Federal Reserve Board Chairman Alan Greenspan, weighing in on one of the most controversial parts of financial services reform, said Thursday that bank holding companies should be allowed to enter nonfinancial businesses.

Mr. Greenspan told lawmakers that banking companies should be allowed to operate "a small basket" of nonfinancial businesses.

The Fed chairman made his comments at a House Banking subcommittee hearing on financial reform. Three bills expanding financial industry powers have been introduced, and one by Rep. Marge Roukema would allow bank holding companies to earn up to 25% of their income from nonfinancial business.

"A small permissible basket would establish, in effect, a pilot program to evaluate the efficacy of further breaching of the banking and commerce wall," Mr. Greenspan said, but he did not endorse 25% or name any other income ceiling.

Legislation sponsored by House Banking Committee Chairman Jim Leach would forbid any mixing of banking and commerce, while a proposal by Senate Banking Committee Chairman Alfonse M. D'Amato and Rep. Richard Baker would eliminate all barriers.

Though Mr. Greenspan strongly endorsed new industry powers, he said federally insured institutions should not be permitted to enter new business directly. He attacked new rules that allow national banks to enter new businesses through direct subsidiaries rather than holding company affiliates.

Mr. Greenspan's comments were a direct challenge to rules issued by the Office of the Comptroller of the Currency in November.

Testifying before House Banking's financial institutions and consumer credit subcommittee, Mr. Greenspan said banks would gain an unfair advantage over competitors if they are allowed to launch businesses such as insurance sales through operating subsidiaries.

"We must, I think, be continually on guard that the subsidy provided by the safety net does not lead outside the institutions for which it was intended and provide a broad subsidy to other kinds of activities," he said.

But Mr. Greenspan may have already lost that battle. Both Reps. Leach and Roukema would put the comptroller's operating subsidiary rule into law.

Rep. Roukema, who leads the financial institutions subcommittee, told Mr. Greenspan that lawmakers are unlikely to drop the provisions.

Testifying later, Comptroller of the Currency Eugene A. Ludwig denied that federal deposit insurance provides bank subsidiaries a competitive advantage over nonbanks.

"Banks actually face higher costs than other financial service providers when the costs of examinations, reserve requirements, and safety and soundness and compliance regulations are considered," Mr. Ludwig said.

Mr. Greenspan also reiterated his opinion that the Federal Reserve should continue to regulate holding companies that own a bank, though he did carve out an exception.

Many industry trade groups have argued that regulators should concentrate on specific subsidiaries or products and keep holding company supervision to a minimum.

The Fed chairman, however, said regulators cannot ignore holding companies. "In all major institutions, risk management is accomplished at the holding company level," he said. "We cannot subject taxpayers to the losses that would result without full umbrella supervision."

Nonfinancial companies that own thrifts would be allowed to make "longer-term divestitures" to comply with new laws, he said.

As a compromise, however, Mr. Greenspan said holding companies that own small banks could be exempt from Fed oversight. "A bank which is a minor part of such an organization can be protected through adequate bank capital requirements" and restrictions on loans to the parent company, he explained.

Under Rep. Leach's bill, the Fed would regulate financial services holding companies, while Rep. Roukema's and Sen. D'Amato's bills create a National Financial Services Committee to draft holding company regulations. The Fed would be one of many voices on the committee, which would include other banking and financial regulators as well as other government officials.

Other financial regulators testifying Thursday, however, said Fed oversight of diversified holding companies would be inappropriate.

Securities and Exchange Commission Chairman Arthur Levitt said securities companies should not be subjected to a "bank-centered regulatory scheme" if banking is only a small part of overall operations.

Mr. Levitt also complained that current proposals would allow some bank securities operations to escape SEC oversight.

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