accounts and attempt to eliminate loan discrimination. Banks would also be prohibited from using certain deceptive advertising practices.

In addition, advocates maintain that breaking down some of the barriers that kept banks out of the securities business and vice versa will result in greater competition, which, in turn, will lead to lower prices for everything from loans to brokerage fees.

Added competition also could spur greater innovation in these industries, they say. And, certainly, it would be convenient to be able to go to just one place for all your banking and investment needs, they add.

Opponents of the bills dispute the prospect of a consumer windfall. The consumer-oriented provisions are solely in the Senate bill, they note. And they are modest changes. To wit:

* The low-cost bank account, for example, would provide basic bank services--a checking account that allows a limited number of transactions each month or provides government check cashing services. The accounts would be available to those earning less than $20,000 annually. How much would the account cost consumers? The rule doesn’t specify. It simply says the bank cannot charge to open the account nor earn more than a 10% profit on it.

* To limit loan discrimination, banks would be required to provide loan applicants with a copy of real estate appraisals. The reason for this, according to a Senate Banking Committee staffer, is that some claim mortgage discrimination is disguised as an appraisal that just didn’t pan out. This would give the consumer the proof or the loan.

* The third provision would simply require banks to stop advertising deposit rates that only apply to a portion of the account. Some banks might advertise a 7% return on a certificate of deposit, for example. But they’d only pay interest on about 88% of the money deposited. The rest of the deposit was not “investable” because the bank needs to keep a certain percentage of its deposits on account with the Federal Reserve. And if the bank doesn’t earn interest on the money, neither should the consumer, the theory goes.

The Senate bill says banks that use the “investable balance” method are, in reality, paying a slightly lower return on the whole deposit. The bill would just force them to reveal that up front.

As for the securities provisions: Banks and thrifts already have some limited powers to sell securities and insurance in some states, and that has not brought down costs or caused sweeping changes in any of these industries, finance experts note. However, because these powers are now so limited, they may not have provided a sufficient competitive boost to give the concept a fair chance, they acknowledge.

Still, some opponents of the bank reform legislation maintain that giving banks new freedoms to sell untraditional products could introduce a myriad of risks for individuals. Those risks range from minor misunderstandings to the type of financial debacle that struck the savings and loan industry and has now added at least $2,000 to every American’s tax burden.

They point to the Lincoln Savings disaster to explain why.

Lincoln Savings, once a low-profile, traditional thrift, started selling debt securities from “investment desks” in the company’s branch offices in the mid-1980s. The debt was backed by Lincoln’s Phoenix-based parent company, American Continental Corp., which developed hotels and resorts.

These bonds often paid rates of return that were 3 and 4 percentage points richer than what Lincoln paid on certificates of deposit. But because they were sold from Lincoln’s branch offices, many of the thrift’s depositors said they didn’t understand the difference between these bonds and federally insured deposits. Others maintain they were misled by unscrupulous bank officers.

American Continental is now in bankruptcy, and Lincoln is under the control of federal thrift regulators. Lincoln’s depositors were protected by federal insurance that backs up to $100,000 in individual deposits. But bondholders have been told that their securities may be worthless.

Admittedly, Lincoln and American Continental are the exception. Savings institutions that now offer securities or insurance investments are often extra cautious to explain how these investments differ from deposits.

Nevertheless, some industry experts worry that consumers, long-trained to expect a high degree of safety when investing with a bank, will fail to recognize the dangers of these new investment options.

“Some less sophisticated investors ascribe more credibility to bankers than to stockbrokers,” one congressional aide said. “People see the (FDIC sticker) in the window, and they think all the investments sold there are federally insured. They don’t fully understand what they are getting into.”

The bottom line is this: If the bank reform legislation passes and banks are allowed additional powers, consumers may reap rewards in lower costs for bank and brokerage services. However, they will have to become a bit more savvy about the differences between investments.

Let the Investor Beware

If the bank reform legislation passes and banks are allowed additional powers, consumers could see lower costs for bank and brokerage services. But they’ll have to be more careful about the differences between investments. Here are some of the suggested reforms:

Low-cost bank account: Would provide basic bank services. The accounts would be available to those earning less than $20,000 annually. But cost to the consumer is not specified in the legislation.

Loan-discrimination provisions: Banks would be required to provide loan applicants with a copy of real estate appraisals. Some claim mortgage discrimination is disguised as an appraisal that just didn’t pan out. This would give the consumer the proof or the loan.

Advertising: Banks would be required to stop advertising deposit rates that only apply to a portion of the account.