Banking is and always will be pervasively affected by regulation. An understanding of market factors alone will never be sufficient to permit a banker to make informed decisions.

Equal parts of regulatory and political ingredients must be mixed with economic reality to divine an intelligent course for any depository institution. In that respect, it is likely that several trends may affect the business and the regulation of banking in this decade.

Populist Decision-Making

As long as C-SPAN continues to provide a theatrical forum, sound bits rather than sound analytical thought will influence bank regulation toward whatever appears to be the most populist (albeit not most economically sound) position of the moment.

Fear of public criticism by all but the most confident and self-assured regulators will continue to encourage a regulatory system that seeks to eliminate all risk.

In so attempting to prevent bank failures, the system will similarly limit avenues of success and profit that would normally accompany prudent levels of risk-taking and diversification.

Broad Regulatory Mandate

Moreover, supervisory efforts to develop uniformity of operation among all financial institutions will further exacerbate their competitive search for the same profitable assets.

To avoid the long-term detrimental effects that this trend can have on the banking industry, the industry should labor mightily to retrieve for federal bank regulators the breadth of latitude and freedom of judgment that has been the hallmark of federal bank regulation for 130 years.

While state regulation will continue to become an irrelevancy because of federal deposit insurance and the trend toward interstate banking, dual regulation will not die.

It will, however, take on a new form that distinguishes powers, diversification, capital, and other operating privileges based on health of the institution. This trend was begun in the Federal Institutions Reform, Recovery, and Enforcement Act in 1989 and Federal Deposit Insurance Corporation Improvement Act in 1991.

It seems destined to be the principal form of regulatory segregation in the 1990s, thus creating a class of banking "havenots" who are likely to slowly wither from the heat of regulatory pressure and the insatiable thirst for quality assets and activities that will be unavailable to them.

Flight from Lending

The risk-based capital regulations have had the incontrovertible effect of steering financial institutions toward low-risk assets such as mortgage-backed securities and high-grade investment securities.

However, the kind of credit reallocation that occurs as institutions seek to so lower their capital requirements, in the long run, will have adverse effects on commercial access to bank credit, dampen economic revitalization, and force the capital markets to develop new funding sources and products to fill the void.

Thus, this force flight from commercial lending ultimately will make banks a much smaller player in that market, even when things change and that business becomes more attractive to them.

This will only increase the competition for less capital-intensive assets, such as mortgage-related securities, investment securities, and consumer loans.

Inevitably, there will not be enough of these products to satisfy the investment needs of all financial institutions. At the same time, commercial credit users will find other sources that reduce their reliance on bank lending.

The result will necessarily be a continued reduction in the number of regulated financial institutions.

Risk/Reward Ration

While some portion of this syndrome which has developed over the last four years is necessary, overzealous emphasis of this aspect of financial regulation communicates the clear message to competent directors and officers that even small mistakes can blacklist them and put their personal net worth at risk.

Giver that risk/reward formula, it seems obvious that a continuation of such a severe enforcement environment will create a systems of adverse selection for bank management. The pool of candidates is likely to contain many who do not have the ability to be where the risk/reward ration is more favorable.

Perhaps the most crippling side effect that can derive from shackling the banking business with the kinds of impediments discussed above is likely to be the increased difficulty that that will pose in attracting new capital.

Capital will not seek out businesses that cannot provide an adequate rate of return, will not appreciate in value, or are subject to seemingly arbitrary and endless business and regulatory intrusions by Congress and regulators.

Indeed, beyond the obvious quantitative business factors that capital will inevitably measure before making an investment decision, is the qualitative element of certainty.

Without the certainty of business opportunities, future earnings and the absence of unanticipated government interventions, investors will not be able to calculate a reasonable return from the banking business that is worth the risk.

Banking will be equally influenced in the next five years by continued and dramatic advancements in technology. Technology has already allowed institutions to leap-frog over many difficult issues, such as interstate banking.

