Goldman Sachs and Morgan Stanley, the last big independent investment banks on Wall Street, will transform themselves into bank holding companies subject to far greater federal government regulation in a radical move that will reshape US high finance.

Goldman Sachs and Morgan Stanley, the last big independent investment banks on Wall Street, will transform themselves into bank holding companies subject to far greater federal government regulation in a radical move that will reshape US high finance.

"We believe that Goldman Sachs, under Federal Reserve supervision, will be regarded as an even more secure institution with an exceptionally clean balance sheet and a greater diversity of funding sources," said Lloyd Blankfein, the chairman and chief executive of Goldman.

The Federal Reserve said Goldman and Morgan Stanley requested the change themselves as Congress and the Bush administration rushed to pass a $700bn rescue package for financial companies. The US central bank said early yesterday that it has approved the request.

Banking analysts said the shift in the banks' status was a blunt acknowledgment that their model of finance and investing had become too risky, and that they needed the safety net of bank deposits that had kept big commercial banks relatively safe amid the recent financial sector turmoil created by the sub-prime mortgage crisis and subsequent credit squeeze.

The change in the way the two big investment banks operate marks a turning point for the high-rolling culture of Wall Street, with its huge bonuses and lavish executive perks. It effectively returns Wall Street to the way it was structured before Congress passed a law, known as the Glass-Steagall Act, during the Great Depression separating investment banking from commercial banking.

By becoming bank holding companies, the firms are agreeing to significantly tighter regulations and much closer supervision by bank examiners from several government agencies, rather than only the Securities & Exchange Commission. Now, the firms will look more like commercial banks, with more disclosure, higher capital reserves and less risk-taking.

For decades, firms like Morgan Stanley and Goldman made massive profits by taking bold bets with their own money, often using enormous amounts of debt to increase their profits, with little outside supervision.

They were dominant players on Wall Street, landing headline-grabbing deals and advising companies and governments around the world on mergers, stock offerings and restructurings. But that method of doing business collapsed in recent weeks as investors lost confidence in the way they made those bets during the recent credit boom, when investment banks expanded into many different types of investments, the risks of which were not easily understood.

During the financial sector panic, clients pulled out their money, share prices plunged and these banks and the entire US investment bank sector nearly collapsed. JP Morgan Chase acquired Bear Stearns this spring in a fire sale brokered by the government, while Bank of America has agreed to buy Merrill Lynch for $50bn. Lehman Brothers, one of Wall Street's most venerable institutions, fell into bankruptcy.

In exchange for accepting more regulation, the companies will have access to the Federal Reserve's lending facilities. It should help them avoid the fate of Lehman, Bear Stearns and Merrill Lynch.

The decision also raises questions about whether the Federal Reserve will seek to regulate hedge funds, many of the largest of which closely resemble investment banks like Goldman.

As bank holding companies, the two banks, whose shares have lost about half their value this year, will have to reduce the amount of money they can borrow relative to their capital. That will make them more financially sound but will also significantly limit their profits.

As bank holding companies, Morgan and Goldman will have greater access to the discount window of the Federal Reserve, which banks can use to borrow money from the central bank. While they were allowed to draw on temporary Fed lending facilities in recent months, they could not borrow against the same wide array of collateral that commercial banks could. The discount window access for investment banks is expected to be phased out in January.

It will take time for Goldman and Morgan to transform into fully regulated banks because they cannot quickly reduce how much money they borrow relative to their assets.

The Fed and the SEC have had examiners at investment banks since March, giving regulators huge insight into their operations.

Both banks already have limited retail deposit-taking businesses, which they plan to expand. Morgan Stanley had $36bn in retail deposits as of August 31 and Goldman had $20bn in deposits.