WASHINGTON - An interim merchant banking rule and proposed capital requirements are unreasonable, unfair, and counterproductive, industry leaders asserted Tuesday.

Speaking at a joint hearing by two Senate Banking subcommittees, financial executives argued that the Federal Reserve Board and Treasury Department defied Congress by the constraints on March 28.

"These restrictions, in all likelihood, will unduly interfere with the ability of financial holding companies to engage in merchant banking - an activity specifically authorized as financial in nature by the Congress," said John P. Whaley, a partner at Norwest Equity Partners, part of the private equity investment business of Wells Fargo & Co.

The Gramm-Leach-Bliley Act of 1999 lets banks, brokers, and insurers combine under parents called financial holding companies. The law permits these firms to make equity investments but left it to the Fed and Treasury to impose limits. The agencies issued a joint rule in March, and the Fed proposed a tough capital standard at the same time.

The industry and some lawmakers have criticized regulators, saying the rules put companies that own banks at a competitive disadvantage.

On Tuesday, Fed Governor Laurence H. Meyer said the agencies have not overstepped their authority.

"The Gramm-Leach-Bliley Act specifically authorizes the board and the secretary of the Treasury to issue regulations implementing this new authority, including limitations that we jointly deem appropriate to protect depository institutions," he said.

The House Banking Committee last week held a similar hearing, at which lawmakers told Mr. Meyer and Treasury Under Secretary Gary Gensler to run final rules past Congress before they are issued.

The Fed's capital proposal would require banks to hold 50 cents for each $1 invested in merchant banking activities, an increase from the 8 cents required now. Industry officials said this increase would put an undue burden on financial holding companies.

"The capital charge will have a real, concrete, and significant impact on institutions," said Jeffrey Walker, a managing partner at Chase Capital Partners. "It will require institutions to raise additional capital for each equity investment. It will do so for no economic reason."

Mr. Walker also blasted the capital charge.

"It should be understood that, if allowed to stand, the 50% capital charge will render uneconomic many of the investments previously made," Mr. Whaley added. "These investments will become uneconomic not because of any change in inherent worth but solely because of an unanticipated change in regulatory treatment."

The executives said the 50% capital charge was based on "cherry-picking" by federal regulators who said they relied on internal risk models at banks and securities firms. Mr. Walker said the Fed looked only at the part of the model that assigned higher charges to riskier investments and ignored the lower charges for less-risky investments.

Mr. Gensler and Mr. Meyer defended the proposed capital increase, arguing that it is necessary to ensure safety and soundness.

Some senators disagreed, saying the 50% requirement would be too high and not necessary to help manage risk. Sen. Charles E. Schumer, D-N.Y., said other alternatives would be less intrusive. "I feel like [regulators] are using Big Bertha, when Small Sally would do," he said.

Banking executives also complained about the interim final rule, which capped investments in new activities at $6 billion, or 30% of Tier 1 capital, and restricted the ability of holding companies to invest in and manage private equity funds.

Frederick Fritz, president of BancBoston Capital, testified that his $187 billion-asset company would quickly run up against these limits.

"It does not make sense to penalize successful, established private equity players who have already demonstrated an ability to manage the risks associated with merchant banking," Mr. Fritz said. "We believe these restrictions are generally unnecessary and create yet another competitive disadvantage for financial holding companies."

Many of the senators and witnesses at the hearing expressed frustration at revisiting the Gramm-Leach-Bliley Act enacted just seven months ago.

"To quote Yogi Berra, 'This is déjà vu all over again,' " said Marc E. Lackritz, president of the Securities Industry Association. "I thought we resolved this during the debates last year."

Mr. Gensler and Mr. Meyer promised to consider all the comments made by senators and industry officials before issuing final rules.

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