WASHINGTON (TheStreet) -- Janet Yellen, the White House's nominee to head the Federal Reserve pushed back against calls to rollback Dodd-Frank Act provisions that she said have helped bank regulators eliminate the perception that the largest financial institutions are too-big-to-fail.
"My assessment would be that we are making progress," Yellen told lawmakers on the Senate Banking Committee at her confirmation hearing for the position. "Dodd-Frank has put into place an agenda that should make a very meaningful difference in addressing too-big-to-fail."
Democratic and Republican senators pressed Yellen, currently vice-chairman at the Fed, with concerns that large financial institutions receive an implicit funding advantage over their mid-sized or smaller rivals because of expectations on the part of creditors, shareholders and counterparties that the government will shield those stakeholders from major losses in the event of a large institution's failure. Sen. Pat Toomey, R-Penn., for one, worried that the regulatory atmosphere and compliance burdens imposed in the wake of the crisis has lead to "significant" consolidation among community banks "which pose no systemic risk to the economy."
In response, Yellen outlined a whole host of new requirements she'd like to see imposed on big financial institutions that she believes would contribute to limiting their too-big-to-fail perception, including new restrictions on short-term wholesale funding big banks often rely upon to make loans. She added that the central bank is hoping to complete new restrictions "in the months to come," adding that the Fed has already raised capital standards and will raise capital buffers further for the largest institutions that pose the greatest risk by proposing so-called Systemically Important Financial Institution surcharges.
The Fed, she noted, has on its "drawing boards" the possibility of having the largest banks hold additional unsecured debt to make sure that if they are ever in trouble they can be dismantled in a way that does not cause Lehman-like collateral damage to the markets.
Nevertheless, Sens. Mike Crapo, R-Idaho, and Kay Hagen, D-N.C., raised concerns about a provision in Dodd-Frank that seeks to require the biggest banks to divest part of their derivatives business into separately capitalized subsidiaries.
Known as the Lincoln Rule, after former Arkansas Democrat Sen. Blanche Lincoln, the measure was set up to have riskier credit derivatives trades of the sort that gotAmerican International Group Inc.in trouble take place in a separately capitalized unit so that any trading failure there would not have access to the institution's commercial bank division, which is backed by insured deposits and taxpayers through the Federal Reserve's discount window. However, critics, including some House and Senate Democrats and Republicans worry that it will hurt the ability of farmers and manufacturers to conduct risk-mitigating hedging.
"This move would raise costs to the end users without significantly reducing risks to the financial system," said Hagen, who has introduced a bill to repeal parts of the measure.
In response, Yellen said she believes that the Fed can address concerns about the measure in the final regulations "so that it won't be necessary to repeal the rule." She added that the Fed would like to release a measure by year-end. On the flip side, some Senators urged the Fed to take steps beyond its current efforts to hike restrictions on the biggest banks.
Sen. David Vitter, R-La., supported an effort by the Fed and other bank regulators to cap the leverage of the biggest banks beyond that considered in Basel III, the global agreement on bank capital. However, he said it wasn't enough, urging Yellen to take further steps to limit leverage.
Yellen said she wants to wait until after the Fed and other regulators have implemented all the Dodd-Frank requirements before examining whether further leverage caps are necessary. Vitter, together with Sen. Sherrod Brown, D-Ohio, have introduced legislation that would require the biggest banks to hold 15% of their assets in equity, an amount that could force some big banks to divest assets.
Republicans and Democrats also squabbled over another key Dodd-Frank provision - the so-called Volcker Rule which seeks to prohibit big federally insured banks from trading derivatives and stocks with their own money. Sen. Jeff Merkley, D-Ore., said he wanted to make sure that when regulators adopt a final rule it won't adopt a hedging exemption in a way that creates a loophole permiting otherwise prohibited speculative proprietary trading.
However, Toomey reiterated his concerns about the Volcker Rule, arguing that it could be too restrictive.
He told reporters after the hearing that the decision by Congress to allow big banks to engage in proprietary trading of U.S. Treasury bonds was made to ensure that these instruments remain more liquid. Toomey added that he understands that the final Volcker Rule is expected to exempt some foreign sovereign bonds from the proprietary trading prohibition. But even that was not enough, the legislator claimed, saying the cost of borrowing would be raised to issuers if U.S. corporate bonds weren't also exempted from the rule.
"I do think there is some category of sovereign issuers that might be exempt from the rule," he said. "It is not so much that I object to that as I think that such an exemption is an implicit acknowledgement that these restrictions add to the cost of issuers," he said. "What does that do for General Electric? What does that do for the American companies that have to issue debt?"
Yellen said that the Fed is working with other regulators "very closely" to complete the Volcker Rule. Regulators are squabbling over whether they can approve the measure, expected to be over 1000 pages in length, by year-end.
Toomey added that he was "deeply concerned" about consolidation taking place in small banks, adding that almost no new community banks have launched since the 2008 crisis.
The banking committee is expected to vote on Yellen's confirmation shortly. She is expected to be approved by the panel quickly, even obtaining the backing of some Republicans. Toomey told reporters that he has not made up his mind yet on whether he would back the nominee.
Once the committee votes, Yellen's candidacy goes up for a Senate vote, where she eventually is expected to obtain the filibuster-proof 60 votes needed to be approved for the job. At least three Republican lawmakers - Sens. Rand Paul, R-Ky, John McCain, R-Ariz., and Lindsey Graham, R-S.C. - have said they plan to put a hold on her nomination, however regulatory observers don't expect that to delay her confirmation.
--By Ronold Orol in Washington.