UPDATE 1-Push to break up too-big US banks doesn't sway Fed's Dudley

Thu Nov 7, 2013 2:25pm EST

By Jonathan Spicer

NEW YORK Nov 7 (Reuters) - One of Wall Street's top regulators on Thursday said he was not yet convinced by the arguments of some lawmakers and at least one fellow Federal Reserve official that breaking up banks that were "too big to fail" was the right way to protect the U.S. financial system.

New York Fed President William Dudley instead repeated his endorsement of so-called living wills for big banks, but said those needed to be twinned with higher capital and liquidity requirements and incentives for bank management to act to stem problems when they first arise.

In the darkest days of the 2008 financial crisis, the U.S. government and central bank stepped in to extend funding to Wall Street's biggest banks. The failure at the time of investment bank Lehman Brothers set off a global panic that led to the Great Recession, the effects of which remain today.

Richard Fisher, head of the Dallas Fed, has proposed reorganizing big banks to eliminate the perception that they will be bailed out if they get in trouble.

Meanwhile in Washington, senators Sherrod Brown and David Vitter have introduced a bill that would cap how much banks can borrow, while Elizabeth Warren and other senators want to bring back elements of the Depression-era Glass-Steagall law that divided commercial and investment banking.

"I am not yet convinced that breaking up large, complex firms is the right approach," Dudley told a Global Economic Policy Forum at New York University's law school.

Doing so might harm the benefits of size that such banks are able to pass along to U.S. clients, he said.

"The costs incurred in breaking up such firms need to be considered," Dudley said, adding, "the breakup of such firms would not necessarily result in a significant reduction in overall systemic risk if the resulting component firms were still, collectively, systemic."

As for a revised Glass-Steagall, Dudley said it is not obvious that the combination of investment banking and more traditional banking at large institutions was behind the crisis.

While the bank break-bills in Washington are not expected to become law, debate has swirled over whether enough was done in the wake of the crisis to protect the U.S. economy.

The living wills, or resolution plans, are a key component of regulators' efforts to prevent another crisis. The 2010 Dodd-Frank law called for banks to spell out how they could be taken apart in a way that avoids a costly taxpayer bailout.

"Even with an appropriate resolution process in place that ends too big to fail, the consequences of failure will still be messy," Dudley said.

He urged a more "holistic approach" that includes "enhanced prudential standards and initiatives to further reduce the probability of default and the social losses associated with a default, and that (incentivizes) management to intervene early to address incipient problems before they threaten the viability of the firm."