NEW YORK (

TheStreet

) -- The

Federal Reserve

has a new reason to question whether its post-crisis banking sector fixes targeted at Wall Street behemoths can also work on Main Street America.

After taking on "too big to fail" lenders, the Fed now faces the challenge of defining its oversight of smaller banks that dot Main Street and are at the heart of local commerce, in a crucial test of its increased power after the 2010 Dodd Frank Act.

On Monday, the Federal Reserve said it would delay a stress-testing program for banks with assets between $10 billion and $50 billion, caving in -- at least for now -- to protests from small and midsized lenders who argue they are struggling to keep up with a growing post-Dodd Frank Act regulatory burden.

In December 2011, the Fed proposed that savings and loan institutions with more than $10 billion in assets comply with annual company-run stress tests, subjecting them to capital requirements. In its delay, the Fed said concerns on the limited resources and readiness of those lenders gave it reason to reconsider how and when it will invoke the tests.

Separately, on Monday, the

Federal Deposit Insurance Corporation

also said it would postpone stress tests.

The delay is a setback to the Fed's overall stress testing program, which got positive reviews after March tests of "too big to fail" lenders like

JPMorganChase

(JPM) - Get Report

,

Bank of America

(BAC) - Get Report

,

Goldman Sachs

(GS) - Get Report

Morgan Stanley

(MS) - Get Report

and

Wells Fargo

(WFC) - Get Report

showed sector-wide capital ratios that give America's largest lenders the strength to withstand a European debt spiral or a double dip U.S. recession. The tests also paved the way for most of America's largest banks, excluding

Citigroup

(C) - Get Report

, to launch dividend boosts, share buybacks, or both, in a catalyst to what's been a 2012 banking sector rally.

But while stress tests are being seen as a positive for America's largest banks, Monday's delay for smaller banks -- many holding $10 billion to $50 billion in assets are regional and even community lenders -- signals that programs designed for "too big to fail" institutions may not work on Main Street.

"These are not the banks that are going to damage you," says Nancy Bush, the head of banking sector research firm NAB Research. "These are the companies that should be doing the most lending to small businesses and Main Street and guess what? They aren't. This is a problem for the Fed," she adds, noting the costs of regulations like stress tests.

Already, the Fed has been criticized for near-zero interest rate policies and added easing measures that are cutting at the earnings of traditional lenders, while acting as a subsidy for the largest banks, which deal in global markets and scores of financial products beyond traditional mortgage, small business and consumer loans.

The Fed may find that it needs to discriminate between rigorous tests for "too big to fail" banks and less harsh measures on the health of banks that don't present a systematic risk to the market. New Dodd-Frank capital requirements and those of

Basel III

already ask that systemically important institutions hold excess capital compared to lenders of a lesser size.

Rules on bank oversight may now also make the distinction.

Monday's delay indicates the Fed may decide to phase in stress testing programs designed for "small enough to fail" banks, which will contrast to more stringent "too big to fail" tests on larger lenders.

Instead of a holistic test like the Fed's March review of the largest U.S. lenders, NAB Research's Bush argues for more targeted tests. The Fed should test, "whatever it feels is the Achilles heel of these banks, whether it is liquidity or capital. Take that element and stress test it first," says Bush.

While smaller lenders face new regulations from the

Consumer Financial Protection Bureau

and the

Durbin Amendment

, the benefits of stress testing, if done properly, may yet outweigh the costs, according to Kevin L. Petrasic, a partner in the global banking practice at Paul Hastings. "Hopefully we are not just kicking the can down the road," says Petrasic.

As with March tests, the Fed's seal of approval on a bank's capital and liquidity could inspire depositor confidence and give investors an objective industry-wide ranking of bank health. Tests would also motivate failing banks and low passers to take decisive action on their capital, in moves that may expedite a return to loan growth.

The weak capital position of European banks and expectations that only the best lenders will muddle through the region's debt crisis strengthens the argument of test advocates. The financial crisis indicates that given the choice, banks will dither on capital buffers until it is too late, proving the necessity of regulators.

Tests could also minimize future bank failures, a key considering that the FDIC currently counts 732 banks containing $282 billion in assets as "problem" institutions. Petrasic estimates that it may take the FDIC another decade to earn back losses it suffered during the financial crisis, signaling that regulators should implement capital tests that may prevent a new string of bank failures.

On Wednesday, the FDIC said it earned $34.5 billion in the second quarter, a more than 20% year-over-year earnings boost as it claws its way back from the deep financial crisis-caused hole.

"Ultimately a strong and robust regulatory model is going to benefit a strong and robust banking industry," says Petrasic."The big challenge for regulators is going to be to define what is necessary and to define what is perhaps not quite so important."

As it stands, the Fed's post-crisis banking reforms have been far more successful with Wall Street's "too big to fail" lenders. That needs to change. On Main Street, "small enough to fail" is what matters.

-- Written by Antoine Gara in New York