In the name of maintaining stability, federal regulators have done some huge favors for uninsured depositors over the Now the banking industry is paving the price.

Depositors lost nary a nickel in the failures of Bank of New England Corp., Continental Illinois Corp., and First Republic-Bank Corp.

The banks, of course, were deemed "too big to fail" by virtue of their massive linkages to the financial system. And despite talk that the unwritten bigness policy has been rescinded, many regulators say that big banks will always get favored treatment when the chips are down.

But bankers increasingly argue that the advantage is a millstone for their industry. That's because those who oppose liberalization of banking laws scream "too big to fail" whenever interstate banking, broader securities powers. or other such notions are broached. These critics say that if under some circumstances the government would prop up banks, it must deny them new powers that might increase the risk to depositors and taxpayers.

Big Banks Interested

It's an old story, but it's taking on new meaning as bankers openly debate the merits of "too big to fail" and its implications for deposit insurance.

Some banks - bigger ones, in particular - are willing to discard "too big to fail" and to lower the level of deposit coverage in return for broader powers.

"If the trade-off for some curtailment of deposit insurance coverage is greater geographic and product powers, the industry should get its act together and move ahead on that," said Richard L. Thomas, chairman of First Chicago Corp., in an interview last week.

Many say an insurance roll-back is a political necessity, since Congress - scarred by the thrift industry scandals - needs assurance that new powers won't lead to taxpayer bailouts.

Staunch Opposition

But small banks vociferously oppose reducing insurance coverage. Take away the $100,000-per-account protection, they say, and depositors will flock to big banks that are perceived to be less risky - particularly if "too big to fail" has not been officially abandoned. "We are at an impasse," said Edward Brandon, chairman and chief executive of Cleveland-based National City Corp. "It is not morally right that the safety net helps big banks more than small banks, but it also is not right to deprive regulators of an important emergency tool."

Fresh concerns about the strings attached to deposit insurance surfaced this spring, as Mr. Thomas, Mr. Brandon, and other top officers of some of the nation's largest banking companies voiced frustration with evertightening regulations.

"We are all trapped by the deposit insurance system and the control that system gives Congress, the White House, and our regulators," said Hugh McColl, chairman of NationsBank Corp., last week at a Bank Administration Institute conference.

Controversial Proposal

First Chicago's Mr. Thomas said earlier this spring that bankers "have to curtail deposit insurance if we are going to get more freedom." He suggested that coverage be limited to $100,000 per Social Security number.

That's the kind of talk that independent bankers loathe. They say scaling back deposit insurance without a corresponding and convincing rollback of "too big to fail" would drive customers to bulletproof big banks.

"Mr. Thomas essentially has declared war on the deposit base of the nation's community banks," said Kenneth Guenther, executive vice president of the Independent Bankers Association of America.

Some federal regulators, too, say that big bankers - knowing full well that the government cannot permit their companies to fail - should stop the rhetoric.

It's really a foolish idea," said Harrison Young, director of resolutions at the Federal Deposit Insurance Corp. at a recent conference sponsored by the Federal Reserve Bank of Chicago.

He warned that "millions of synapses" in the financial system would be severed if one of the largest banks failed.

The debate is intense even though "too big to fall" was at least partially addressed in the last banking reform law, the Federal Deposit Insurance Corporation improvement Act of 1991.

Under this law, uninsured depositors at a big failed bank would be protected only if the President and Treasury secretary agreed.

|Implied Promises'

But some legal experts sav the legislative language hedges the issue. The law "doesn't do away with |too big to fail' as much as circumscribes its use," said Stuart Greenbaum, head of the Banking Research Center at Northwestern University. "Though weaker, the implied promises are still there."

William Isaac, a former chairman of the FDIC, said lawmakers should simply pick a date five years in the future at which time big-bank protection would be banned. "That would get the big-versus-small debate off dead center, and give everybody time to prepare," he said.

Mr. Brandon disagrees. Emergency depositor protection is needed, he said, to "help maintain the integrity of the system."

Either way, federal could go a long way toward defusing the issue by solving technical problems and more aggressively exercising powers already in hand, said Herbert Baer, a senior economist at the Chicago Fed.

For example, he said, by harnessing early intervention powers granted in 1991, regulators could fix faltering before crises flare and bailouts become necessary. "That certainly diminishes |too big to fail' as an issue," Mr. Baer said.

But at least two more steps need to be taken, he added: The FDIC needs a better information system to identify insured and uninsured depositors, and the settlements system on foreign exchange transactions must be modernized.

"All involved parties need quick and clear information on where they stand," Mr. Baer said.

First Chicago's Mr. Thomas said several more years might pass before it becomes clear whether the 1991 law has indeed curtailed big-bank protection.

The interim ambiguity, he conceded, will complicate any efforts to roll back deposit insurance coverage and increase bank powers.

As a result, he argued, bankers must move forcefully to counter the public impression that they are being coddled by regulators and Congress. In other words, they must fight for a rollback of insurance coverage and an explicit end to "too big to fail."

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