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By Emily Stephenson
WASHINGTON, July 31 (Reuters) - Big U.S. banks' ability to borrow at lower rates than smaller competitors has eroded since the 2007-2009 meltdown but could return in a crisis, a U.S. official said, previewing a highly anticipated report on whether banks remain "too big to fail."
Most industry participants believe the 2010 Dodd-Frank law reduced the likelihood the federal government would bail out big banks again, said Lawrance Evans, director of financial markets at the U.S. Government Accountability Office.
The long-awaited report, which looks at whether size gives big banks an unfair advantage, is due on Thursday afternoon. Evans previewed it in planned remarks for a Senate Banking Committee hearing on Thursday.
Lawmakers, regulators and bank experts debate whether investors are willing to lend to the biggest banks at lower rates because they believe they would be bailed out in a crisis.
Bank critics say this amounts to a subsidy for being "too big to fail."
Evans said most of the GAO's models showed that the biggest banks actually had higher funding costs in 2013 than smaller banks, based on an analysis of bond yield spreads.
But in hypothetical scenarios with credit risk as high as 2008, the peak of the financial crisis, the GAO found that big banks' funding costs were lower.
"Today's report confirms that in times of crisis, the largest megabanks receive an advantage over Main Street financial institutions," Senators Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican, said in a statement. The two requested the GAO report.
Evans also said the Dodd-Frank law may have made the financial system safer, meaning credit risk levels experienced in 2008 might not return.
The law forces banks to rely less on debt, undergo annual tests of their financial health and plan for their demise.
"These findings reflect increased market recognition of what we have consistently said - Dodd-Frank ended 'too big to fail' as a matter of law," a Treasury official said in a statement.
The International Monetary Fund said in April the subsidy persists but had declined since the crisis. But a study published by The Clearing House, a bank group, said the advantage was negligible.
Evans said the GAO report's findings should be interpreted cautiously because it was unclear why funding costs changed over time. But reform advocates and bank supporters quickly weighed in with their analyses Thursday.
"A subsidy, is a subsidy, is a subsidy and today's GAO proves that there is indeed a taxpayer subsidy associated with too-big-to-fail," said Camden Fine, president of the Independent Community Bankers of America, which is critical of big banks.
Big banks said any funding cost difference had nothing to do with investors' expectations of bailouts.
"The GAO's findings show the impact of the numerous legislative, regulatory and industry-led reforms that have made the U.S. financial system much less complex, stronger and more resilient," said Rob Nichols, head of the Financial Services Forum, which represents big banks.
Editing by Bill Trott, Phil Berlowitz and Dan Grebler