Limits on Interest Rates Gaining Steam on Capitol Hill

Interest rate ceilings, swept away by deregulation in the 1980s, may make a comeback under a proposal that appears to be gaining ground rapidly on Capitol Hill.

As the House Banking Committee prepares to take action on industry reforms, Rep. Charles E. Schumer (D-N.Y.) is gaining adherents to his notion of a “core bank” that would have to peg its interest rates to U.S. Treasury instruments in return for the right to accept insured deposits.

Customers who want higher rates would have to put their deposits in bank affiliates that would not have government insurance and would be likely to make riskier loans.

Supporters see the idea as a way to prevent abuses of the deposit insurance system. Critics warn against reregulation of interest rates--and against another part of the core banking proposal that would put stricter limits on the amount a bank could lend to one borrower.

Both camps agree that the proposal would shrink the industry’s insured deposits by as much as $1 trillion of its current $3.5 trillion total.

“It will force a substantial contraction of what we now call banks and thrifts” with results that are hard to predict, said analyst Bert Ely, who has studied the issue for the Assn. of Bank Holding Companies.

Ely called the proposal an effort “to turn back the clock to an earlier, simpler time” when regulators, not markets, set bank interest rates.

Even so, the Schumer proposal “is definitely picking up steam,” said Karen Shaw, president of the Institute for Strategy Development.

“It has a lot of appeal because it is the first so-called new idea to come up” as the House considers a sweeping overhaul of the banking and financial services industry, she said.

Key allies include House Banking Committee Chairman Henry B. Gonzalez (D-Tex.), who signaled his support last week. The committee is working on the Bush Administration’s banking-reform package and is expected to complete its work on the bill next week.

Federal Deposit Insurance Corp. Chairman L. William Seidman is also reported to favor major elements of the approach.