The Deal: Yellen Defends Regulator Oversight of Big Banks

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NEW YORK (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.