(Updates with comment from the Treasury and Federal Reserve officials and background)
WASHINGTON -(Dow Jones)- World governments developing new financial standards must ensure they match the stringency of regulations just adopted by the U.S., the head of the Treasury Department's international affairs told Congress Tuesday.
"Without internationally consistent standards, large financial firms will tend to move their activities to jurisdictions where standards are looser and expectations of government support are stronger," said Lael Brainard, U.S. Undersecretary of the Treasury for International Affairs, in prepared testimony before a Senate Banking subcommittee.
"This can create a race to the bottom and intensify systemic risk throughout the entire global financial system," she said.
The U.S. Congress last week approved a sweeping financial regulation bill aiming to fundamentally overhaul the industry, coming in the wake of a global financial meltdown that precipitated a major economic recession. President Barack Obama is expected to sign the bill into law this week.
U.S. officials are concerned that European governments in particular are dragging their feet on new capital standards, will water down new regulations, and put the U.S. financial industry at a competitive disadvantage.
"They're rubbing their hands and licking their chops because of what we've done" with the financial regulatory bill, said Senate banking committee member Bob Corker, (R., Tenn.), at the hearing.
Brainard told the Security and International Trade and Finance subcommittee Europe's governments "must develop the most globally convergent financial protections the world has ever attempted."
"It is critical to level the playing field up, while protecting against future financial crises and promoting economic growth," she said in the prepared testimony.
European officials are concerned that forcing strict new capital requirements on their banks amid the sovereign debt crisis rocking the continent may undermine much needed growth and erode liquidity fueling their economies.
Lawmakers at the hearing expressed skepticism about the ability of the Obama administration to encourage harmonization of international standards, particularly given the political challenges internationally of approving laws that may curb banks' profitability.
But Brainard said that all of the nations negotiating new standards are motivated to draft stringent standards because they've all "come through the common crucible of the crisis."
The Basel Committee on Banking Supervision--an international panel of regulators named after the Swiss town in which they meet-- is crafting new capital standards for the Group of 20 largest nations to consider later this year.
With major differences between U.S. and European officials on what's considered adequate levels of capital and appropriate to categorize as capital, the Basel committee has weakened recent drafts from earlier proposals.
U.S. Federal reserve governor Daniel Tarullo told the Senate panel that while the Basel Committee is on track to cementing a proposal this year, "some of the hardest decisions have yet to come."
Given the disagreements, Brainard said that a capital framework that takes into account the risks in a bank's portfolio is likely to be replaced by a simple leverage ratio, "a supplementary backstop to cut through some of the complexity." Even so, Brainard said "it may take some time for (the leverage ratio) to become a mandatory part of the framework."
Tarullo said while he believed there's a "reasonable prospect" for the G-20 to agree on a leverage ratio this year, he warned that without categorizing capital, regulators wouldn't adequately take into account the risks associated with assets. "That's why they have to be done in tandem," he said.
While the Treasury official stressed work is underway to converge bank capital standards and derivatives regulation, she said it may prove beneficial in other areas of new regulations "by coordinating different approaches across nations, reflecting deeply rooted differences in national structures and institutions."
As part of an effort to strengthen the financial system, the European Union will disclose later this week the results of bank stress tests for scores of key institutions across the region. Analysts and some U.S. officials worry the tests may not reveal the depth of financial problems within the system.
"This European effort--with the appropriate assumptions and disclosures--could play a helpful role in dispelling uncertainty about the financial conditions of individual financial institutions in Europe and in strengthening transparency and bank balance sheets," Brainard said.
The Treasury official said the administration was also working to prevent discrimination against U.S. hedge funds in Europe that may prevent access to firms under some proposed new standards.
Tarullo said several provisions were unlikely to be incorporated into standards overseas. In particular, he pointed to a rule that prohibits U.S. banks from proprietary trading and investing in private investment funds, another that bans trading of some types of derivatives, and a rule that prevents firms from amassing market shares deemed too large.
Copyright 2009 Dow Jones Newswires
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