In the race to the bottom among bank regulators, the Office of Thrift Supervision appears to be the first loser.

According to President Barack Obama's plan to re-write financial regulation, the federal overseer of savings and loans will soon cease to exist. Created 20 years ago in response to the nation's last banking crisis, the maligned government agency is now widely blamed for allowing a new larger banking crisis to balloon.

For banks, the plan will mean one less regulator competing for jurisdiction, which could lead to harsher scrutiny and less frothy profits.

"Regulatory reforms will bring about the end of 'light-touch' regulation," said Philip Finch, an analyst at UBS AG (UBS), in a note to clients. "The future will be one of lower average return on equity" -- a key measure of firms' profitability.

Under the current regime, U.S. banks are regulated by one of three federal bodies; one of myriad state-level banking regulators; or some combination thereof. Other federal regulators include the Federal Reserve Bank and the Office of the Comptroller of the Currency -- which, like the OTS, is an agency of the U.S. Treasury.

In the past, banks had considerable say in who regulated them, and could often change regulators when they felt too restricted.

Historically, banks "are able to essentially pick their regulators," says Lauren Willis, a Loyola Law School professor and a former Justice Department trial attorney who focused on housing and lending discrimination.

The competition for bank charters, she says, "leads to...a race to the bottom" among regulators, amid which banks pitted one agency against the others to land more lax oversight.

Many former regulators have argued that thrift charters, which reside at the OTS, often carried the least stringent regulation.

Their argument has its merits: The OTS was officially charged with monitoring Washington Mutual Inc. and IndyMac Bancorp Inc. -- two of the largest banks to collapse in history -- as well as portions of American International Group Inc. (AIG), the mammoth insurer that's required more than $100 billion in public support to avoid failing.

The Obama administration itself placed blame on the lax oversight of thrifts on Wednesday, and also singled out the destructive competition among regulators for banks' business.

"The availability of the federal thrift charter has created opportunities for private sector arbitrage of our financial regulatory system," the administration wrote in its proposal.

Under thrift charters, companies are typically required to hold about two-thirds of their assets in mortgage-related investments or loans -- a reflection of the U.S. government's 80-year push to nurture an entire industry of mortgage-focused banks. Amid the current nationwide housing market depression, that business model now looks especially risky.

Some OTS defenders say the mandate that thrifts focus on mortgages helped fuel the crisis, and the OTS is simply taking the blame. Defenders also say the entire U.S. system of patchwork-style regulation -- not just the OTS -- has failed thoroughly.

Unlike the Federal Reserve and the OCC, the OTS didn't have the luxury of bailing out its biggest troubled firms, says Kevin Petrasic, an attorney at Paul Hastings and an assistant chief counsel at the OTS.

A number of large banks overseen by other regulators "would have failed," Petrasic says. "But because of systemic risk, they were not allowed to fail."

What's more, the move by the administration to close the OTS may be more political maneuvering than a genuine effort to thoroughly scrub the national patchwork of bank regulators.

From one angle, the Obama plan merely consolidates two agencies -- the OTS and OCC -- that have existed side-by-side at the U.S. Treasury.

"They were obvious targets for a merger," says William Black, a University of Missouri-Kansas City law school professor and a former senior counsel at the OTS.

What remains far less clear is how administration officials plan to merge the two agencies' staffs -- and how many positions they'll fill with people from an agency the administration just openly criticized.

"You don't want to lose the expertise" of veteran staffers," says Petrasic. "There's a dramatic need for talented regulators."

-By Marshall Eckblad, Dow Jones Newswires; 201-938-4306; marshall.eckblad@dowjones.com