Gov. George E. Pataki raised industry eyebrows last week by backing legislation that would let insurance and securities companies merge with New York-chartered banks.
It was quickly hailed as an effective state government response to Capitol Hill's plodding efforts to reform U.S. financial laws. But experts cautioned that New York banks would still be hamstrung by federal laws and regulations.
"It's not going to allow for any substantial restructuring of financial services without federal legislation," said David L. Glass, a banking lawyer at Rogers & Wells in New York. "It's really a cleaning up of New York law."
"This is no substitute for Congress acting this year on financial modernization," agreed L. Thomas Block, senior vice president of government affairs at Chase Manhattan Bank.
The Pataki plan would repeal New York's so-called "mini Glass-Steagall" that mirrors the federal law separating commercial from investment banking. It would let banks conduct insurance and securities underwriting through direct subsidiaries, and insurance companies and securities firms could buy or invest in banks.
State-chartered banks also would be able to make limited merchant banking and real estate investments.
Like the federal legislation, the New York bill would create wholesale financial institutions-often called "woofies"-that are not backed by the Federal Deposit Insurance Corp. A New York woofie could only accept initial deposits above $100,000 and could be owned by nonbanks.
And without federal legislation, New York woofies could offer checking and savings accounts or commercial loans-but not both.
However, existing federal laws and regulations would prevent state banks in New York from using these powers.
The Glass-Steagall Act prevents mergers between banks and securities firms, and the Bank Holding Company Act prohibits banks from underwriting insurance.
Federal regulators also have the authority to reject underwriting or other risky powers for state-chartered banks, and the Federal Reserve Board could declare a bank's buyer a holding company, which would subject the securities or insurance firm to extensive oversight.
Elizabeth McCaul, acting superintendent of banks in New York, agreed in an interview last week that federal law cannot be preempted.
But, she contended, "companies could use the New York charter ... to move forward with a much broader panoply of powers than has been available previously."
Assuming the New York law is adopted, a securities or insurance company could offer all financial services but retail banking through a woofie. Retail banking could be conducted through a thrift charter.
"If the federal law doesn't pass, New York banks will still gain broader powers and greater flexibility to compete," said H. Rodgin Cohen, a partner in the Sullivan & Cromwell law firm in New York.
Though the plan has been blessed by Merrill Lynch & Co., Citigroup Inc., and other big players, its fate in the state Legislature remains uncertain.
The heads of the banking committees in the state Assembly and Senate are expected to introduce the legislation this week and could advance it under expedited procedures before adjournment this summer. However, New York lawmakers could be distracted by a brewing budget battle.
Ms. McCaul predicted the proposal would play well in Albany because financial services companies play an important role in the state's economy.
"The governor has been very interested that the state charter is the most attractive state charter in the nation," Ms. McCaul said. "This is very powerful legislation. History has shown states have been incubators for change."
New York Bankers Association president Michael P. Smith said he is worried that industry executives will mistakenly assume that the New York bill eliminates the need for federal legislation. But, he added, "It certainly turns the heat up a notch on financial modernization."
Mr. Block agreed that the New York legislation serves as "a little nudge on the Washington scene to get moving."
But sources on Capitol Hill said they are still studying Gov. Pataki's plan.
"It was a surprise," a House Banking Committee spokesman said. "People have not come to any conclusion on how it would relate to the financial modernization bill."