Responding to a barrage of criticism from banks, the Treasury Department said this week it will back off from a controversial money-laundering proposal.

The industry fervently opposed an agency proposal in early September that would exempt banks from filing currency transaction reports on established customers if the bank collects annual deposit and withdrawal data.

The Treasury seeks to relieve small banks in particular of paperwork burden, but bankers said the plan would impose onerous record-keeping requirements that defeat its purpose.

"They convinced me that there was a serious problem with the way we were going about it," said Stanley E. Morris, director of the Financial Crimes Enforcement Net-work-a Treasury unit that collects these currency reports."We can come up with a better way."

Mr. Morris said late Monday that the agency will extend the comment period more than a month, to Jan. 16. A notice expected to be published Friday in the Federal Register will encourage bankers to use the extra time to offer alternatives to the disputed proposal.

The Treasury unit, known as Fincen, will propose its own, two-step alternative in the notice. Under Fincen's plan, a bank would have to show that it verifies the identities of its customers and would have to certify that none of the customer's transactions prompted the bank to file a suspicious activity report.

Bankers welcomed Fincen's change, of course. But John J. Byrne, the American Bankers Association's money laundering expert, said the industry will oppose Fincen's alternative. Mr. Byrne said banks fear being sued by the government or another company if they incorrectly certify that a customer has not committed any illegal acts.

Banks would rather establish their own methods for assessing whether a customer should be exempted, and then be held accountable if they err, Mr. Byrne said.

"Leave it up to the bank or the holding company to create that standard," agreed Phillips G. Gay Jr., a senior vice president with Commercial Bank of Florida, Miami.

Financial institutions are required to file currency transaction reports each time a business customer deposits or withdraws more than $10,000. Banks filed 12.75 million of these reports in 1996, nearly double the amount in 1990. Many bankers do not use the current exemption system because it is too complex.

In 1994, Congress ordered Fincen to slash the number of currency transaction reports by 30% within a reasonable period. In response, Fincen has been streamlining the CTR exemption process.

Since May, Fincen has exempted banks from reporting on transactions by other banks, government agencies, and companies listed on major stock exchanges. That rule is expected to eliminate two million filings a year.

Under Fincen's latest proposal, banks could obtain exemptions for small U.S.-based retail, service, and wholesale businesses if they have been customers for more than a year and frequently engage in large cash transactions.

Before Fincen revised the rule, banks seeking the exemption would have had to estimate a customer's annual total deposits and withdrawals. Banks also would have had to report these totals annually.

Bankers balked at the requirements. "The systems that some banks have in place don't have the capability to handle this type of data processing," said Dennis L. Algiere, vice president of compliance for Washington Trust Co., Westerly, R.I.

Mr. Morris said Fincen's goal is to reduce the number of CTRs while ensuring banks are carefully monitoring the cash transactions of exempted customers.

But Mr. Byrne said banks will not use the exemptions unless Fincen lightens the paperwork burden.

"If the exemption proposal is not accepted by the banking industry, routine reports will increase exponentially and nobody benefits," Mr. Byrne said. "It's up to them on to sell us on what they want to do."

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