One plank in the U.S. Treasury's proposal for modernizing the financial system would allow commercial firms to own banks. It should not be approved. Right now, it would raise very little of the much-needed capital for the banking system. What's worse, from a broad philosophical perspective, it would eventually produce a corporatist type of state, in which power is concentrated in fewer decision makers, free markets are suppressed and economic dynamism is stifled.

Not now but over a period of time, the joining of industry and banking will produce mammoth entities. These combines will have a strong influence on the flow of credit and thus on business competition. A large corporation that controls a big bank will give in to the temptation to use it for extending credit to those who can benefit the whole organization. The captive bank will attract low-cost funds through insured deposits and will deploy them to finance retailers, jobbers, manufacturers and individuals who further the distribution of the parent's products and services. The bank will be inclined to withhold credit from those who are, or could be, competitors to the parent corporation.

Thus, the cornerstone of effective banking, independent credit decisions based on objective evaluation of creditworthiness, will be undermined. Instead, credit decisions will be subordinated to the broader business interests of the parent corporation. This process will chip away at the traditional arms-length relationship between creditor and debtor, corrupt the normal contractual presumptions underlying debt obligations and foster economic inefficiencies.

For monetary policy, the merging of banking and commerce also will be detrimental for at least two reasons. The first is that no matter how many times the authorities may say the opposite, in an emergency the safety net that now covers large banking institutions deemed to be "too-big-to-fail" will have to be extended to shield their parent corporations as well. Otherwise, the bank will inevitably be vulnerable to huge withdrawals of deposits.

Some may claim that this risk can be avoided through strict fire walls between a bank and its parent. That is naive. There are practically no benefits from a passive relationship between a bank and business corporation. Historically, banking is not consistently more profitable than well-run businesses. Nor can banking profits in one phase of the business cycle predictably offset a temporary slowing in business profits.

Therefore, the only kind of linkage between a large corporation and a large bank that is likely to happen is an intimate one. Ultimately, the government will have little choice but to extend the safety net to the combined entity. Naturally, there will be a quid pro quo. Government will demand -- and get -- supervisory authority extending beyond the bank to the parent corporation. The result will be an expanded safety net but greater government intrusion into the private sector and official sanctioning of increased business and financial concentration. All are adverse to the public interest.

There is a second detrimental impact on monetary policy. When large commercial firms control big banks, support for a steady anti-inflationary monetary policy will wane. There is a basic difference between banking and industry. Banks are the channel through which the central bank tries to achieve its objectives. By contrast, business corporations are the targets. It is their profits that are restrained or enlarged through monetary policy. Consequently, it is in their nature to have more of an inflationary bias than independent financial institutions.

As for our long-term economic growth potential, the creation of giant banking-industrial combines will have numerous detrimental consequences. It will create a powerful, self-perpetuating elite. It is folly to believe that government would stay aloof from this elite group. Through the back door will come an insidious form of "industrial policy."

This industrial-banking-governmental leadership group will become highly protective of existing organizations. For many corporations and very wealthy families, the emergence of a corporatist state in which there is an elitist control over the economy may be quite desirable. Economic inefficiencies can be covered up. Downside economic risk can be limited through the safety net.

However, for most Americans, this anti-growth and elite-managed industrial policy would incite envy and dull economic aspirations. Economic renewal and vitality would be retarded as our tradition treatment of healthy, free-wheeling markets gave way to discriminatory treatment of emerging businesses and the overall discouragement of market disciplines.

For the ordinary shareholder, the conglomeration of banking and business is another way of subverting the shareholder's role. If a corporation has sufficient excess cash to invest in a bank to control it, the better alternative would be to return that cash to the shareholders. They can then make their own decisions about whether to invest in a bank. This would encourage economic democracy rather than erode it.

In the near term, the likelihood of major business corporations buying control of big banks is gratefully small. Few corporations have expressed interest in doing so. And one wonders how many AA- and AAA-rated companies have the financial wherewithal to acquire a major bank at this stage of the business cycle.

To be sure, many large business corporations have developed extensive financial activities outside banking. They operate captive insurance companies. Many run huge finance companies such as GMAC and IBM Credit. Some have built multifaceted financial enterprises as General Electric and Sears have done. A few have acquired savings and loan associations. So far these activities have not posed a general threat to our economic system, because even the largest involvement in the financial sector provides limited scope for conflicts.

But approval of major corporations controlling the biggest banks in the country is another problem entirely. It certainly isn't allowed in any other major industrial country, even in places like Germany, where banks are permitted to own significant equity stakes in commercial firms.

Rehabilitation of our banking system is of crucial importance. It is an essential prerequisite for getting out of recession and for achieving sustainable economic growth in the 1990s. Improving our banking system requires, among other things, a deposit insurance format that will make banks prudent lenders with strong balance sheets. It requires a program of resolving troubled banks and thrifts that will improve lending margins and profits for healthy survivors. It requires authorization of full nationwide deposit banking. And it requires centralized supervision over all institutions and markets.

It also requires enhanced bank capital. But that capital should be injected by private investors through the free operation of the marketplace. Let us not try to solve the problem of insufficient capital through direct ownership and control of banks by commercial enterprises and thus create a thicket of future problems that will pose a far greater challenge to our economic democracy and our way of life.

The writer is president of Henry Kaufman & Co. Inc., a financial management and consulting firm in New York.