WASHINGTON - A controversial measure to restructure the way Federal Home Loan banks pay interest on thrift bailout bonds has been dropped from legislation to modernize the Home Loan Bank System.

"It was removed because it was clearly going to be too contentious," said an aide to Rep. Richard Baker, the Louisiana Republican who sponsored the bill. "The district bank presidents clearly are not willing to sit down and compromise on this."

The original Baker bill proposed a new method of allocating interest payments for bonds issued as part of the 1989 thrift bailout law.

The plan proved controversial, however, because thrifts in some areas, including Pittsburgh and Boston, would have ended up paying more, while others - particularly in California - would have seen their costs shrink.

"We're disappointed, but we have not given up yet," said Lou Nevins, president of the Western League of Savings, which represents California thrifts. "We understand that Rep. Baker is still trying work this out."

While dropping the interest allocation provision removes a major hurdle that had threatened to trip up the bill, which contains two new stumbling blocks for member banks.

One arises because Rep. Baker removed a provision that would have allowed commercial banks to increase their borrowings above the current ceiling of 30% of Home Loan Bank System advances.

Banking industry representatives said that leaving the 30% cap intact would make commercial banks shy away from joining the system.

"It's just a matter of time before that limit is bumped against systemwide, and it's already being bumped against in some districts," said Ann Grochala, director of bank operations for the Independent Bankers Association of America.

"This is ugly. Things that the trade groups have long supported are disappearing from the bill," Ms. Grochala added.

Also causing concern is a new provision that would toughen standards for membership in the system. As of 1999, mortgage-backed securities would no longer count toward a requirement that members hold at least 10% of their assets in housing-related loans.

"There are about 700 small bank system members now that would not meet that requirement," said Brian Smith, director of policy for America's Community Bankers. "This is going to be tough on smaller rural banks in smaller housing markets."

The House Banking subcommittee on capital markets, which Rep. Baker leads, is scheduled to take up the legislation Thursday.

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