William J. McDonough, president of the Federal Reserve Bank of New York, warned bankers Friday that European monetary union will hurt several profitable business lines.

Most at risk are foreign exchange trading, foreign currency transfers, and holdings of foreign-denominated core deposits, Mr. McDonough said.

"The move to a highly securitized single-currency European capital market cannot be expected to be completely painless," he told the Bankers' Association for Foreign Trade. "As the main intermediaries of cross-border transactions, banks will bear the brunt of the costs associated with the changeover to a common currency."

European banks are likely to be hardest hit by the adoption, scheduled for next Jan. 1, of a common currency, he said. "The commercial position and earnings of some European banks are likely to come under pressure," he said. "This pressure may accelerate the ongoing restructuring of Europe's banking industry."

Still, he said, monetary union could offer some long-term benefits for U.S. and European banks. "The larger single market will create new opportunities for banks, particularly in the area of investment banking and the cross-border sale of deposits, mutual funds, and other savings products," he said.

In wide-ranging remarks, Mr. McDonough also urged bankers to prepare contingency plans in case the year-2000 computer glitch causes local power and telephone grids to collapse.

"Without certainty that telecommunications and electrical services will be unimpaired by the century date change, banks, like many other types of businesses, face the risk that their own operations could be halted," he said.

Mr. McDonough said all banks should begin immediately testing their computer systems for year-2000 compliance, even though the tests are expensive.

"Failure to test thoroughly can put the operations of a unit or an entire firm at risk, while putting in jeopardy the well-being of the entire financial network," he said.

Despite the importance of fixing year-2000 problems, Mr. McDonough said banks should not cut corners by skipping background checks for consultants brought in to repair the systems. "Any compromise of security simply cannot be tolerated," he said.

Mr. McDonough also reiterated his call made last fall for an overhaul of how regulators supervise large, internationally active banks. Umbrella supervision and revised capital rules are critical, he said. The New York Fed will hold a conference on the supervisory question next month.

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