Canada took a critical step toward liberalizing its banking system Tuesday as a government-appointed task force recommended lifting restrictions on foreign financial institutions and allowing megamergers among Canadian banks.

"The report offers a thoughtful, outward-looking model and a good assessment of international finance trends and what they mean for participants in this important market," said Edward W. Russell, senior vice president for international government affairs at Chase Manhattan Corp.

He and other bankers welcomed the report's recommendations favoring legislation that would let foreign banks operate in Canada through branches as well as through subsidiaries and to expand other operations.

The recommendations are expected to have an important impact on a review by Canada's House of Commons on removing constraints from foreign financial institutions, including restraints on supplying a broader range of financial services and gaining access to Canada's payment systems.

"It's a pro-competitive and pro-deregulation point of view," said Fred Lazar, a professor of business and finance at York University in Toronto. "It's an important first step."

Separately, the report gave its blessing in principle to the planned mergers of Royal Bank of Canada with Bank of Montreal and of Canadian Imperial Bank of Commerce with Toronto-Dominion Bank.

The proposed mergers have drawn fierce opposition by consumer groups concerned about the enormous market share the combined entities would have.

"The task force recognized that mergers can be a valid business strategy," said Harold MacKay, a Canadian lawyer and chairman of the task force, in a statement.

"It concluded that there should be no absolute ban on mergers among large banks, insurance companies, or other financial institutions."

U.S. banks have long sought to operate in Canada through branches of their parents rather than through separately capitalized subsidiaries that limit the scope of their operations and are more expensive to run.

U.S. financial institutions are also seeking greater powers to directly distribute banking and financial products, such as insurance, across the border via phone and mail. Just last week Banc One Corp., Columbus, Ohio, said it would establish within 60 days a unit to market credit cards in Canada, an operating center in Ottawa, and a business development office in Toronto.

Proposed changes to Canadian banking regulations that would allow U.S. banks and financial institutions greater leeway were first presented in a government White Paper last September. But they were put on hold pending recommendations of the task force as well as approval by Canada's Competition Bureau and Ministry of Finance.

After those hurdles are cleared, final legislation will have to be approved by Canada's Parliament.

"The emphasis of the report is very much on allowing greater competition," said A. Roy Palmer, a Canadian banking analyst in Toronto with TD Securities.

"It's now up to U.S. bankers to seize the opportunities."

U.S. bankers and analysts cautioned that the fine print of any change has yet to be spelled out, along with conditions that might be imposed on banks in Canada, such as requiring them to reduce fees or increase small- business lending.

They also expressed concern that legislation allowing foreign banks greater leeway could be delayed by merger-related legislation.

"What's important is how they tie the two things together," said Thomas Farmer, general counsel of the Washington, D.C.-based Bankers Association for Foreign Trade. "Presumably they will go ahead with foreign bank legislation because it's part of their World Trade Organization commitment."

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