CHICAGO - City government here may stop doing business with banks that make predatory loans or buy such loans on the open market.

A proposed ordinance working its way through the City Council's finance committee would bar Chicago from investing any of its $1 billion of municipal funds at banks with predatory loans on their books and from doing other business with such banks.

The ordinance would require the 27 banks that act as depositories for municipal funds to certify that they do not fund predatory loans. The institutions range in size from $651 billion-asset Bank of America Corp. to $48 million-asset Community Bank of Lawndale. The same certification would be required of banks that have other city contracts.

The proposal, pushed by Mayor Richard M. Daley, targets banks that own subprime mortgage subsidiaries making purportedly predatory loans in the Windy City, along with banks that buy such loans from a third party. The council is expected to take up the matter next month after the finance committee votes.

If some version of the ordinance passes the council, which observers believe is likely, Chicago would become the first city in the nation to impose sanctions on banks linked to predatory lending, industry groups said.

"We don't have regulatory authority … but we do have leverage over the institutions we invest our money in," said Erika Poethig, assistant commissioner of the Chicago Department of Housing. "We'll use that leverage to promote good practices and responsible lending. We don't want our money used to destabilize the same communities we're trying to assist."

Predatory loans, generally defined as mortgages made with exorbitant interest rates and high fees, are drawing the ire of politicians nationwide. One state, North Carolina, has passed legislation restricting predatory lending, and similar proposals are afloat in Congress and in states including New York and Illinois.

But unlike federal and state initiatives, which would impose regulatory restrictions and disclosure requirements on allegedly predatory mortgage lenders, Chicago is pointing its finger at banks.

City officials noted that two of the largest subprime lenders operating in Chicago - Money Store and Equicredit Corp. of America - are owned by banks, First Union Corp. and Bank of America, respectively. They also contended that both small and large banks fund predatory lending indirectly by buying pools of mortgage loans - some made on predatory terms - in the secondary market.

"Until recently, the banking industry didn't understand its role in this problem," said Bruce J. Baker, senior vice president and general counsel at the Illinois Bankers Association.

Chicago's proposal defines predatory loans as mortgages that have interest rates five percentage points or more higher than the yield on U.S. Treasury securities of comparable maturities - which today would mean roughly an 11% mortgage rate - or that charge points and fees totaling more than 4% of the loan amount.

Chicago officials are concerned that some subprime mortgage lenders are targeting low-income neighborhoods with mortgages they believe the borrowers will be unable to repay.

The homes are eventually repossessed, creating tracts of vacant buildings that attract crime, said Mayor Daley. The city says that more than 40% of repossessions last year were the result of subprime loans, up from 15% in 1993.

"Chicago's residents, and their city government, have spent too much time building up our neighborhoods over the last 10 years to let this new breed of fast-buck artists tear them down," Mayor Daley said.

Even the Illinois Bankers Association is not fighting the ordinance head on. Rather, it has offered an alternative measure that would define predatory loans as those with interest rates eight percentage points above comparable Treasury yields or imposing fees totaling 6% of the loan amount.

The group also has called for the city to establish strict definitions of predatory and fraudulent behavior to ensure that subprime loans are not labeled predatory just because they charge a higher interest rate.

"We should not throw the baby out with the bath water," Mr. Baker said. "There are many people who have access to credit only through subprime lending."

Banks want to avoid other potential unintended consequences of the proposal.

Chicago-based Corus Bank, for instance, has joined a city-run program in which it committed a $20 million line of credit to revitalize and rebuild neighborhoods surrounding high-rise public housing.

However, the bank admittedly has bought $87 million of loans from a now-bankrupt subprime lender called Cityscape Financial Corp., an Elmsford, N.Y., company accused in lawsuits of predatory practices. If the ordinance passes, Corus might be forced out of the program, cutting off money to neighborhoods the city is trying to revive.

"Would we prefer to not have a prohibition from doing business with the city? Of course," said Dave Johnson, executive vice president of the $2.2 billion-asset bank.

Ordinance proponents contend, however, that City Council action would at least be a start on combating predatory lending.

"This could have some impact on the worst lenders affiliated with banks," said Dan Immergluck, senior vice president of Chicago's Woodstock Institute, a think tank that monitors banks and encourages community investment. "It would also send a strong message to Washington that this is a major urban issue."

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