WASHINGTON -- Banking regulators may soon have sales practice rules in place for banks that sell their customers government securities and derivative instruments issued by government-sponsored agencies.

The Office of the Comptroller of the Currency, together with the Federal Reserve Board and the Federal Deposit Insurance Corp., is developing the suitability standards under authority granted by last year's Government Securities Act, said Douglas Harris, senior deputy comptroller for capital markets at the OCC.

"I would hope that within a few months we would have something. I don't think we are working on something real complicated, so I would hope that we can do it sooner than later," Harris said in an interview. "It's very difficult to say because we are working with other regulatory agencies."

The suitability standards would apply to the sale of government securities, including Treasury bonds.

They would also apply to the sale of structured notes issued by government-sponsored enterprises, such as the Federal National Mortgage Association and Federal Home Loan Mortgage Corp.

These government agency derivatives, which in some cases have depreciated in value as interest rates have risen in the past year, have been the source of losses for a wide variety of financial and other institutions.

The banking regulators' efforts come as the National Association of Securities Dealers, which has received comments on its proposals, has been working on rules that would apply to securities dealers.

The dealers group will forward its recommendations for government securities suitability standards to the Securities and Exchange Commission, which in turn must go through another comment period and consult with the Treasury Department before taking final action.

Under the Government Securities Act, which was signed into law last year, federal agencies were authorized to improve the sales practices used by dealers that sell government securities.

In passing the act, Congress intended to give regulators the power to develop standard sales practice rules, coveting such issues as sales practice abuses, markups, and churning of accounts.

At the time Congress was considering the legislation, new derivative products were being introduced based on treasury and government agency securities, which are often subject to greater risks than the underlying securities.

In particular, Congress was concerned about the need to develop rules that would account for the new types of government securities that were entering the market. In some cases, these instruments brought -- and have continued to bring -- substantial losses to state and local governments.

But as the banking agencies now work toward setting suitability standards for government securities, they are not drafting suitability standards for other off-balance sheet derivatives, Harris said.

"We think that our current rule, our guidance Section C- 1 of our banking circular, serves not only to protect the bank but also to protect the customers," Harris said. "At this point, we don't think that there's a need to go further.

"National banks following our guidance are unlikely to engage in a transaction that is inappropriate for that customer" Harris said.

In addition, suitability standards applied to other off-balance sheet derivatives, which would include interest rate swaps, would change the nature of the banking industry, Harris said. He maintains that over-the-counter derivatives transactions, similar to other bank services and transactions, such as loans, deposits, and letters of credit, are entered into on a principal-toprincipal basis.

"The bank does not act as broker to or agent for the customer," he said last week at a Commodity Futures Trading Commission advisory meeting. "Bank regulators have not imposed a suitability requirement on banks with respect to other bank products and services."

For example, when a bank makes a loan to a customer, bank regulators do not require that the bank, in order to protect the customer, determine that the loan is suitable for the customer.

"The application of a suitability rule to dealer banks' off-balance sheet derivatives transactions would raise the question of why such a rule should not be applicable to almost all of a bank's transactions with its customers or to all new ,bank products and services that may be developed in the future," Harris said.

"At the OCC, we do not currently believe that it is necessary to make such a fundamental change in the relationships between banks and their customers or, more specifically, in the obligations of banks toward their customers," Harris said. An aide to Rep, Edward Markey, DMass., who crafted legislation to improve the regulation of derivatives, said the derivatives industry as a whole is becoming more complex, making suitability standards even more necessary.

"I think that the increased complexity of the product and the relationship of trust and confidence that develops between the customers and the dealers, makes derivatives a rather different product," the Markey aide said. Meanwhile, Harris said the OCC will continue to study the issue of offbalance sheet derivatives sales and will draft stronger rules if needed.

"If we find that national banks are not following the guidance contained in Section C-1, either to their own detriment or the detriment of their customers, a stronger standard may be required," Harris said.

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