WASHINGTON -- The Federal Reserve is considering relaxing the volume restrictions on banks that underwrite and deal in ineligible securities through affiliates.
Currently, banks with these so-called Section 20 subsidiaries cannot earn more than 10% of the unit's gross revenues from ineligible securities. Rather than lifting the cap to 20% or 25%, the Fed on July 6 proposed three other ways of calculating the existing cap.
"I'm frankly a little disappointed that they didn't just bite the bullet and raise the 10%," said James D. McLaughlin, director of agency relations at the American Bankers Association. The Fed ought to start lifting the threshold in 5% increments until it gradually gets to 25%, he said.
Assets, Volume, or Both
The Fed's first option would base the cap on total average daily assets over a rolling eight-quarter period. The second alternative would calculate the limit based on total sales volume over the same time period. The third choice would use a combination of the two.
This proposal, open for comment until Aug. 12, is another in a series of steps the central bank has taken to loosen the limits on ineligible securities activities. "Ineligible" is the word the Fed uses to describe securities aCtivities that are barred by the GlassSteagall Act, the Depression-era law that separated commercial and investment banking.
It is section 20 of the act that forbids banks to become "engaged principally" in the securities business. The Fed is charged with defining that term.
In April 1987, the Fed breached the law by allowing several large banks to underwrite commercial paper, mortgage-backed securities, and municipal revenue bonds. The Fed slapped a 5% limit on revenues from these new activities.
In January 1989, the Fed bumped the revenue cap to 10% and permitted five banks to underwrite and deal in corporate debt. The Fed added equity underwriting to banks' powers in 1990. Today, some 30 banks have section 20 securities units.
When banks first started underwriting and dealing, the cap was not a constraint. But interest rate fluctuations lowered gross revenues at banks' securities subsidiaries, which artificially decreased the 10% limit.
Indexing Seen as Too Complex
To fix this problem, the Fed in January 1993, gave banks the option of indexing the cap to interest rate changes. But the calculations are complicated and just four banks adopted it. Thus, the Fed has devised three new ways to tote up the 10% limit.
Under the proposal, banks could apply the 10% to average assets or sales volume rather than gross revenues. Banking industry experts said these switches could help banks expand their ineligible securities business.
H. Rodgin Cohen, a partner with Sullivan & Cromwell in New York, said primary dealers that adopt the asset-based test will be helped the most. These banks have a large amount of relatively low-yielding eligible securities so 10% of their assets will amount to more than 10% of their revenues.
But the Fed will be pressured to go further.
"It's not enough," said Richard M. Whiting, general counsel at the Bankers Roundtable. "'Principally engaged' is something much greater than 10% of revenue."
In comments on the proposal, the Roundtable will ask for at least a 25% minimum, he said.
"If they would go to 25%, I think the banking industry would find that clearly superior," said Mr. Cohen.
