WASHINGTON — The Federal Home Loan Bank System could finally be on its way to shrinking.

The Federal Housing Finance Agency on Monday issued a proposal that would provide specific guidelines and procedures to allow for the voluntary merger of any of the 12 Home Loan banks.

The banks were already allowed to merge under the Housing and Economic Recovery Act, but regulators had provided no details on the terms of a merger or whether it would be approved.

Industry observers said that outlining those terms could eventually pave the way for consolidation in the Home Loan Bank System.

"This proposal reflects the parlous condition at the majority of the banks. Last week FHFA disclosed that seven of the 12 have very low supervisory ratings," said Karen Shaw Petrou, managing partner at Federal Financial Analytics Inc. "The proposal paints a broad landscape of strategic options for the banks, with voluntary merger just one of them. I think the banks will need very, very quickly to consider their strategic options under this proposal and draw up plans ASAP before their choices are constrained still more and FHFA is forced to intervene."

The notice comes as the Obama administration is working on a plan to revamp the mortgage finance system, a restructuring that will include Fannie Mae and Freddie Mac. The administration has promised to unveil a reform package in January. The Home Loan banks are lobbying to be kept out of the reform process, arguing that their help was vital during the financial crisis.

In its proposal the FHFA said it was open to a merger where two banks combine to form an entirely new Home Loan bank, and a purchase and assumption transaction, in which one or more banks acquires substantially all of the assets and assumes most of the liabilities of another Home Loan bank.

Although the FHFA opened the door wide to any proposed combination, it said it would make approvals on a case-by-case basis.

"The breadth of the definition does not imply that FHFA would necessarily approve all types of mergers, but only that regulations contained in this part would not preclude a proposed business combination that involve something other than a legal merger," the proposal said.

"FHFA would consider the merits of each proposed transaction, regardless of its structure, on a case-by-case basis in deciding whether to approve the transaction."

The agency made clear that the existence of "voluntary mergers" under HERA demonstrates congressional intent to permit banks to consider various business combinations that could benefit their members or to the system as a whole. "The addition of the Banks' voluntary merger authority to the Bank Act appears intended to enable and encourage the Banks to develop merger proposals based on their own assessments of their business needs," the proposal said.

The FHFA said all new capital structure plans and modifications to any existing capital structure plan would have to be approved by the agency.

The agency said its standards would largely track other federal banking regulators in consideration of a merger.

The proposal said the FHFA's director will take into consideration "the financial and managerial resources of each of the bank, the future prospect of the bank, and the effect of the proposed merger on the safety and soundness of the continuing bank and bank system."

The agency had some clear ideas on a way ahead, but it left open for discussion other areas, including what voting programs would be most appropriate for obtaining members' approval of a proposed merger; how those may best be structured; and how to address the transition from a separate board of the banks to the combined board of the new bank.

Although many have questioned the need for 12 Home Loan banks in the modern economic system, efforts to merge some of them have never gotten far off the ground.

The Chicago and Dallas banks came closest to a voluntary merger in 2008, but it was scuttled, partly over concerns about the Chicago bank's exact worth.

The FHFA proposal is open for comment for 60 days.

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