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Fed expands bank underwriting powers

December 20, 1996

WASHINGTON (AP) _ The Federal Reserve Board today unanimously agreed to let banks earn more revenues from underwriting stocks and bonds, the latest move by regulators to allow banks into Wall Street-type businesses.

The Fed increased the ceiling on what banks can earn from securities underwriting to 25 percent from the current 10 percent limit. The expansion comes after Congress declined again this year to pass a bank modernization bill.

``We hope the next move would be up to Congress to review this whole area,″ said Alice Rivlin, the Fed’s vice chairman. The new rules will become effective in 60 days.

Fed staff said the expansion wouldn’t threaten the safety or soundness of the banking system and that it would result in greater competition, convenience and efficiency for bank customers.

Directly affected by the Fed’s move will be 38 bank holding companies that were permitted to deal in stocks and bonds through separate affiliates insulated from the bank.

These affiliates were first created in 1987, when J.P. Morgan & Co. found a way around the Glass Steagall Act, the law passed in the Depression to separate banks and securities firms following major bank failures.

Glass Steagall forbids banks from owning or affiliating with a company that’s ``engaged principally″ in underwriting or securities dealing. J.P. Morgan’s lawyers successfully argued they could set up a securities arm that deals in securities only to a limited extent, generating only 5 percent of the company’s revenues, thereby not violating the ``engaged principally″ test.

Raphael Soifer, bank analyst for Brown Brothers Harriman & Co. in New York, said that ``fateful loophole″ was later broadened so banks could underwrite stocks and bring in 10 percent of their revenues from securities deals.

Soifer and most modern economists believe banks can safely underwrite stocks and bonds without posing big risks to the federal deposit insurance fund. In fact, stock underwriting is safer than some of the risky derivatives that banks sometimes buy and sell.

Soifer said the Fed’s decision on the higher limit was ``a foregone conclusion, but it is a big deal.″

He expected the Fed’s rule will trigger a new type of merger activity, with regional banks acquiring smaller, regional brokerage firms. Stock prices are too high now for combinations of the larger banks and brokerages, he added.

While banks were ready to praise the move, the Securities Industry Association argued the Fed’s expected action would create an unfair playing fields for Wall Street firms. The new rules could make it easier for banks to buy securities firms, but the reverse is not true, as restrictions remain on who can own a commercial bank.

Meanwhile, House Banking Chairman Jim Leach, R-Iowa, who failed to move a broad bank modernization bill through the 104th Congress, told an industry group Wednesday he intends to try again.

To address Wall Street’s concerns, Leach said he will introduce a new bill to create Investment Bank Holding Companies, which can be owned by either banks or Wall Street firms, that can engage in a wider range of financial activities. Leach’s bill also would abolish the savings and loan association charter, which would force S&Ls to convert to banks.

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