The drive to deliver government benefits electronically will stall unless Congress exempts states from liability for fraud losses, state officials told the House Banking Committee Wednesday.

Rep. Jim Leach, R-Iowa, the committee chairman, said more than $110 billion of cash benefits and food aid may eventually be provided through electronic benefits transfer, or EBT.

While officials would prefer to deposit government benefits directly into bank accounts, many people receiving assistance do not have relationships with financial institutions.

For example, in Massachusetts, one-third of 750,000 recipients would have to get their benefits though an EBT program, said William Kilmartin, the state's comptroller. EBT reaches the unbanked by giving them cards that can draw funds from a central account.

Industry officials who testified Wednesday argued that banks should play a central role in the process.

"The EBT system should use insured, examined, regulated, and capitalized financial institutions," said William H. Phillips, the American Bankers Association's director of policy development.

The Clinton administration launched a campaign in 1993 to deliver most government benefits through automated teller machines and point of sale terminals by the end of the decade. A consortium of southeastern states is leading the way with Citicorp, First Union Corp., and Bank of Boston Corp. as prime contractors.

The momentum could be slowed by a February 1994 Federal Reserve Board ruling that applies Regulation E to electronic benefits transfers as of March 1, 1997. That means state governments must replace a recipient's benefits if a debit card and personal identification number are lost or stolen and the account is emptied.

Last summer, Congress passed legislation excusing the states from Reg E, but the measure was vetoed as part of the welfare reform bill.

"If we are not exempted from the liability provisions of this regulation ... then EBT is dead in its tracks in many western states," Idaho state Controller J.D. Williams said. "The responsibility of having to pay the Regulation E liability protection would simply make EBT too expensive."

Mr. Kilmartin and an official from Minnesota echoed that concern and said contracts to provide EBT services would be canceled unless the Fed backs off.

To cut costs and curb fraud, federal and state government officials want to piggyback EBT on the banking industry's payment systems. Those systems are subject to the Electronic Funds Transfer Act, enforced by Regulation E, which limits a consumer's loss to $50.

In a statement to the banking panel, the Fed reiterated that EBT transactions fit the definition of electronic funds transfers and must be covered by the same rules. "All consumers using EFT services should receive substantially the same protection under the EFTA and Regulation E," the Fed said.

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