Federal Reserve Chairman Paul A. Volcker told Congress yesterday that it's time to start lowering the barriers to interstate banking, but recommended safeguards against concentration.

Citing technological advances, numerous "nonbank bank" applications and, above all, regional banking legislation enacted by various states, Volcker told the House Banking Committee that "the time has come for Congress to authorize some interstate banking."

He urged the legislators not to wait until the Supreme Court renders its opinion, expected this summer, on the constitutionality of reciprocal regional banking pacts. The case, brought by Citicorp to challenge the exclusion of New York state banks by a regional system set up by the New England states, is pivotal to the future of interstate banking.

The original law prohibiting branch banking across state lines dates from 1927. Yet, Volcker observed, de facto interstate banking has existed for some time, given the ability of banks to open loan production and other limited purpose offices, and to make loans and take deposits electronically anywhere in the country.

He also noted that 14 states permit reciprocal banking within selective areas, while a dozen more are considering it. Four other states allow out-of-state banks regardless of origin.

Opposition to interstate banking is heard primarily from small, independent banks that fear they will be swallowed up by money center banks seeking to establish themselves nationwide. The Independent Bankers Association, representing 7,400 small banks, even opposes regional bank ownership, which is intended to give medium-sized banks a chance to develop before the advent of full interstate banking.

Volcker cited Citicorp's unsuccessful attempt to challenge banks in upstate New York. Although Citicorp eventually backed out, its presence resulted in competition, causing other banks to lower their loan rates. However, to minimize concentration, Volcker suggested that Congress prohibit the 25 largest bank holding companies from merging with one another and encourage states to set asset limits for acquisitions.

For example, a purchase would be denied if the combined assets of a merged institution exceeded 15 or 20 percent of total bank assets in a state. An exception could be made for failing institutions.

Volcker also proposed that even if Congress does not make progress toward allowing interstate banking, it should permit branching -- perhaps inside of a year -- within metropolitan areas and for neighboring areas of contiguous states.

Asked if legislation to allow interstate banking would cause a takeover frenzy like that now occurring in the rest of the corporate world, Volcker said any such activity would be "highly inappropriate."

He said the Fed could prevent the use of "junk bonds" -- low-rated securities paying a high rate of interest -- to take over banks because it would not permit the resulting institutions to be excessively leveraged.