Banking's Fire Walls

FINANCIAL returns are coming in for 1993 and one clear winner is emerging: Mutual funds, which again were at the front of the class compared with bank certificates of deposit or savings accounts. US stock funds actually outperformed the Standard & Poor's 500.

Thus, it comes as no surprise that many commercial banks would like to ride the boom in mutual funds. Most large bank-holding companies now offer mutual-fund products, either through subsidiaries or as agents for outside companies. But some banks want more. First Union Corporation, in Charlotte, N.C., purchased a fund manager last year, Lieber & Company. Pittsburgh's Mellon Bank Corporation recently took an additional step: It agreed to merge with Dreyfus Corporation, the giant mutual fund company, in a transaction estimated at $1.7 billion.

The movement of banks back into the securities business shows how dramatically the political landscape has changed in the United States. In the 1930s, federal regulators sought to get banks entirely out of the securities trade, following the collapse of many financial institutions during the Depression. But since the 1960s, in particular, the regulatory fire walls keeping banks out of the securities business slowly have been coming down. Nor is the erosion of fire walls restricted to mutual funds: More commercial banks are moving into corporate finance, once largely the province of giant investment banks.

Profits for commercial banks rose for the second year in a row in 1993, helped by low interest rates, which reduce banks' borrowing costs. But if interest rates begin to climb, banks will find it tougher to keep profits high.

US commercial banks find themselves under continued challenge from ``nonbank banks,'' such as American Express Company and Ford Motor Company. Clearly, diversification - being able to offer a wide array of services and products - is in the best interests of the banking system and consumers. The taking down of regulatory fire walls is appropriate, provided, as is now the case, that the banking trade (involving customer deposits) and the securities trade (the stock market) do not directly mingle.

As in a good mutual fund itself, some portfolio balance is in order: Regulators should allow banks to diversify broadly; but regulators also need to keep customer safety at the top of their agenda.