WASHINGTON - Many midsize banks and thrifts have become risky "arbitrage funds" that gamble with federally insured deposits and will fail if interest rates rise sharply, a risk management expert said in a speech here.

These institutions supplement their deposits with big-money repurchase agreements and Federal Home Loan Bank advances, said Mary Gottschalk, director of treasury risk management at Arthur Andersen in New York. They then invest most of this money in complex mortgage-backed securities.

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