WHILE IT'S unfortunate, it's not surprising that the health of the S&L industry continues to decline. By tradition and by law, the S&Ls are tightly tied to real estate. When real estate values decline, as they are now doing in many parts of the country, the fortunes of the S&Ls inevitably accompany them. Their losses come out of their capital, making it harder than ever for them to meet the new capital requirements that the federal regulators are now enforcing with a vigilance born of the recent scandals and disasters.

Fewer than half of the country's 2,505 savings and loan institutions were profitable and adequately capitalized at the end of March, the regulators reported last week. The condition of the industry has further deteriorated since March. At this rate, within 10 years there will be no S&Ls. Nor should there be.

The idea of a class of financial institutions dedicated to lending to one highly cyclical industry is dangerously obsolete. Attempts to perpetuate it increase the risks to everyone -- including the taxpayers. A year ago, when Congress enacted the reform legislation, it decreed that S&Ls must keep a high proportion of their loans in housing -- currently 60 percent, shortly to climb higher. That was a response to developers who feared losing a familiar source of lending. The effect is to prevent precisely the evolution that now needs to take place. S&Ls need to diversify their lending and turn themselves into commercial banks. Otherwise they won't survive.

Diversification is essential to financial safety: that's been one of the great and costly lessons of the 1980s. It's as true for banks as for S&Ls. The banks went into the past decade tightly restricted by a vast array of rules, much of it the product of populist prejudices earlier in this century that tried to keep banks local and, if possible, small. Banks were forbidden until recently to cross state lines. In some states they were forbidden even to open branches. That left them perilously vulnerable to local disruptions like the collapse of oil prices in Texas, where the troubles of the banks further aggravated the strains on Texas businesses.

To rationalize the American financial system means, among other things, encouraging the formation of nationwide banking companies to protect not only banks but their customers from the effects of regional depressions. Similarly, it means encouraging the S&Ls to go beyond real estate lending to protect themselves and their customers from the vicissitudes of one unstable industry. Until Congress allows that, the condition of the S&Ls will continue to deteriorate.