With plans to become a retail banking powerhouse, State Farm Mutual Automobile Insurance Co. won government approval Thursday to charter a federal thrift.

The decision has the potential to reshape the banking industry's competitive landscape and affect congressional debate over financial reform.

"There is a danger of creating a parallel banking system that would be less regulated," said James D. McLaughlin, director of regulatory and trust affairs at the American Bankers Association. "This more prosperous, less regulated part of the banking system will thrive and flourish and eventually starve out the more regulated traditional banking system."

Jeff Rodman, executive vice president of the Illinois Bankers Association, said, "Congress is going to have to decide quickly what it wants the financial services industry to look like because, while they debate, it is changing without them."

Community bankers have been bracing for this approval since July 1997, when State Farm filed its charter application with the Office of Thrift Supervision. Though many other insurance companies are seeking thrift charters, State Farm is the biggest and the first to pursue a retail strategy.

State Farm-the nation's largest property and casualty insurer, with 66.2 million policies outstanding-plans to offer the gamut of consumer deposit and loan products, from money market accounts and certificates of deposit to auto loans and mortgages.

State Farm Financial Services, the newly chartered thrift, plans to market these products through the insurer's network of 16,000 sales offices, which would become the functional equivalent of banking branch offices.

Agency offices will not be branches, however; if they were, State Farm would have to comply with the Community Reinvestment Act nationwide. Operations such as loan underwriting and account openings will actually occur in Bloomington, Ill., State Farm's headquarters city.

During its first two years, the thrift is to limit operations to the Bloomington-Normal and St. Louis metropolitan areas. Arizona is to be the next target market before the operation goes nationwide in 2002.

Stanley R. Ommen, president and chief executive officer of the thrift, denied in an interview that CRA was a factor in State Farm's decision to centralize operations in Bloomington. He said after three years the thrift will devote 5% of its assets to loans in low- and moderate-income areas.

In its approval, the OTS said State Farm Financial must comply with the CRA but limited this obligation to the Bloomington-Normal area, at least until the thrift expands.

The OTS held a hearing this summer to let community groups air their concerns about State Farm's record in low-income communities.

Some community activists praised the OTS for requiring State Farm to collect data on the race and gender of borrowers. "This is an important first step that the insurance industry and State Farm have resisted for years," said Robert Gnaizda, general counsel to the Greenlining Institute, a San Francisco-based coalition of community organizations.

But Malcolm Bush, president of the Woodstock Institute, a Chicago think tank for community reinvestment issues, disagreed. "OTS let State Farm off the hook," he said. "It is a terrible decision and a back-door attack at the integrity of CRA."

The agency should have required State Farm to meet the community reinvestment needs of every town where it extends credit, he said. "This creates the uneven playing field that banks are always complaining about," Mr. Bush said. "It is saying to banks that we will do CRA exams where you do most of your business but for State Farm we will not."

Bankers in Illinois blasted the OTS decision.

James P. Ghiglieri, president of $125 million-asset Alpha Community Bank, Toluca, Ill., will go head-to-head with State Farm. Operating about 30 miles north of Bloomington, Mr. Ghiglieri said he expects the competition to be tough. But he is more worried about how the new thrift will be regulated.

"I have a hard time believing the OTS can possibly regulate something as large as State Farm, with literally tens of thousands of what amounts to branches out there.

"Agents do not have experience dealing with issues such as Truth-in- Lending and Truth-in-Savings," he said. "It all sounds good on paper, but what is going to happen when something goes wrong?"

James T. Ashworth, president and chief executive officer of $250 million-asset Carlinville (Ill.) National Bank Shares, operates about 90 miles from Bloomington. "We have a big problem with this," he said.

The OTS decision could push Congress to enact financial reform-or not.

Jeffrey A. Myers, assistant vice president for public affairs at the Independent Insurance Agents of America, said he expects the ruling to encourage Congress to pass reform before more nonbanks get charters.

"This will put more pressure on Congress to act and lay out the framework for an integrated financial services industry," he said.

But Marty Farmer, a lobbyist for the Independent Bankers Association of America, said insurers will be less likely to support financial reform. "This diminishes the prospect for financial reform because it lets an insurance company into the banking business without the need for a bill," he said.

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