WASHINGTON - Federal regulators are debating whether they should deny Shawmut National Corp.'s applications to acquire several New England banks because of questions about lending discrimination at a mortgage subsidiary.

The Federal Reserve is considering applications by Shawmut to acquire New Dartmouth Bank of Manchester, N.H., and Peoples BancoRp of Worcester, Mass. On Friday, Shawmut agreed to acquire Gateway Financial Corp. of Fairfield County, Conn., which will also require Fed approval.

Sources say regulators are considering whether to deny approval because the banking company's mortgage arm is under investigation by the Justice Department for lending bias. The probe of Shawmut Mortgage Co. resulted from a Federal Reserve referral to the Justice Department, after the lender provided the agency data for a study on lending discrimination.

No Formal Allegations

Officially, the Fed will acknowledge only that the agency is considering two Shawmut applications. But privately, Fed officials have been debating about how to proceed with the proposals, sources say.

Some Fed officials argue that since no formal allegations have been lodged against Shawmut, the government cannot punish it by denying the application. And since the Justice Department probe is no where near completion, the Fed cannot keep the lender in limbo for long, they argue.

But others at the Fed say that as long as the discrimination cloud is hanging over Shawmut, regulators should withhold approval.

The Fed - which in the past has had a reputation of being lax on lending discrimination - would open itself to widespread criticism, they say, if after approving the application, the Justice Department announced that it found evidence of widespread bias.

The Shawmut dilemma exemplifies a new issue that all the banking regulators face: how to handle corporate applications when there are allegations - but no formal charges - that illegal discrimination exists.

Fair lending is an important component of a bank's performance under the Community Reinvestment Act, which must be considered when an application for expansion is reviewed.

Regulators recently pledged to get tough on discrimination. Not only have they broadened their own investigations of possible problems, but they also have begun referring cases to the Justice Department for further review.

The Fed has already approved at least one application submitted by a lender under Justice Department investigation. In October, it approved an application by Barnett Banks Inc. to acquire Citizens and People's National Bank of Pensacola, Fla.

The precedent in the Barnett case may not carry over to Shawmut, because the Justice probes are in such different stages of investigation. The Attorney General has not yet decided whether to broaden the Barnett probe into a full-scale investigation, as it has for Shawmut.

The apparent controversy does not appear to have slowed Shawmut down.

"Certainly we're going to proceed with the acquisitions we've announced, and we're going to proceed with the acquisition strategy we have in place," said Shawmut spokesman Brent DiGiorgio. "Our policy has and continues to be to lend to credit worthy customers based on their ability to repay rather than on the color of their skin."

Nader's Backing

And it enjoys some considerable support from some unlikely sources. Ralph Nader's group Essential Information recently singled out Shawmut as an "affirmative lender" and an example of strong lending in minority communities, in a study.

The New Dartmouth application has been reviewed by the Boston Fed and sent on to Washington for review by the board of governors, a Fed spokesman said. The People's Bancorp application is still being processed in Boston. The third has not yet been submitted.

As has been the case in many significant corporate applications, the bank has conferred with the Fed on proceeding with the case, sources said.

"Most of the effectiveness of CRA comes through staff working with banks during the applications process, making sure that before any application comes to the board, it at least has a good chance of clearing any CRA hurdles that might emerge," said Fed governor Lawrence B. Lindsey.

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