CRANSTON — Domestic Bank and its mortgage subsidiary have agreed to pay $1.8 million after federal regulators cited the Cranston-based financial institution for engaging in unsound mortgage-lending practices.

The agreement with the U.S. Treasury’s Office of Thrift Supervision also will lead to the departure of Nathaniel B. Baker, the bank’s founder, chairman and chief executive officer, who has agreed to step down to help resolve the matter.

Domestic Bank also must name three independent directors to its board of directors and reconstitute its audit committee.

Fewer than six other people, all of whom worked for the subsidiary, were fired as a result of the matter, according to a bank official.

“We accept responsibility,” said Craig A. Baker, an executive vice president and a son of the founder.

Domestic Bank and the subsidiary, Intervale Mortgage Corp., agreed to pay an $850,000 fine and $1 million to fund financial-literacy and credit-counseling programs under the terms of an agreement signed June 30 with the Office of Thrift Supervision.

The bank also has set aside $5 million to reimburse borrowers who were adversely affected by the practices noted in the agreement. The money will return to borrowers the amounts paid to “field loan officers” who arranged the loans. That money must be repaid by Nov. 14.

In addition to replacing the chairman and CEO, the company must hire a full-time compliance officer responsible for reviewing the institution’s consumer-banking practices. Also, it has until Aug. 29 to hire a consultant responsible for a quarterly review of compliance activity.

By July 31, the bank must review the loans arranged through the subsidiary for any suspicious activity and report noteworthy findings to the federal government.

The orders issued last month do not require the bank to raise additional capital.

The requirements are detailed in orders posted June 30 on the thrift supervision office Web site.

The bank notified its customers of the matter in a letter sent out the same day, according to the bank’s executive vice president.

The Office of Thrift Supervision said the bank violated laws barring unfair or deceptive practices and regulations that require proper disclosures about adjustable or variable-rate mortgages. The agency also said the bank had “sham employees” that wrongly presented themselves as employees of a federally chartered savings bank.

In a letter to Domestic Bank customers, Nathaniel B. Baker stated: “The terms of the OTS order don’t require us to comment on nor agree with the OTS concerns, and we accepted the proposed terms in order to put the matter behind us and to continue to move Domestic Bank forward.”

Founded in 1967, Domestic Bank has nine branches.

Craig Baker said the problems were traced to independent mortgage brokers who found prospective borrowers and processed loan documents for Intervale between 2003 and late 2006.

Thousands of “non-conforming” loans were made to borrowers who either provided smaller down payments on residential mortgages than typically required by banks or “who may not have fully documented their income,” Baker said.

The loans originated in New York and other states outside Rhode Island, Baker said, and were then sold by Intervale into the secondary market.

“None of the assets remain here,” said Baker during an interview in the bank’s Reservoir Avenue headquarters.

He said the bank expects to recoup its money from the brokers and its insurance company. “We do expect to collect a good portion of the $1.8 million from other companies,” Baker said.

The $1 million in education funds will be spread among a variety of nonprofit groups in Rhode Island and Massachusetts, where Domestic Bank’s branches are located, to pay for consumer financial-literacy classes.

Domestic Bank already sponsors financial-education classes, some of which are taught by its own workers, but the financial institution will not use any of the money to pay itself for the new efforts.

“Our plan now is to put it behind us,” Baker said.

pgrimald@projo.com