Amid concern that bank deposits are not growing enough to cover loan demand, bankers are urging their peers to back legislation that would expand the Federal Home Loan Bank System.

"The funding issue is not going to go away," said Jeffrey L. Plagge, president and chief executive officer of First National Bank of Waverly, Iowa. "The Home Loan system is a willing partner for banks, and we need to support them."

Mr. Plagge and representatives of the Home Loan banks addressed bankers last Thursday in a telephone briefing sponsored by the American Bankers Association.

Legislation introduced in both houses of Congress would ease membership restrictions and scale back collateral requirements for banks with less than $500 million of assets. Banks are currently limited to borrowing only against housing loans, but the bills would let them use agricultural, small-business, and community development loans as well.

Critics say the new rules would take the Home Loan Bank System too far from its original mission. But banking representatives insist the changes would make it easier for the system to help community banks in rural areas.

"Public policy clearly is on the side of keeping local banks as the primary credit source in their community," said James R. Faulstich, the recently retired president of the Federal Home Loan Bank of Seattle. "The idea here is not a handout."

About 55% of the nation's 9,000 commercial banks belong to the Home Loan Bank System. Mr. Plagge said the system will become more important to community banks if deposits continue to leave the banks in favor of Wall Street.

"Short term, the problem is only in some areas," Mr. Plagge said. "But long term, you need to know your options."

Since 1987, mutual funds have grown 634%, from $753 billion held to $5.5 trillion at yearend 1998.

At the same time, bank deposits have grown only 1.9%, from $4.1 billion to $4.2 billion, according to Federal Home Loan Bank of Des Moines statistics.

"Traditional funding sources are changing," said Craig W. Jordan, senior vice president of the bank in Des Moines. "Banks need money to make loans, and we want to be able to provide those funds."

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