Banks doff 'conservative' gloves to deal with hotter competition

United States banks are taking more risks today. They've been driven to do so by hot competition. A growth ethic has also taken hold, especially at (formerly) aggressive banks like Continental Illinois. The Continental Illinois failure, banking analysts say, may temper bankers' appetite for high-risk investments. It probably also will slow the campaign by banks to free themselves from more and more government regulation.

Nonetheless, Edward J. Kane, a professor of economics and finance at Ohio State University, sees three key areas that are driving banks to take more risks these days compared with a decade or so ago:

* Technology - telephone and computer systems - has made it easier to gather funds overnight in huge amounts and has tempted banks to put these resources to work in ''iffy'' loans.

* Volatile interest rates have put banks and thrifts off balance. It is easy to understand that a bank will lose money if it lends money at 10 percent and the rate it has to pay to attract new money goes up to 12 percent. But even if a bank lends at a floating rate - one that is adjusted for every rise in such basic rates as the prime or the London interbank - it can still be strapped. This is because the interest rate a bank is paying for its funds can go up overnight, but the rate it receives in interest from its outstanding loans is adjusted less quickly - three months, six months, a year. That lag creates an imbalance between assets and liabilities and the bank loses money.

* A breakdown in the rules of the game has pitted banks against aggressive nonbank financial institutions. Competitors include firms such as Merrill Lynch and others with their money-management accounts (on which you can write checks and receive a consolidated statement of the account, just like at a bank), vastly diversified credit-card companies such as American Express, and financial supermarkets such as Sears.

This competition has caused banks to become more aggressive and to try to maximize the return on their assets in order to improve their earnings. Moreover , because all national banks, whether their financial structure is shaky or not, receive FDIC coverage at the same cost, some analysts say this is an incentive to take extra risks - a safety net that allows banks to perform ever more daring financial acrobatics.

In the case of Continental Illinois, all deposits, even those above $100,000, were guaranteed. That has not always been the case with failing smaller banks. Banking consultant Carter Golembe notes that this raises the question of discrimination: ''Not only is this (the Continental bailout) viewed as unfair but also as a course of action likely to drive depositors toward the very largest institutions, particularly when there is a general concern about the stability of the banking system.''

Mr. Golembe adds that the FDIC was acting as an ''economic stabilization agency'' in the Continental bailout and some arm of the federal government would have had to intervene even if deposit insurance and FDIC merger-making did not exist.

The FDIC's precedent in the Continental Illinois case bothers Rep. Fernand J. St Germain (D) of Rhode Island. Faced with the massive liabilities of federal deposit insurance, he says, federal regulators must avoid closing down any large bank. The result is ''a nursemade-type regulation'' that forces the government to take over bad loans in a failing bank's portfolio and lets other insured banks take over the good loans.

The House Banking Committee, chaired by Representative St Germain, is scheduled to hold hearings beginning Sept. 18 on the Continental Illinois takeover and the issues involved. Because ''banks respond to increased government protection by taking on greater risk, the Continental Illinois rescue could greatly affect bank safety and soundness in the longer term,'' St Germain contends.

Daring is a word not usually associated with banking. In industries such as venture capital, money-management, and insurance, high risk is a factor. Banks, on the other hand, like to be regarded as conservative. Even though the FDIC seal (or FSLIC, for thrift institutions) gives a degree of assurance, depositors will likely avoid banks they don't trust.

Opinion is divided about how to keep banks on safe ground, and here is where the Continental Illinois problem ultimately finds its way back to the long-running debate over the deregulation of financial services.

The Continental crisis, many feel, may slow the pace of deregulation. But there are as many arguments being advanced for fewer regulations, to prevent a recurrence of the Continental problem, as against.

''It's certainly not going to help the public attitude in general,'' says Fritz Elmendorf of the American Bankers Association, ''but there is general agreement that the Continental problems did not relate to deregulation.''

Most bankers argue for fewer federal fetters so that banks will have a ''level playing field'' with the financial concerns that are challenging them. But financial service firms claim that the FDIC, the Fed, and customer loyalty already give banks huge advantages and that any further diversification of banks could erode safeguards against conflicts of interest erected after the 1933 bank panic.

In the wake of the Continental Illinois failure, the deregulation of financial services probably will continue, for it is driven in large part by technology and market forces. Money can move fast, deals can be made in a split second, and customers have shown a preference for the convenience of multi-branch banking, automatic teller machines, and discount brokerage services.

The House Banking Committee hearings on Continental Illinois may result in recriminations, and Congress and federal agencies could slow banking deregulation if it is shown to be jeopardizing the financial system. A more immediate result, however, seems likely to be even tougher examinations by federal authorities of the quality of loans being made by American banks.

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