WASHINGTON - The banking industry has sharply criticized a complex proposal that would set higher capital requirements for institutions vulnerable to shifts in interest rates.

In written comments, some 220 banks urged regulators to amend and delay the measure, arguing that it would constrict credit, increase overhead costs, and raise the price of banking services for consumers.

"One of the unintended negative consequences of your proposal to the public may be to limit the supply of three- to five-year fixed-rate loans to consumers and small businesses," wrote Roger Fitzsimonds, chairman of Firstar Corp. in Milwaukee.

Complicated Procedure

The proposal, floated by the three banking agencies, outlines a complicated procedure for measuring interest rate risk. it has already been revised once, causing regulators to miss the June 19 implementation deadline set by Congress.

In September, regulators said they would adopt the new rules by yearend, with partial implementation next March and full implementation by December 1994.

But now that time frame appears impossible,

"There are quite a few substantial issues outstanding," one regulator writing the rule said Thursday. "I wouldn't look for this any time soon."

The best guess is that the interest rate risk rules could be finished in March. Implementation could be delayed until sometime in 1995.

There are two big undecided issues:

* Whether banks that are found to have too much interest rate risk should automatically have to raise capital.

* How to determine interest rate risk.

Not surprisingly, banks strongly objected to the prospect of rigid capital requirements for interest rate risk.

Frederick H. Pennekamp, treasurer of Lawrenceville, N.J.-based First Fidelity Bancorp., wrote that the regulators' method for measuring interest rate risk is "too imprecise to be used as the basis for a specific capital charge."

Flexibility Urged

Most of the comment letters said examiners, not a formula, should decide whether banks must add capital

"We feel maximum flexibility ought to be accorded examiners in their ultimate assessment of capital adequacy," wrote Peter J. Tobin, chief financial officer of Chemical Banking Corp.

Bankers were asked to comment on how large a potential swing in interest rates the proposal should measure: 100 basis points, 200 basis points, or some other amount.

Some banks, like Chase Manhattan Corp., backed 100 basis points.

But others, including Citibank, opposed a specific figure.

"Since institutions differ in their ability to adjust their positions, it is inappropriate to use any single rate shock for the entire industry," wrote Citi treasurer Peter M. Gallant. "The size of the rate shock should be determined during the examination process."

Five Years in the Making

Federal regulators promised five years ago to augment risk-based capital standards by including the risks posed by fluctuating interest rates. Risk-based capital, adopted in 1989, classifies a bank's assets by credit risk and requires more capital behind the riskiest assets.

Congress nudged the regulation along in 1991, mandating regulations to take account of interest rate risk by June 1993.

The agencies have tried twice.

Their first plan, in August 1992, was met with widespread protest. The regulators went back to the drawing board and issued a revised plan on Sept. 14.

While bankers consider the second version an improvement, they still think the agencies' approach will not accurately measure the risk posed by fluctuating interest rates.

The rules will mainly affect the largest banks, as the proposal would exempt 7,500 smaller banks thought to be less vulnerable to rate swings.

The proposed regulation provides a model for measuring interest rate risk that would slot all of a bank's assets and liabilities into seven categories, based on maturity.

Each category would be multiplied by a risk weighting, depending on its rate sensitivity. Finally, the risk-weighted figures would be totaled and expressed as a percentage of total assets.

When a bank's market value declined by more than 1% of assets, it would be required to allocate capital to cover that excess risk. For example, if a bank's market value fell 2.5%, then it would have to come up with 1.5% in capital.

The proposal also allows banks that already have sophisticated software for tracking interest rate risk to use their own models.

Banks welcomed this option, but noted that the regulation still would require a bank using its own model to calculate and report their results under the model provided by the regulators.

"Imposition of the supervisory model would create dual reporting and increase costs with marginal benefit," wrote David P. Bolger, treasurer at First Chicago Corp.

Swaps Issue

Many banks criticized the regulator's model because it covers trading-account assets, including derivatives.

"To subject the trading positions of the U.S. banking institutions engaged in these activities to a one or two percentage point interest rate volatility test will Put them at a significant competitive disadvantage relative to nonbank and foreign bank competitors," Chemical's Mr. Tobin said.

Deposits that do not have set maturity dates also should be excluded from the regulation, bankers told the agencies.

The regulation as proposed would force banks to treat non-maturity deposits as shorter-term liabilities than they actually are, Mr. Tobin explained, Unless this were changed, banks would have to shorten the maturity of corresponding assets, which would increase repricing risk, he added.

Many bankers said compliance with these rules could be a waste of time, because an international interest rate risk rule is expected from the Bank for International Settlements, which brokered the risk-based capital standards among the major industrial countries.

Regulators are considering eliminating the leverage capital ratio once interest rate risk rules are in place. This, bankers agreed, is a good idea.

"We see no value in having a catch-all measure, i.e. leverage ratio measure," wrote Daniel T. Mudge, managing director at Bankers Trust Co., New York. U.S. banks have been "competitively disadvantaged" by the leverage ratio requirement, he wrote, because most foreign banks operate without one.

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