WASHINGTON - Regulators defended restrictions on merchant banking activities on Capitol Hill Tuesday, saying their rule governing equity investments by financial holding companies and a related capital proposal reflect the wishes of Congress.

Federal Reserve Board Governor Laurence H. Meyer acknowledged that the Gramm-Leach-Bliley Act grants banks broader investment powers, but reminded lawmakers that the bill also set limits on how far they may delve into nonfinancial investments.

The landmark 1999 law "imposed limits on bank funding of portfolio companies owned by the bank's parent holding company and on cross-marketing activities between banks and portfolio companies owned by the financial holding company," Mr. Meyer said during testimony before the House Financial Services subcommittees on financial institutions and capital markets. "These restrictions were also intended to reinforce the separation between banks and commercial companies owned in reliance on the new merchant banking authority."

Mr. Meyer was responding to criticism that the rules are too restrictive and hamper financial holding companies' ability to compete with other firms.

One of the rules was issued jointly by the Fed and the Treasury Department in January. It governs the operational requirements for firms that make merchant banking investments. It says, for example, that financial services companies cannot be involved in the day-to-day operations of the firms they invest in.

Industry representatives, backed by the subcommittee chairmen Reps. Spencer T. Bachus, R-Ala., and Richard H. Baker, R-La., said that will make it difficult for banking company executives to monitor their investments.

If a venture becomes troubled, the banking company should be able to bring in its experts, Rep. Bachus said.

Mr. Meyer responded that, in certain cases, the rules automatically permit involvement in an investment that becomes troubled, and reiterated that regulators were simply trying to honor provisions of the law that limit the mingling of banking and commercial ventures.

"We did not put into legislation things like holding periods and routine management. You did, and I assume you did it to ensure the separation of banking and commerce. We are merely reflecting what you did," he said.

The chairmen said they would write the Fed outlining their concerns on the matter.

Another issue got a more solid promise of action from lawmakers. Banking officials testified that regulators' interpretation of the law puts banks at a competitive disadvantage. A cross-marketing restriction prevents bank affiliates of financial holding companies from marketing services through companies in which the holding company has made a merchant banking investment, they said.

That puts banking companies at a disadvantage, they said, because the law explicitly allows such arrangements by insurance companies. Rep. Bachus said he and Rep. Baker would consider introducing a bill to fix the inequity.

The second rule, proposed by the Fed, would set capital requirements on merchant banking investments and drew heated objections from the industry.

In response, the Fed issued a softer rule in January.

The Fed was worried that if banks used too much debt to finance a venture and the stock market or economy took a dive, the industry's wellbeing could be at risk, Mr. Meyer said.

The Office of the Comptroller of the Currency had initially worried that the capital requirements would apply to investment arms, such as small-business investment corporations, that predate Gramm-Leach-Bliley. Comptroller John D. Hawke Jr. said the OCC is satisfied with the revised capital proposal.

"The OCC favors the approach adopted in the recent proposal," Mr. Hawke said. "We believe that the revised capital proposal promotes the continued conduct of private equity investments while maintaining safety-and-soundness principles and preserving the intent of Congress to promote bank investments in small businesses through the SBICs."


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