UPDATE 1-Fed's Lacker gives lukewarm backing to higher U.S. bank capital

Thu May 9, 2013 9:40am EDT

By Jonathan Spicer

NEW YORK May 9 (Reuters) - A top Federal Reserve official on Thursday gave only lukewarm support to a fresh drive by regulators to increase capital at big banks, arguing capital buffers are important but just how much more is needed remains up for debate.

Jeffrey Lacker, president of the Richmond Federal Reserve, said that broker dealers "deserve special attention" in this debate. Some of his colleagues, including Boston Fed President Eric Rosengren, have suggested requiring higher capital at such firms.

"I do favor increasing capital and I've been in favor of the broad upswing in capital that we have seen," Lacker said of bank holding companies. "Whether we need more or not, I think we're sorting through that as a regulatory community and as a financial community," he told the Council on Foreign Relations in New York.

"I certainly see great advantages in larger capital buffers."

The debate about too-big-to-fail banks - which are perceived as implicitly relying on taxpayers to bail them out no matter how risky their business conduct - has heated up in Washington in the last few weeks.

Some regulators and other critics of the Basel III international agreement to protect against another global financial crisis have said it is too easy on banks, and that it relies too much on letting banks use complex calculations to determine how much equity they should hold.

Lacker said that requiring banks to hold more debt that converts into equity when the firms get into trouble, an idea backed by Fed Governor Daniel Tarullo, is one way to ramp up capital though perhaps not the best.

"Convertible debt is a clever way of taking advantage of the tax subsidy for debt with an equity-like instrument," he said.

"At the end of the day, yes, if that provides a greater buffer, fine, but I don't think we should be focused ... on incentives at the holding company level."

But regulators need a plan for when that capital dries up, Lacker said, reiterating that more should be done to ensure such large firms can be safely wound down if they get into trouble.

Lacker said the "living wills" program will need more "hard work and detailed analysis" so that bankruptcies can take place without the U.S. government stepping in to bail out banks as it did in the 2008 financial crisis.

"I see no other way to reliably identify exactly what changes are needed in the structure and operations of financial institutions to end 'too-big-to-fail'," Lacker said.

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