WASHINGTON — The push to create a single bank regulator is driving a growing debate over whether consolidated supervision threatens the dual banking system.

On one side are community bankers and Federal Deposit Insurance Corp. Chairman Sheila Bair, who argue that a single regulator would focus all of its attention on the largest institutions, leading to policies that disadvantage smaller, state banks. Eventually, there would be little to no reason for banks to opt for a state charter, as they would face an additional regulator but receive none of the benefits of a national charter.

"Over time, a single federal regulator would have a corrosive effect on the state system of regulation to the point the state system would become irrelevant and too expensive to maintain," said Camden Fine, the president and chief executive of the Independent Community Bankers of America. "State banks would basically gravitate to the single regulator."

But proponents of a single regulator, including Senate Banking Committee Chairman Chris Dodd, argue that protections can be built into the system to ensure that community banks are not disadvantaged.

"All the new consolidated supervisor is doing is assuming the federal component of the existing supervisory framework," said Eugene Ludwig, the chief executive of Promontory Financial Group and a former comptroller of the currency. "I can envision a consolidated supervisor reducing burdens in respect of community bank regulation and supervision and actually enhancing the community bank franchise."

Dodd has championed the idea for the past two months, but only recently signaled his intention to pursue a regulatory reform bill that would consolidate the banking regulators into one. Under his plan, the Federal Reserve Board and FDIC would lose their state supervisory responsibilities, and hand them to a new, more powerful Office of the Comptroller of the Currency. (The Office of Thrift Supervision would also be combined into the new agency).

During a hearing last week, Dodd acknowledged bankers' worries, but insisted there was a way to structure the new regulator to protect small institutions' interests.

"We need to preserve our dual banking system … A single federal bank regulator can work with the 50 state bank regulators," Dodd said. "Any plan to consolidate bank regulators would have to ensure community banks are treated appropriately."

Dodd suggested creating a division within the new federal agency devoted exclusively to state banks, and he noted that the OCC already has separate divisions for large, midsize and small banks.

This has done little to quell opposition, however. Industry representatives contend that state regulators would be powerless in the face of a single federal regulator.

"I'm not sure having a division allows the state to put forth their authority over in a new agency," said Diane Casey-Landry, the chief operating officer of the American Bankers Association.

Fine said a single regulator could run a greater risk of being "captured" — an accusation thrown at the OTS in recent years. Though there are many small thrifts, the agency was seen by some as favoring its largest institutions, such as Washington Mutual and Countrywide.

"Don't the members of Congress criticize OTS because it became captive to those firms?" Fine asked. "If only one regulator regulates firms larger than Countrywide or Wamu, wouldn't you think that same thing would happen?"

Much of the issue comes down to trust. While the Fed also supervises large holding companies, most view the FDIC as the agency that represents community banks' interests at the federal level. The agency supervises state nonmember banks, which are mostly small, community institutions. It was the first agency, for example, to object that proposed Basel II capital rules for the largest banks could end up giving them a break on capital requirements, putting smaller institutions at a competitive disadvantage.

Before Dodd publicly embraced the idea, Bair openly opposed it. In an op-ed in The New York Times last month, Bair warned that community bankers were right to fear a single regulator.

"Concentrating power in a single regulator would inevitably benefit the largest banks and punish community ones," the FDIC chief wrote. "A single regulator's resources and attention would be focused on the largest banks."

But some industry observers deride this defense, arguing that it is only about turf.

"The death of dual banking is a scare tactic," said Lawrence Kaplan, a lawyer at Paul, Hastings, Janofsky & Walker LLP. "I don't think you are going to see anyone say get rid of the states."

Opponents of a single regulator also worry about its chartering powers. Currently, neither the Fed nor the FDIC can approve a charter for a bank — that must be done through the states, the OCC or the OTS.

If the same regulator that chartered national banks also examined state-chartered banks, some worry the single regulator could pressure state-chartered banks to convert, or subject state-chartered banks to more rigorous standards.

"While the Fed and FDIC can trump our authority, they can't charter institutions," said John Ryan, executive vice president of the Conference of State Bank Supervisors. "When the federal government becomes that relationship and chartering authority … they would have incentives to make it more difficult to operate under 50 jurisdictions."

The whole idea of the dual banking system to many is that it can serve as a place for innovation. State regulators may be more willing to work with community banks on new, creative ideas.

At a certain point, opponents say, there would be no reason for state chartered banks to exist at all because institutions would receive no benefit from it. In theory, at least, smaller banks receive better supervision from local supervisors that understand their business and customer base — and those supervisors are backed up by federal agencies that ensure proper safety and soundness procedures are met.

But most do not see a single regulator as a backup supervisor, and said institutions will just charter with the national bank supervisor to save time and effort.

"You are on a slippery slope," said Kip Weissman, a partner at Luse Gorman. "If there were a single regulator, it would clearly weaken the state charter, so over time there probably would be companies switching from a state to a federal charter."

But Doug Elliott, an economic studies fellow for the Brookings Institution, dismissed these concerns as just resistance to change.

"There is always a strong bias in keep the regulator you have," he said. "You know how they operate and usually you've developed friendships and alliances, you are more comfortable and know how to get your voice concerned. I think there is an overriding public policy objective to have consistency of approach. Having multiple regulators leads to the potential for confusion and one of them to be weak."

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