A new Colorado law meant to safeguard school districts' funds could inadvertently deprive the state's community banks of tens of millions of dollars in deposits.

By the end of the month the school districts must put the funds they use to repay school bonds into a commercial bank or depository trust company that has full trust powers.

The new requirement is a result of Senate Bill 237, which was passed in April to protect bond funds from misuse by preventing districts from commingling their bond redemption and general funds. However, Colorado State Treasurer Mike Coffman, the law's author, did not realize that only five banks doing business there have full trust powers, according to Barbara Walker, the executive officer of the Independent Community Bankers of Colorado. They include three large, out-of-state companies: Bank One Corp. of Chicago, Wells Fargo & Co. in San Francisco, and U.S. Bancorp in Minneapolis.

Consequently, many of the 200 or so other commercial banks doing business in Colorado collectively stand to lose millions of dollars in school district deposits, which, for some of the smaller banks, make up 10% of the deposit base, she said.

The Independent Community Bankers of Colorado did not protest the bill as it was moving through the General Assembly, according to the state Treasurer's Office. But Ms. Walker said that is because her group had thought the bill implied that banks without trust powers could still accept deposits from school districts, as long as separate administrators watched over the different funds.

The Colorado Bankers Association got the bill amended to allow districts to put their bond funds in more than one bank. Jennifer Waller, the group's senior vice president, says it supported the amended version of the bill, because they thought it struck a fair balance between the needs of banks and school districts.

But now the group plans to seek another amendment, to allow banks without trust departments to accept school district bond funds and outsource the trust business to a third party.

The Independent Community Bankers plans to go even farther. It wants the state to let banks put bond redemption funds into an escrow account. All Colorado banks can offer such accounts, which the group calls a more-than-adequate safeguard.

"Banks don't need an entire trust department to do this - all they need are escrow accounts," Ms. Walker said.

Farmers Bank of Ault lost about $2 million of deposits when two local school districts withdrew their bond redemption funds in the last month. That was a significant hit for a $65 million-asset bank, says Fred Bauer, its president and chief executive officer.

It has replaced those funds with higher-priced certificates of deposit, he said. But Farmers fears that something even more damaging will happen. "We've had really good relationships with these districts," which still have about $3 million of additional deposits at the bank, but they may find it inconvenient to have accounts at two banks and close all their accounts with Farmers.

According to Colorado Deputy Treasurer Benson M. Stein, the law was prompted by scandals at two school districts last year.

At the Elizabeth School District, the state stepped in to repay bondholders when the Treasurer's Office realized that the district was about to default on its bond payments, Mr. Stein said. Funds had been commingled, and two top officials have been indicted on theft and embezzlement charges.

The Treasurer's Office was also concerned that the St. Vrain Valley School District in Longmont would soon commingle its funds as well. Last fall the district was $12 million in the red, Mr. Stein said; this month the Boulder County prosecutor blamed mismanagement but said officials were not criminally liable.

The Treasurer's Office did not mean to harm smaller banks, and it will work with the trade groups to amend the law so that more banks can accept school district funds, Mr. Stein said. "As long as there are sufficient safeguards to ensure that there would not be commingling of funds, then we'll certainly look at whatever the bankers propose."

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