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WASHINGTON (Reuters) - Bank holding companies would not be allowed to dip below the strict capital standards of their federally insured bank units, under a proposal issued by U.S. bank regulators on Tuesday.
Advocates of this approach argue bank holding companies relied too heavily on their insured banking units as a source of capital strength during the 2007-2009 financial crisis, leading to government bailouts.
The rule proposed by the Federal Deposit Insurance Corp and other banking regulators on Tuesday would set a uniform risk-based capital floor across the banking industry, but will not necessarily spark any capital raising in the short term.
U.S. banks, pushed in part by industry regulators, have already built large reserve pools of capital in the wake of the financial crisis.
"This should have been in place years ago. I'm not saying it would have stopped the crisis, but it would have helped to hold bank holding companies to the same standards," said Paul Miller, bank analyst at FBR Capital Markets.
The FDIC is required to take the action under the Collins amendment in this year's Dodd-Frank financial overhaul law.
It is just one of the myriad capital rules that banks are facing in the coming months and years, as regulators roll out strict international standards following the financial crisis.
FDIC Chairman Sheila Bair, a self-described "capital hawk", worked closely with Senator Susan Collins to include the amendment.
Bair wrote in a letter to Collins in May that bank holding companies were relying on their insured depository institutions as a source of capital strength when the opposite should have been the case.
The Basel II international capital agreement could have worsened the situation. Although never utilized by U.S. banks once the crisis erupted, those rules would have allowed the largest institutions to have a big say in setting their minimum risk-based capital levels, instead of complying with a uniform capital floor.
Bair has argued those rules would have allowed firms like Washington Mutual, which collapsed in 2008 in the largest U.S. bank failure ever, to have had even less capital going into the financial crisis.
"The Collins Amendment, in my view, will do more to strengthen the capital of the U.S. financial system than any other section of the Act," Bair said on Tuesday. "Large financial institutions need the capital strength to stand on their own without government assistance."
The FDIC voted to put the proposal out for 60 days of comment, seeking feedback on how it should be implemented.
The new capital floor would also apply to any non-bank institution that regulators deem important to the financial system and therefore subject to supervision by the Federal Reserve.
The FDIC also approved stricter standards on how banks assess risks associated with their trading books when determining how much capital they have to hold. Banks would have to assume a time of economic stress in gauging risk.
The largest U.S. lenders, such as Bank of America and Citigroup, are preparing for new international capital rules called Basel III, which will be phased in over the next several years, requiring banks to maintain an 8 percent core capital ratio.
A question surrounding the FDIC proposal is how it will mesh with Basel III, which was endorsed in November by leaders from the Group of 20 developed and emerging nations.
An FDIC official told reporters that U.S. rules implementing Basel III would only go further than Tuesday's proposal. "That's pretty much a slam dunk with Basel III, they're going to be higher."
Also on Tuesday, the FDIC approved a final rule setting a much higher long-term target for the minimum level of its insurance fund.
The fund's reserve ratio measures its balance versus the amount of insured deposits, and is used to cover the cost of bank failures. The board set a 2 percent reserve ratio as its long-term goal.
The Dodd-Frank law sets the minimum ratio at 1.35 percent and the agency has 10 years to hit that target.
Banks have complained the 2 percent goal is too high and the money they contribute to the fund could be better used for lending and other activities.
The FDIC also approved its 2011 operating budget, which at $4 billion is slightly less than in 2010. It is the first time in four years the budget has failed to increase, a sign that the wave of bank failures that followed the financial crisis is slowing down.
Reporting by Dave Clarke; Additional reporting by Joe Rauch in Charlotte, N.C.; Editing by Tim Dobbyn