WASHINGTON(AP) – With regulators warning that rising losses on commercial real estate loans pose risks for U.S. banks, senators asked last month for greater attention to be focused on vulnerable smaller banks.

The smaller, community banks are especially exposed to commercial real estate loans, which now pose the biggest challenge for many financial institutions and their overseers, Federal Deposit Insurance Corp. Chairman Sheila Bair told lawmakers at a Senate hearing.

A year after the financial crisis struck with force, the stability of the banking system has improved but remains fragile, and commercial real estate lending is a key trouble spot, said Federal Reserve Gov. Daniel Tarullo.

With more than 7 million U.S. jobs lost in the recession, office space has sat empty and developers have defaulted on their loans. Nearly $500 billion in commercial real estate loans are expected to come due annually over the next few years.

The Fed and the other federal bank regulators are developing guidelines for banks’ modifications of troubled commercial real-estate loans that will call for banks to accurately account for their losses on the loans, Tarullo said. The principle that modifying loans is “often in the best interest of both the financial institution and the borrower” will be part of the guidelines, he said.

Bair said she has been discussing with Treasury Department officials the possibility of giving community banks greater access to federal funds under the $700 billion financial bailout program – which benefited mostly big Wall Street institutions. Officials have been weighing a fresh round of bailouts for banks that were deemed to risky to qualify for earlier aid.

Sen. Tim Johnson, D-S.D., chairman of the Senate Banking subcommittee on financial institutions, said he was “concerned about the lending environment, particularly for small businesses” and about smaller banks that remain vulnerable to borrowers’ risky levels of debt.

But Sen. Bob Corker, R-Tenn., chided Bair and U.S. Comptroller of the Currency John Dugan for supporting bailout funds for banks under their authority. Reflecting a common opposition among Republican lawmakers to the Troubled Asset Relief Program, Corker told the regulators, “I just hate to hear us moving to that mode. I think we should end TARP at the end of the year.”

New York Democrat Sen. Charles Schumer said recent increases in overdraft and ATM fees by many banks demonstrates the need for “a strong independent agency to protect the interests of consumers,” as the Obama administration has proposed.

Legislation establishing a Consumer Financial Protection Agency, which would police mortgages, credit cards and other financial products, is fiercely opposed by banks and business groups. Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, has said he intends to have the panel adopt a measure by week’s end.

“There are undoubted merits to having a single consumer protection agency,” Tarullo said at the hearing, but also a potential risk that it could dampen the availability of credit. “I think there would be costs,” he said.

Ninety-eight U.S. banks have failed so far this year, many succumbing under the weight of failed real estate loans. The number of banks on the FDIC’s confidential “problem list” jumped to 416 at the end of June from 305 in the first quarter. That’s the highest number since June 1994 in the wake of the savings and loan crisis. Experts say as many as 400 more banks could fail in the next couple of years.

“There will be more failures,” Bair testified. “It will continue at a pretty good pace this year and next. We are ready for this.”

The number of failures next year will be closer to the 2009 level than last year’s 25, she said.

The spate of bank failures has cost the federal deposit insurance fund an estimated $25 billion so far this year and is expected to cost about $100 billion through 2013. The insurance fund has fallen into the red, and the FDIC board recently proposed to have U.S. banks prepay about $45 billion of their insurance premiums – three years’ worth.

The FDIC is backed by the government, and deposits are guaranteed up to $250,000 per account. Also the FDIC still has tens of billions in loss reserves apart from the insurance fund.