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UPDATE 1-Trump's bank watchdog defends his stock trades to Congress

(Adds comment on fair lending rules)

WASHINGTON, June 14 (Reuters) - A top U.S. banking regulator who bought financial stocks in the months before he became a regulator for the industry told lawmakers on Thursday that those investments were allowable and proper.

Joseph Otting is prohibited from buying U.S. bank stocks as the comptroller of the currency but the former banker did invest in the sector in the months between his nomination and swearing-in.

"I was in constant communication with the Treasury Department ethics department through this entire process," Otting told the Senate Banking Committee. "No one had ever at any point in time told me that it was improper or illegal."

Reuters reported the trades in April, based on financial disclosure documents filed with the Office of Government Ethics. Experts in U.S. government ethics standards told Reuters at the time that the trading activity, while not illegal, could have violated the spirit of rules designed to prevent conflicts of interest.

Sherrod Brown, the top Democrat on the banking panel, said Otting had damaged the public's trust by buying more stocks in a sector that he was about to regulate.

"I don't question your integrity here but maybe your judgment," said Brown. "You buy stocks after you get appointed to a job like this?"

Otting, who was formally nominated in June 2017 and took office in November, said he had no knowledge of the specific trades because they were handled by his broker.

He added that he would have had to forego 10 months of investment opportunities had his broker halted trading during the nomination process.

FAIR LENDING

At a Congressional hearing on Wednesday, Otting said he had no knowledge of banks discriminating against minorities. At Thursday's hearing, he pulled back from those remarks and said racism exists in the lending industry.

"I believe that there is," Otting told Senator Robert Menendez, a Democrat from New Jersey, who asked if there was racial bias in the mortgage lending business.

Otting enforces fair lending laws and the Community Reinvestment Act (CRA), which requires banks to offer credit in minority communities.

Otting said he wants the CRA to help more poor communities and that he will punish banks that treat minorities unfairly - even if the bank does not explicitly promote racism.

"I think there is disparate impacts that occur in America," Otting said, referring to a legal theory that lenders should be punished when their lending policies are not openly racist but still hurt minorities.

(Reporting by Patrick Rucker and Michelle Price in Washington; Editing by Meredith Mazzilli and Lisa Shumaker)