LET BANKS COUNT DEBT AS EQUITY, STUDY SAYS

LET BANKS COUNT DEBT AS EQUITY, STUDY SAYS

Regulatory changes - not expanded bank powers - are the key to making banks more competitive, according to a study by the Federal Reserve Bank of Chicago.

Although allowing bank holding companies to engage in underwriting and other types of financial services will make holding companies more profitable, it's unlikely that banks themselves will become more profitable or more competitive, the study states.Instead, the study advocates regulatory changes that would allow banks to compete more strongly against the commercial paper market in providing low- risk loans.

The study, written by Harbert Baer and Christine Pavel, proposes that banks be permitted to substitute subordinated debt for equity capital. That, the authors say, would allow regulators to increase the capital buffer in the banking system without damaging banks' competitiveness .

Alternatively, the authors propose that high- and low-risk loans be differentiated in determining a bank's minimum capital ratio.

In either case, the authors say, the result would be a more-effective capital market in which bank competitiveness would be determined more by efficiency than by regulation.

Many of the problems faced by banks, the authors maintain, stem from a policy that requires banks to increase their equity-to-asset ratio without regard to the risk of the underlying assets.