Comptroller of the Currency John D. Hawke Jr. told Congress Thursday that the highly controversial know-your-customer proposal should be abandoned.

Citing concerns over customer privacy, competitive disparities between banks and nonbanks, and financial burdens on small institutions, Mr. Hawke told a House Judiciary subcommittee that the anti-money-laundering proposal should be withdrawn after the March 8 deadline for public comment and not replaced.

"I firmly believe that any marginal advantages for law enforcement in this proposal are strongly outweighed by its potential for inflicting lasting damage on our banking system," said Mr. Hawke, the only agency chief to testify.

Mr. Hawke's statement was the strongest yet by any regulator. Federal Deposit Insurance Corp. Chairman Donna A. Tanoue has said the proposal must be reworked, but she and other bank regulators have stopped short of saying no regulation is needed.

The Federal Reserve Board's position is unclear but crucial because the central bank was the key architect of the know-your-customer proposal.

Richard A. Small, an assistant director of banking supervision at the Fed, was nearly alone in defending the proposal at Thursday's hearing.

The rule "would not require banks to monitor every customer transaction," he said. It would actually reduce the burden on banks by focusing efforts on their riskiest customers.

Mr. Small said the Fed will weigh concerns over privacy, cost, and public confidence before making a final decision on how to proceed.

The know-your-customer proposal has generated a barrage of negative comments since the four bank and thrift regulators issued it Dec. 8. The proposal would require banks to determine their customers' identity and the source of their funds. They would also monitor accounts for unusual activity and report any suspicious transactions to law enforcement.

In an interview after the hearing, Mr. Hawke said regulators should move on to other business and let bank trade groups collect and distribute information on "best practices."

"We have a million areas" like this in banking supervision, he said. For example, "we don't have a regulation that spells out what (the internal controls) ought to be," he said. "Our examiners are perfectly capable of looking at a bank's voluntarily adopted processes and judging whether they're reasonable or not."

James D. McLaughlin, director of regulatory and trust affairs at the American Bankers Association, said Mr. Hawke had made "the right decision." Mr. McLaughlin testified that the rule would drive bank customers to other financial service providers and impose significant new costs on banks, citing a $936 million-asset community bank holding company's estimate that it would have to spend more than $110,000 to comply in the first year.

But Mr. McLaughlin balked at Mr. Hawke's suggestion that bank trade groups fill the regulatory vacuum.

"If we were to take a very forceful posture, we would be put in a very awkward position," he said in an interview. "We have no enforcement authority over our members."

Mr. Hawke was not sympathetic. "The trade associations ... are very good at complaining about things," he said. Here, by contrast, they "have the opportunity to play a very constructive role."

Lawmakers at the hearing criticized the proposed rule.

Rep. George W. Gekas, chairman of House Judiciary's subcommittee on commercial and administrative law, called it "vexatious at best, dangerous at most." The Pennsylvania Republican also pressed agency witnesses to cite the precise law that inspired the proposal.

Rep. Bob Barr, cosponsor of an anti-know-your-customer amendment to financial reform approved by House Banking on Thursday, called Mr. Hawke's opposition "heartening." A former U.S. Attorney, the Georgia Republican testified that the proposal was "totally unnecessary" from a law enforcement perspective and another example of the government's "war on privacy."

Rep. Jerrold Nadler, a New York Democrat, said the rule would "do violence" to customers' privacy and should not move forward.

Rep. Ron E. Paul, whose Know Your Customer Sunset Act has collected 40 cosponsors, said that a powerful combination of citizen activism and Internet access had pushed the volume of comments far beyond the average response of 200 or 300 letters.

The FDIC has received 135,000 comments, all but 20 of them negative and the majority funneled through Web sites.

"The Internet will be the musket of the 21st century, for it will provide freedom-loving Americans with the tools to keep government power in check," Rep. Paul said.

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