Congress' perennial financial reform debate is stalling several key regulatory initiatives.

Apparently fearful of offending lawmakers working to modernize the nation's financial laws, the banking agencies have shelved new rules on foreign banking, merchant banking, and operating-subsidiary powers. Supervisors also are not doling out any significant new powers to banks.

"You can certainly understand the regulators' position. They don't want to be seen preempting congressional action," said H. Rodgin Cohen, a partner in the New York law firm Sullivan & Cromwell. "But the downside is that Congress has had this legislation out there since 1995, and who knows if it is going to get done this year, next year, 2005, or 2010."

"All of these items are pawns in a bigger game of chess," said Karen Shaw Petrou, president of the industry consulting firm ISD-Shaw Inc. "That is becoming inconvenient to the pawns."

The most critical rule put on hold is the Federal Reserve Board's overhaul of Regulation K, which governs the overseas activities of U.S. banks and the operation here of foreign banks.

Proposed in December 1997, the rule is especially controversial because it would expand U.S. banks' authority to underwrite securities in overseas subsidiaries. Part of the debate on financial reform is whether banks may underwrite securities and insurance directly or whether these activities should be walled off in holding company units.

The Reg K proposal also would expand merchant banking opportunities and expedite overseas branching applications.

"We regard this proposal as very important to be able to compete in a global marketplace," said Larry B. LaRocco, managing director of ABA Securities Association. "Resolving this sooner rather than later is imperative."

Mr. Cohen, who represents several internationally active banks, said, "U.S. banks really are at a disadvantage overseas, and every day makes it worse."

The Reg K proposal also would streamline many regulatory requirements imposed on foreign banks here, including liberalizing the test used to determine if an overseas financial conglomerate qualifies to own a bank in the United States.

"We have been waiting for these rules for a long time," a senior U.S. official of a European bank said. "These rules would be a vast improvement. It would be a lessening of regulatory burden."

The Reg K delay is especially frustrating because the Fed originally planned to rewrite the rule in 1995, several industry officials noted.

Fed Vice Chairman Alice M. Rivlin said the central bank is not delaying Reg K for political reasons. "It is still being worked on," she said. "We have a lot of complicated issues to work out."

Industry sources, however, do not accept that explanation.

"They would be loathe to admit it," said Richard M. Whiting, acting executive director of the Bankers Roundtable, "but as a matter of fact they don't like to delve into areas that are politically controversial and may affect pending legislative proposals."

Also on hold is a 1997 Fed proposal to impose on bank operating subsidiaries the same capital and funding restrictions contained in sections 23a and 23b of the Federal Reserve Act.

The proposal drew howls of protest from the Office of the Comptroller of the Currency, which accused the Fed of trespassing on its turf by trying to regulate national bank activities. The proposal was widely viewed as an effort to make it less attractive for banks to house securities underwriting units in divisions of the bank, rather than in section 20 holding company units.

"It seemed at the time as a shot across the bow of the OCC," said William Sweet, a partner in the Washington office of the Skadden, Arps, Slate, Meagher & Flom law firm.

Yet the Fed has not finalized the proposal, and sources said it will not be finalized until Congress wraps up financial reform.

Mr. Whiting said the Fed is afraid to enact the rule because it might offend lawmakers. "If the Fed takes an action, they are sending a signal that could affect the debate on financial reform," he said. "It could take the steam out of the legislation."

The regulators also are discouraging banks from applying for new powers. For instance, the OCC last granted a new bank operating-subsidiary power in December 1997 when Zions National Bank was allowed to underwrite municipal revenue bonds. The agency has sat on an application by Bank of America to develop real estate directly.

"There are a lot of rumors that the OCC has discouraged national banks from coming in with innovative ideas for operating subsidiaries," said Gilbert T. Schwartz, a partner in the Washington law firm Schwartz & Ballen.

Comptroller John D. Hawke Jr. said the agency has not discouraged new operating-subsidiary applications, though he added that he was too new to the job to comment further.

The Fed also appears reluctant to grant new powers. "There are people waiting in the wings to come up with proposals in the mutual fund area, but the Fed has said do not send us anything right now," Mr. Schwartz said.

Banks are eager for the Fed to drop restrictions on the underwriting of mutual fund shares and want it to let the industry act as a riskless principle for securities purchases, Mr. Schwartz said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.