The stock market collapse should not dissuade Congress from overhauling a Depression-era law that bars banks from full participation in the securities business, two top federal banking regulators said yesterday.

Comptroller of the Currency Robert L. Clarke and Federal Deposit Insurance Corp. Chairman L. William Seidman told a House panel that their proposals for restructuring the banking industry would prevent a repetition of the wave of bank failures that followed the stock market crash in 1929.

"Opponents of reform will cite {the market nose dive} as evidence that securities activities are entirely too risky for commercial banks. Although such a notion may have some popular appeal, I do not think that it withstands critical analysis," said Clarke, whose office regulates federally chartered banks.

Both Clarke and Seidman, whose agency insures deposits in commercial banks, said banks should be allowed to enter the securities business through separately capitalized subsidiaries.

If the securities subsidiary went sour, the bank would be barred from pumping additional money into it to prop it up, they said. The bank would also be prohibited from lending money to its subsidiary on anything less than an "arms length" basis, using the same criteria it uses to make loans to other customers.

"Clearly if the securities affiliate went broke, the bank would lose all or part of its investment ... the bank's capital would still be adequate -- reduced, but adequate," Clarke said.

Seidman said problems in the Depression arose not because of the intermingling of the banking and securities industries, but because of lax regulation aimed at preventing conflicts of interest.

The Glass-Steagall Act, which separated the two industries, was overkill, he said.

"It was a supervisory problem, not a structural problem," Seidman said. He is proposing an increase in supervision to accompany any expansion of powers for banks, which he said is needed to allow banks to compete with mutual funds, commercial paper underwriters and others encroaching on their business.

Some members of the House Banking subcommittee on financial institutions, supervision, regulation and insurance, expressed skepticism about Clarke and Seidman's assertions.

Their questions focused in particular on the losses in the market collapse of a subsidiary of Continental Illinois National Bank & Trust.

According to Clarke, the Chicago-based bank improperly lent $25 million to its subsidiary, First Options of Chicago Inc., which lost $90 million in the market dive.

The subsidiary executes trades for and provides loans to options traders.

Federal regulators forced the subsidiary to return the loan within 24 hours and the bank signed a consent agreement Monday promising not to exceed lending limits in the future.

"It appears clear the walls of separation are a legal nicety but not a practical reality," said Rep. Henry B. Gonzalez, D-Texas. " ... It concerns me that the parent company will always have an opportunity to bail out a subsidiary in a time of crisis."

But Clarke said, "In my judgment it is an example of how the system works" because the bank was required to take back the improper loan in less than a day.

The subcommittee hearing was one in a series being held during a moratorium on expanded banks powers that took effect in August. The moratorium prevents regulators from expanding bank powers piecemeal until next March, allowing Congress time to work out a legislative solution.

In a statement issued in New York, Edward O'Brien, president of the Securities Industry Association, the main trade group for brokers, said allowing banks to enter the securities markets in the wake of the recent turmoil would be a mistake.

"To make this suggestion at a time of unprecedented volume in the marketplace ... is unwise," O'Brien said, referring to the testimony by Clarke.

"No matter how structured, banks and customer deposits cannot be insulated from a high-risk marketplace," O'Brien said.