Effort to Limit Interest Rates Picks Up Steam in Congress

WASHINGTON -- Interest rate ceilings, swept away by deregulation in the 1980s, may make a comeback under a proposal that appears to be gaining ground rapidly on Capitol Hill.

As the House Banking Committee prepares to take action on industry reforms, Rep. Charles E. Schumer, D-N.Y., is gaining adherents to his notion of a "core bank" that would have to peg its interest rates to U.S. Treasury instruments, in return for the right to accept insured deposits.

Customers who want higher rates would have to put their deposits in bank affiliates that would not have government insurance and would be likely to make riskier loans.

Supporters see the idea as a way to prevent abuses of the deposit insurance system. Critics warn against reregulation of interest rates -- and against another part of the core banking proposal that would put stricter limits on the amount a bank could lend to one borrower.

Both camps agree that the proposal would shrink the industry's insured deposits by as much as $1 trillion of its current $3.5 trillion total.

"It will force a substantial contraction of what we now call banks and thrifts," with results that are hard to predict, said analyst Bert Ely, who has studied the issue for the Association of Bank Holding Companies.

Mr. Ely called the proposal an effort "to turn back the clock to an earlier, simpler time" when regulators, not markets, set bank interest rates.

Even so, the Schumer proposal "is definitely picking up steam," said Karen Shaw, president of the Institute for Strategy Development.

"It has a lot of appeal because it is the first so-called |new idea' to come up," as the House considers a sweeping overhaul of the banking and financial services industry, she said.

Key allies include House Banking Committee Chairman Henry B. Gonzalez. The Texas Democrat signaled his support last week by scheduling a hearing for today -- only a day before the full committee begins voting on the Bush administration's package. It is expected to complete its work on the bill next week.

Federal Deposit Insurance Corp. Chairman L. William Seidman is also reported to favor major elements of the approach. And two large regional banks -- Charlotte-based NCNB Corp. and San Francisco-based Wells Fargo & Co. -- are talking it up.

The American Bankers Association said the great majority of its members are opposed.

Mr. Schumer believes the "core bank" proposal will add a large measure of market discipline by forcing large banks to raise a significant share of their money without the benefit of deposit insurance.

Banks that run into trouble will face a liquidity squeeze, no longer able to bid high for money with the backing of the federal government. As a result, Mr. Schumer said, regulators will be forced to intervene early and close bad banks.

The proposal's intellectual parent, McKinsey & Co. partner Lowell Bryan, believes it will force banks back to traditional lines of business -- which he said still supply most of the industry's profits.

Doing so, he said, could reduce loan chargeoffs from an average of 1.4% of assets now to the 0.4% that was more common in the 1970s "under more prudent lending standards."

The one-percentage-point improvement in profitability, he said, could add $20 billion to the industry's coffers, each year.

Mr. Schumer's proposal, which many regard as radical, comes late in the process, a fact Mr. Schumer attributed both to his involvement with the "Brady bill" on gun control and to the sudden shift in legislative policy that put the banking bill on a fast track.

The core-banking idea has its foundations on anomalies Mr. Bryan believes exist on bank balance sheets. On the liability side, he thinks banks are paying too much for deposits, even though they are essentially borrowing on the credit of the U.S. government, which stands behind the insurance fund.

The deposit anomaly leads, in turn, to a peculiarity on the asset side. Banks have so much money to lend that they are under-pricing loans to large corporations that otherwise raise funds by issuing commercial paper.

"Large borrowers don't need banks," he said. "They go directly to the market. The ones that don't are those that aren't creditworthy."

Mr. Schumer's proposal attacks both anomalies. On the liability side, he would impose a floating-rate ceiling of 105% of the comparable Treasury security. On the asset side, a tiered system of limits would be imposed for banks with Tier 1 capital of more than $100 million -- institutions with $2.5 billion or more in assets.

Exempt banks would be covered by the existing loan-to-one-borrower limit of 15% of capital. For banks with Tier 1 capital of $100 to $200 million, the limit would be the current one for the first $100 million, plus 4% of the next $100 million. Larger banks would have that amount plus 3% of their remaining equity.

Mr. Schumer said his proposal has taken on a sense of urgency in the context of the Bush administration bill, which he said proposes massive deregulation but fails to adequately protect insured deposits.

"The combination of insured deposits and deregulation requires some adjustment," he said. "You could do it on either side, but it's clear we don't do it on the insured deposit side. Treasury didn't call for it."

Some observers said the proposed interest rate caps would have more of an effect on the industry than the lending limits.

"Changing lending limits won't have that much of an effect," said John Rau, former president of Chicago's LaSalle National Bank and now the chairman of the Banking Research Center at Northwestern University's Kellogg Graduate School of Management.

"If you're a big guy with a $200 million lending limit, you don't make a lot of $200 million loans," he said. "You make a lot of $50 million loans. At LaSalle, we typically kept our limit to a third or a half of the legal limit."

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