WASHINGTON - Banks have been warned to tighten their rules for business lending because an economic downturn could leave them vulnerable to a rash of bad loans, the Federal Reserve revealed Tuesday.

In a letter sent last week to bank examiners, the central bank said this was "a critical time for banks to maintain their lending discipline" and to stiffen controls if possible.

The Fed said a study of several hundred loans found a "significant easing" in the past two years in the terms and standards banks set for lending. A growing economy had sheltered banks from a deterioration in loan quality but could not be relied upon forever, it said.

"If carried too far, such easing can undermine a bank's financial health, especially if the economy weakens or the extraordinary recent performance of business profits and cash flows does not persist," the letter cautions.

The Fed letter reflected apparent concern that bankers were so eager to make loans that they have lost their fear about potential defaults, since the U.S. Economy was in its eighth straight year of unbroken growth.

The Fed said competition was "intense" to make loans and said its study had found "noteworthy and measurable easing in bank lending terms" since 1995 and a continuing expansion.

"Banks should resist any tendency to assume in evaluating credits that the unusually favorable economic environment of the last few years will continue indefinitely," it said.

The letter said the Fed was offering guidance, not establishing new regulatory requirements, but it appeared to be aimed at making bankers more wary about lending.

Analysts said the letter was unusual but not surprising in view of past admonishments from central bank policy-makers, including Federal Reserve Chairman Alan Greenspan.

As long ago as December, 1996, Greenspan warned against "irrational exuberance" over equities and real estate potentially setting the stage for a contraction like the one that has racked Japan's equity and real estate markets for the past decade.

The letter to examiners was in a similar vein, said economist David Wyss of DRI/McGraw Hill in Lexington, Mass.

"This is intended to be a warning light for bankers because of the belief that some banks are beginning to believe the business cycle is dead, all loans are safe, there will never be another recession," he said.

The letter to examiners cited several areas in which the Fed has specific concerns and included suggestions for the regulators when they are assessing banks' performance.

The Fed said banks should be "pricing to risk," making sure they set interest rates high enough to ensure a profit rather than keeping them low simply to draw in or retain customers.

It also warned about excessively "rapid growth in exposure to real estate investment trusts over the past year," with the growth in each case amounting to hundreds of millions of dollars."

Real estate investment trusts, or REITs, buy, manage and develop properties and have tax advantages because they pay out a high proportion of profits to investors.

The letter to examiners suggested REITs financial strength could quickly wane if real estate values suffered.