In November the Office of Thrift Supervision returned without action an application by TD Bank USA, a federal savings bank subsidiary of Toronto-Dominion Bank, that would have established a groundbreaking relationship between the bank and Wal-Mart Stores Inc.

An important feature of the proposal was that it would have permitted customers to make deposits and withdraw funds at the cash registers in Wal-Mart stores. In rejecting the application, the OTS said that the arrangement was not permissible, because it might have given Wal-Mart control over TD Bank.

The decision was noteworthy for several reasons. First, the unwillingness of the OTS to approve or even fully consider the application shows a stunning failure of leadership. Clearly, the application raised novel and controversial questions of policy, but the reason the OTS gave for rejecting the application--that the relationship might have given Wal-Mart control over TD Bank--was absurd on its face.

As a wholly owned subsidiary of Toronto-Dominion, TD Bank was clearly controlled elsewhere. The banking regulatory agencies, including the OTS, have long used a facts-and-circumstances test to determine control, but the OTS decision was not based on a facts-and-circumstances investigation, nor was it in accordance with traditional precedents for finding control.

Second, even though the OTS rationale invoked the spirit of separating banking and commerce, it really showed the futility of pursuing that policy in an economic world where services of all kinds are constantly reconfigured to meet the demands of competition. Drugstores gradually expand their offerings to include food and beach equipment, electronics stores open music departments, Ford spins off its thrift, and Sears spins off Allstate Insurance and Dean Witter.

Wal-Mart was apparently testing various ways to reduce the cost of the banking services it already makes available to its customers through financial centers in its stores. These centers, like bank branches, are manned and thus expensive. Automated teller machines have to be serviced. Both require valuable retail floor space.

On the other hand, using cashiers to perform some teller services would have provided a streamlined and less expensive method for Wal-Mart to offer basic banking services, and for TD Bank to attract depositors. Because this would have made these services less costly for both parties, it would have resulted in less expensive banking services for customers.

Savings like this confer real competitive advantages, and for that reason efforts to achieve them cannot be expected to go away. The tissue-thin rationale for the OTS decision has not yet been challenged in court, but if TD Bank and Wal-Mart do not challenge the OTS, someone with a similar plan certainly will.

At that point, the courts will confront a situation much like the one sparked by the Glass-Steagall Act a generation ago. Then, regulators routinely invoked the “spirit” of Glass-Steagall, which was interpreted as mandating the complete separation of commercial and investment banking. However, when the courts actually read the words of the act, they could not find a statutory basis for many decisions, and the separation of commercial and investment banking began to unravel.

Similarly, the notion that a relationship such as the one between Wal-Mart and TD Bank might give a retailer control over a depository institution--and thus violate the separation of banking and commerce--will eventually be overturned by a court. When that happens, a more efficient way of doing business will be available to both retailers and depository institutions, much to the benefit of consumers.

There is also a third lesson in the OTS decision--a more general one, but not less important for that reason. Despite the intentions of its sponsors, the Gramm-Leach-Bliley Act finally exposed the absence of any rational basis for the policy of separating banking and commerce.

Backers of this separation, including some of the act’s sponsors, had argued that if banks were permitted to affiliate with commercial firms, they would provide unfair competitive advantages to their commercial affiliates, and they would be overreached for a bailout if a commercial affiliate encountered financial difficulties.

However, the Gramm-Leach-Bliley Act itself permits banks to be affiliated with securities firms--heavy users of bank credit that are as likely as any other commercial firm to gain a competitive advantage from affiliation with a bank, or to require a bailout. By permitting securities firms to affiliate with banks, Congress showed that it did not actually believe in the hypothetical dangers that have traditionally been cited as the policy basis for separating banking and commerce.

Those who oppose the separation policy--as I do--are frequently asked why they object to it. After all, it is said, there is no clamor for commercial firms to acquire banks, or vice versa.

The proposed relationship between Wal-Mart and TD Bank shows clearly why the separation of banking and commerce is bad policy for a free market economy.

Here, two unrelated entities have proposed a relationship that would clearly benefit consumers--by providing them with lower costs and more convenience in obtaining banking services. Yet, because of a policy for which there is no coherent rationale, consumers are being denied this benefit.

The rejection of the TD Bank application shows why it is now time for Congress--which has already recognized through the Gramm-Leach-Bliley Act that the separation of banking and commerce has no rational policy basis--to renounce this anticompetitive policy once and for all.