WASHINGTON - The Federal Reserve Board proposed Thursday to ease restrictions on the amount of securities banks can underwrite through broker-dealer affiliates.
The move was prompted because a couple of banks - believed to be J.P. Morgan & Co. and Bankers Trust New York Corp. - were in danger of exceeding limits on the underwriting of certain securities.
The Fed described its action as a technical move prompted by unusual interest-rate dynamics. Sources said the cause was not a sudden surge in underwriting activities.
Current rules prohibit securities subsidiaries of banks from deriving more than 10% of their revenues from underwriting or dealing in municipal revenue bonds, commercial paper, asset-backed securities and corporate debt and equities. These curbs were instituted in 1987 when the Fed began opening the door to these activities.
The bulk of revenues in these so-called Section 20 subsidiaries comes from activities that have long been permissible for banks, such as dealing in government bonds.
Driving the proposed change is the steep slope of the yield curve - the spread between short- and long-term interest rates - which in the past seven months has diminished the revenues that banks have been booking from government securities activities.
Morgan and Bankers Trust, the two most active banks in underwriting corporate debt and equity, are said to have approached the Fed last month about their concern over bumping up against the 10% limits.
To counteract the problem, the Fed proposed two ways of adjusting the revenue test to account for "unusual changes in the yield curve."
Under the first method, the 10% revenue test would be indexed to changes in the level and slope of the yield curve since September 1989.
Alternatively, Section 20 subsidiaries could elect to measure revenues from restricted underwriting activities - so-calledineligible activities - as a percentage of assets instead of total revenue. The Fed is considering setting the limit at 15% of the subsidiary's total assets.
Additionally, to provide immediate relief to Section 20 companies, the Fed said they could elect to comply with the revenue test on a quarter-to-quarter basis. That's less stringent than the current rule, which requires the companies to meet the 10% revenue test on an eight-quarter rolling-average basis.
Limit Was Increased
Initially, the revenues generated by "ineligible securities" couldn't exceed 5% of total revenues from all Section 20 securities activities. In 1989, the Fed added debt and equity securities to the list, and raised the revenue threshold to 10%.
"We're pleased that the Fed is addressing the issue, and that they recognize that there are some fundamental problems with the whole revenue test," said Sarah Miller, a securities lawyer for the American Bankers Association. "But this doesn't address the fundamental issues that Congress need to take care of."
"This is very positive, and I think should be received very favoably by the Section 20 companies," said Melanie Fein, a partner with the Arnold & Porter law firm.
About 25 bank holding companies have established so-called Section 20 companies to underwrite and deal in securities since the Fed authorized the activity in 1987.
The Fed stopped short of increasing the revenue limit outright, and agency officials described the move as an effort to maintain the status quo in the face of falling rates.
But industry sources said the practical effect of the move will be to boost the volume of securities that a bank's section 20 affiliate may underwrite, at least in the current interest rate environment.
In a letter last February, Mr. Greenspan assured Rep. John D. Dingell, D-Mich., that the Fed had no immediate plans to expand banks' securities underwriting authority.
Further changes are expected. The Fed has been fine-tuning a plan to reduce three of the 18 firewalls that it established when it authorized the activity in 1987.
"What the Fed is doing once again demonstrates the need for comprehensive financial restructuring legislation," said Marc Lackritz, executive vice president of the Securities Industry Association. "Without it, we end up with this jury-rigged, Rube Goldberg contraption where a regulatory agency is trying to figure out what perceived loopholes mean in different interest rate environments."
"It should help," said Karen Shaw, president of the Institute for Strategy Development. "It's designed to make the rules more flexible."
Ms. Shaw noted that several money center banks have been pressing the Fed for two years to raise the revenue limit. The Fed may have decided on a different approach because "it gets some of the way there without raising congressional hackles so high," she speculated.