New York Fed Chief Expresses Concern on New Leverage Rule

An influential New York bank regulator has privately raised concerns in recent weeks about a proposed rule that seeks to make the nation’s largest banks safer, frustrating other regulators who see it as a centerpiece of a financial system overhaul and want it to take effect swiftly.

William C. Dudley, president of the Federal Reserve Bank of New York, expressed his concerns to senior officials at the Federal Reserve in Washington, according to three people who knew about his efforts. The rule, proposed last July and known as the supplementary leverage ratio, would put a stricter cap on the amount of borrowing that the biggest banks can do. Mr. Dudley raised the possibility that the rule could inhibit the Fed’s ability to conduct monetary policy, these people said. They spoke on the condition of anonymity.

A person with knowledge of Mr. Dudley’s thinking insisted that he was comfortable with the leverage rule. He took his concerns to Fed officials in Washington simply to help make sure that they had properly considered the rule’s potential effect on monetary policy, this person said. The officials listened, but did not think the points he raised were serious enough to warrant significant changes to the rule, the three people said.

Still, Mr. Dudley’s apprehension played a decisive role in holding up the final version of the rule, two of the people said. Some regulators, including officials at the Federal Deposit Insurance Corporation, had counted on the leverage regulation being completed by the end of 2013. Strong supporters of the rule had wanted it issued by then to reduce the chances that pressure from bank lobbyists would dilute it. The rule is now expected to be completed in April at the earliest.

Since the financial crisis, banking regulators have mostly presented a united front as they have introduced a sweeping overhaul. But tensions have often emerged behind the scenes. And when it comes to commitment to the overhaul, the New York Fed faces greater skepticism than other agencies. It was criticized after the 2008 financial crisis for failing to confront the huge weaknesses building up under its nose on Wall Street. Its critics said it had become too cozy with the large banks it regulates.

Since the crisis, Mr. Dudley, formerly an economist at Goldman Sachs, has made significant changes at the New York Fed to try to bolster its supervision efforts. He recently said in a hard-edge speech that the string of scandals at large banks suggested the industry might have a widespread ethics problem. And in the past he has disputed the idea that his time at Goldman had made him more tolerant of the institutions he oversees.

“I do not feel that I in any way hold any allegiance or loyalty to the financial industry whatsoever,” he has said.

Some of the banks regulated by the New York Fed oppose the leverage rule. Citigroup, for instance, sent a letter criticizing it to the Fed last October. One of the main objections of industry lobbyists is that the rule is harmfully blunt.

Banks currently have to hold capital against certain assets to absorb potential losses under two approaches. One allows them to hold less capital against assets that are deemed less likely to produce losses in the future. But regulators knew there were big shortcomings with that “risk-based” approach, and understood that banks might find ways to evade such rules. It is also not always possible to predict which assets have the least risk.

In contrast, the other approach — the leverage ratio — forces banks to hold an equal amount of capital against each type of asset, regardless of its perceived risk. The new supplementary leverage ratio rule only increases the overall amount of capital that banks must hold against all their assets.

The Fed, the F.D.I.C. and the Office of the Comptroller of the Currency are the agencies writing the final rule.

It was not immediately clear exactly why Mr. Dudley thought a small increase in the leverage ratio might interfere with monetary policy. But bankers have often asserted that it could weigh on two types of assets that play a big role in transmitting monetary policy changes into the wider economy.

One is “repo” loans, which are short-term market loans that are collateralized with bonds provided by the borrower. The other is cash that banks have on deposit at the Fed. In theory, banks may hold less cash and engage in fewer repo loans if the leverage ratio goes up. In turn, that might make it harder for the Fed to conduct monetary policy smoothly and effectively.

But the increase in the leverage ratio may have little to no effect on markets. Most large banks already comply with the higher ratio that the new rule will demand. And repo markets have already been shrinking for some time, for various reasons. Moreover, banks have been criticized for leaving cash idle at the Fed when they could be using it to make loans.

“This rule has been debated ad nauseam, like too many rules that are stuck at the Fed,” said Dennis Kelleher, president of Better Markets, an advocacy group that often favors stricter regulation of Wall Street. “The New York Fed should not be holding it up when the votes to pass it have been there for some time.”