It's earnings season again, and U.S. money-center banks are reporting a bountiful harvest of profits from their venture capital and merchant banking businesses.

Flashy as the numbers are, they have raised some questions among investors about sustainability, and among analysts about the strength of the underlying business of retail banking. But bank regulators, whose job it is to find the dark cloud in every silver lining, seem relatively comfortable with the banks' new source of profitability.

The stock market, concerned about banks' ability to keep earnings high in inherently volatile business lines like venture capital and merchant banking, has soured slightly on banks with heavy capital markets gains. On Wednesday, for instance, Chase Manhattan Corp. reported first-quarter earnings well above analysts' expectations, with profit from its global wholesale and investment banking operations up 19%, to $942 million. The same day, its share price fell $2.50, to $78.

Other banks with strong capital markets activities have also seen their share prices fall in recent weeks.

Bert Ely, president of Ely & Associates in Alexandria, Va., asks: "To what extent are the earnings from venture capital and merchant banking masking weakness in the basic banking franchise?" Others wonder about the risk the banking system would face from a sharp economic downturn.

"From a systemic risk standpoint, what happens if all these lines of business have problems at the same time?" asked Michael L. Mayo, an analyst with Credit Suisse First Boston. "Banks are pursuing the same strategies, and the banking system is still untested at this level of capital market revenues through a difficult economic period,"

Regulators, though, argue that the increase in capital market activities has actually had a positive effect on the safety and soundness of the institutions they supervise.

"We have, over the years, encouraged activities that get banks away from a concentration of their business in the intermediation of funds," said James Sexton, director of bank supervision for the Federal Deposit Insurance Corp. "It can have a big cyclical effect on banks when there is a downturn and they have all of their money in loans.

"I am pleased with the diversification banks have made in their products."

This is not to say that they take capital markets activities lightly.

Michael L. Brosnan, deputy comptroller for risk evaluation, said his agency allocates a "disproportionate" amount of resources to the area.

We treat this kind of business with very healthy respect," he said. "We want to make sure it is done right."

And for the most part, he said, even after passage of the Gramm-Leach-Bliley Act, which expanded the range of permissible activities for U.S. banks, the number of institutions that develop extensive capital markets units will probably remain small.

"I think that there is a misperception that now that Gramm-Leach-Bliley is out there, thousands of banks will flock to capital markets activities."

There are about a dozen U.S. banks with the personnel, technology, and capital bases to run large capital markets business. During good times it pays for itself and then some, but in the bad times you have to have staying power."

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