Even without nationwide branches, technology now allows institutions to engage in nationwide lending and deposit taking. As technology continues to develop, it will tend, from a marketing point of view, to break down businesses into their essential component parts.

Thus, banks will find it increasingly difficult to be viewed by the consumers as integrated businesses. Their ability to communicate information instantaneously and act upon the resulting investment decisions will be critical to the relevancy of banks and thrifts in the future.

Interestingly enough, there are as many businesses that are not banks or thrifts that are much better situated today to sell and communicate information to vast arrays of consumers.

Consider, for example, the marketing possibilities and pure technological punch that joint ventures of major communications, computer, and even utility companies can provide to a seemingly captive audience of consumers through the phone line that enters every household.

Local-Global Polarization

The chasm between institutions that can best serve local financial needs and those that will compete in a more global market will grow. As long as there are local markets, there will be a need for locally oriented financial institutions.

Indeed, under the Clinton administration, locally oriented banking is likely to be emphasized over national or global banking.

However, this focus may not be entirely positive even for those who would characterize themselves as local institutions. An increasing political sensitivity for consumer issues, lifeline banking, and subsidized community banks is likely to once again raise the cost of doing business for banks and thrifts throughout the country.

Agency Consolidation

Everything written to date by the Clinton administration about the banking agencies has been critical of the redundancies and overlapping jurisdictions in the system.

It thus seems clear that we will continue to see legislative proposals to merge the agencies and, consequently, end the distinct existence of the banking and thrift businesses.

Accordingly, it seems clear that nonconsolidation will be viewed as making sense only if the banking and thrift industries are viewed as addressing different financial and social markets and needs.

On the other hand, if for instance the Office of Thift Supervision and the Office of the Comptroller of the Currency are merged, it is likely that by 2000 the regulatory system would once again be subdivided to identify one federal regulator for global institutions and one for locally oriented community banks.

Every economist, politician, and academic worth his salt will eventually utter the mantra of "deposit insurance reform" whenever the problems of financial institution failures are studied.

While deposit insurance is probably with us for as long as there are politicians in Washington, there will continue to be pressure to reform the present system.

While many forms of deposit insurance have been studied -- lower limit coinsurance, private insurance, etc. -- perhaps an acceptable starting points for this reform may be to approach it in a three-step process over the next decade:

* Private insurers would underwrite uninsured deposits over $100,000.

* The government would reverse its position and become the reinsurer that back-stops the resources of private insurance companies insuring some or all of the first $100,000 of each deposit.

* Deposit insurance could eventually be modified to emulate the "assigned-risk" features of automobile insurance -- while private companies might insure some or all of the deposits of healthy institutions, weak institutions could be insured entirely by the government.

Naturally, as the system were reformed, the nature and scope of regulation would change, particularly where private insurance companies underwrite primary deposit insurance coverage.

Indeed, the inception of this kind of system could reduce the need for government intervention and supervision as bankers are left to satisfy the market standards imposed by their private insurers.

The trend toward some form of mark-to-market or present value accounting seems likely to continue, particularly in light of the Federal Accounting Standards Board's recent pronouncements regarding the accounting for certain securities held by financial institutions.

However, the refinement and application of these accounting principles must be carefully and comprehensively approached to avoid the problems of the early 1980s, when Congress and the DIDC deregulated the liability side of thrifts' balance sheets before deregulating the asset side.

In addition, mark-to-market accounting should not be oversold as some form of financial panacea. The underlying economic realities of a business, not accounting convention, should determine its success.

In that respect, mark-to-market accounting is just one of many tools that can be used to measure financial performance and should be viewed as such.

Staying Ahead of the Curve

It isn't necessarily required nor possible to know the answers to the questions posed by these trends.

It is, however, critical to understand the direction and velocity of these trend lines and have some influence on where they lead if money is to be made in the business of banking.

Mr. Vartanian is a partner in Washington of the New York law firm of Fried, Frank, Harris, Shriver & Jacobson. He was general counsel of the Federal Home Loan Bank Board and an official of the Office of the Comptroller of the Currency.

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