California community banks are urging state lawmakers to enact legislation that would make it easier for them to grab a chunk of the state's deposits and use that money to lend in their communities.

Though all California banks are eligible to solicit deposits from the state's $2.1 billion short-term-deposit fund, less than a third of the 350 community banks actually do so. The reason: Many are turned off by a law requiring that participating banks back state deposits with 110% collateral, such as U.S. or California bonds.

One lawmaker has introduced a bill calling for an examination of the state's pooled-deposit program. The legislation would ask the California State Library to determine what efforts could be made to make state government funds more attractive to small banks while ensuring that the state is getting the best return on its investments.

If the research bodes well for California community banks, a bill may be introduced to encourage more banks to bid for state deposits. It would be the first legislation in the country geared toward increasing the participation levels of community banks in state deposit programs.

"We would like to see the pooled-money account go to smaller banks in the state, because smaller banks are more directly involved with lending to their immediate communities than the larger banks," said William George, chief consultant to the bill's sponsor, Rep. Lou Papan. "This would assist them in liquidity, which would help them to function better."

Some bankers are calling for legislation to loosen the collateral requirements, an issue Mr. George acknowledged is always "touchy." Indeed, California Treasurer Philip Angelides has publicly expressed reluctance toward any relaxation of collateral requirements, in light of the notorious bankruptcy fiasco of Orange County, Calif., in 1994.

"We have to avoid any increased risk and any perceived impropriety," Mr. George said. "But I think you could satisfy the [state's] prudent-person standard and still change the collateral requirements."

A spokesman for Mr. Angelides said the Treasurer's office is currently reviewing Rep. Papan's bill.

Craig Hudson, executive director of the California Independent Bankers, said that the legislature might want to consider loosening restrictions for banks that are already well-capitalized.

"If a bank has a lot of capital, the state could require that deposits from the pooled fund only be 50% collateralized by the bank," Mr. Hudson said. "Of course, there would be mechanisms in the law to assure safety and soundness."

Mr. Hudson added that if the state does not find ways to open the door further for smaller banks, state funds - a good chunk of which are deposited in Charlotte, N.C.-based Bank of America - may be used to grow communities elsewhere.

"There is a realization with certain state legislators that the big banks aren't here anymore, so there's a lot less money going into the state," Mr. Hudson said. "If we get more money to the local institutions, we can do a lot more for the local communities."

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