The Federal Home Loan Bank System would face sweeping changes of its capital and investments under a proposal issued Wednesday.

The plan would require the 12 Home Loan banks to increase lending to member banks and thrifts and gradually pull out of the mortgage-backed securities market.

The proposal-issued by the system's regulator, the Federal Housing Finance Board-would also impose risk-based capital requirements on Home Loan banks.

Much of what the finance board is trying to accomplish would be required by the financial reform legislation pending in Congress. Critics Wednesday suggested the agency wait and see what Congress does.

"This is a bit of the cart before the horse," said Robert R. Davis, government relations director at America's Community Bankers. "It's hard to create a regulatory framework before you know what the statutory authority for capital structure will be, and we don't know that at this time."

The proposal, put out for comment for three months, would widen the Home Loan banks' investment options beyond traditional advances to member institutions.

For instance, a Home Loan bank could buy pools of mortgages from member banks. Other investments would split risk between Home Loan banks and their member institutions as in the Mortgage Partnership Finance pilot program.

"We're really creating a whole new business opportunity in regulatory terms," said finance board Chairman Bruce A. Morrison.

Industry observers said it is hard to gauge whether Mr. Morrison's plan to expand the Home Loan banks' investments in member mortgage assets will provide enough liquidity and return to match what they realize from mortgage-backed securities.

"The proposed regulation is predicated on the ability of the Federal Home Loan banks to significantly reshape their balance sheets," said John von Seggern, executive vice president of the Council of Federal Home Loan Banks, which includes 10 of the 12 banks.

Member banks are concerned other investments will not be as lucrative as mortgage-backed securities and could lead to higher advance rates, said Ann Grochala, director of bank operations at the Independent Community Bankers of America.

Yet Mr. Morrison said new investments could provide strong earnings.

"Member mortgage assets are homegrown mortgage pools," he said. "If you make your own, you don't have to pay somebody else the manufacturing costs. So the return on these should be at least as attractive as what you buy on the Street."

The Finance Board proposal would gradually wean the Home Loan banks from mortgage-backed securities by 2005.

Currently, the Home Loan banks buy mortgage-backed securities with funds raised by issuing AAA-rated government bonds. (The banks' outstanding debt totaled $397.8 billion on March 31.)

By 2001, the Home Loan banks would have to lend at least 80% of their revenue to the more than 7,000 banks, thrifts, credit unions, and insurance companies that belong to the system. By 2005, the Home Loan banks would have to lend all their revenue to member institutions.

The Home Loan banks had advanced nearly $300 billion to member institutions as of March 31. Collectively, they own about $50 billion worth of mortgage-backed securities.

The Home Loan banks are dwarfed by other buyers in the $2 trillion mortgage-backed securities market. Though the investments add to the general liquidity to the mortgage market, critics have said the purchases do not directly benefit homeowners.

Instead, the Home Loan banks and their shareholders profit from the spread between mortgage-backed securities prices and bond issuance revenue. This arbitrage by the banks is criticized as taking unfair advantage of their government-sponsored status, which affords them the AAA ratings.

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