New Banking Legislation Follows National Upturn for Industry

WHEN President-elect Clinton takes office in January, he is expected to face one fewer major economic challenge: The United States banking system, which only a year ago looked as if it were about to slip into the type of financial disaster that characterized the savings-and-loan industry, is turning in its best earnings ever.

Moreover, tough new rules, effective the week of Dec. 21, are expected to enable regulators to move more quickly to prevent bank crashes - and the ensuing erosion of public confidence. The new law requires, among other steps, that banks set aside two cents of every dollar in deposits as a cushion against losses.

The increasingly upbeat assessment of the banking industry can only come as welcome news to the Clinton economic team; escalating costs associated with the cleanup of the thrift industry - running into the hundreds of billions of dollars - has been a recurrent nightmare for the Bush administration.

The relatively rosy banking scenario contrasts sharply with the political drama faced by another newly elected Democratic administration when it took office 60 years ago next year: In 1933 the incoming Roosevelt administration had to first shore up the troubled banking system before it could enact legislation to rejuvenate the economy.

"We're definitely seeing a national upturn for the banking industry," says Robert Foley, an analyst with Veribanc Inc., a bank rating and research firm in Wakefield, Mass. "Despite some regions with special problems for banks, such as California, where the economy is in trouble, the credit problems linked to banks have definitely declined."

Wall Street investors, meantime, continue to favor selected bank stocks.

Through the first nine months of 1992, the US banking industry racked up a record $24.1 billion in profits. And 1993 is shaping up as also good, experts say. The industry's previous best year was 1988, when US banks earned $24.9 billion.

Not all industry experts are euphoric about the well-being of the nation's 11,600 commercial banks.

Even generally upbeat analysts, such as Prof. Paul Nadler, of Rutgers University, in Newark, N.J., argue that the industry must modernize to remain competitive with well-financed and aggressive new nonbank "banks," ranging from consumer companies like Sears, Roebuck & Co. and American Express, to commercial credit providers such as General Electric. Moreover, foreign banks continue to make inroads in the US.

Several months ago federal bank regulators predicted that about 20 banks and at least 20 thrift institutions might not be able to meet the tough new bank standards. Independent presidential candidate Ross Perot referred to this problem as a "December surprise." But it appears that the biggest surprise is that there will be no surprise - that only a few troubled institutions may require federal intervention. "The bank failures are mainly behind us," Professor Nadler says.

Banks are currently paying depositors about 3 percent interest on short-term savings accounts. The banks then take that money and buy long-term US government Treasury bonds that earn between 5 and 7 percent interest. Banks are clearly having more fun lending to Uncle Sam than making commercial loans - the industry's traditional business. According to federal data, as of June the investment portfolios of banks - where their assets are invested - stood at $734 billion, compared with only about $550 billion

in outstanding loans to businesses and industry.

Tom Miller, a policy analyst for the Competitive Enterprise Institute, a Washington think tank, says the gains for many banks resulting from the interest rate spread "are illusionary," constituting a "false spring."

Mr. Miller is concerned that when interest rates start to rise, banks will have to increase payments to depositors to hold existing accounts; at the same time, banks could sustain losses on their government bonds, since the value of bonds drops as interest rates climb. Current federal deposit insurance gives bankers too much latitude to take risks, he says.

Edward Kane, a finance professor at Boston College, says that much of the upbeat news on banking is "propaganda" and that lawmakers and regulators need to remember that there would be politically unacceptable risks for saddling the American public with another costly bailout, as occurred with the thrift industry. Professor Kane says that about one-sixth of the nation's commercial banks remain "troubled" and that the industry, despite having made gains, is far from being out of the economic woods.