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By Douwe Miedema and Emily Stephenson
WASHINGTON, Nov 14 (Reuters) - Big banks can still borrowmore cheaply than competitors and should face tougher rules, theprospective new head of the U.S. Federal Reserve told lawmakerson Thursday.
Large banks may have an edge because markets think they havegovernment backing in times of crisis, said Janet Yellen,President Barack Obama's choice to be the Fed's new head,unveiling some new steps the central bank could take toencourage those firms to downsize.
"Most studies point to some subsidy that may reflect too bigto fail," she said during a hearing into her nomination beforethe Senate Banking Committee.
"Since those firms do pose (a) systemic risk to thefinancial system, we should be making it tougher for them tocompete, and encouraging them to be smaller and less systemic."
Yellen, currently the Fed's vice chair, largely echoed theFed's existing policy on bank regulation, but did reveal somenew details of her thinking about Wall Street's role incommodity markets and on short-term funding.
Wall Street critics argue that banks such as JPMorgan Chase and Citigroup are too big to fail, and politicianssuch as Sen. Sherrod Brown - an Ohio Democrat - have introducedbills that could force them to cut their size.
A government report found on Thursday that bigger banksreceived more support than smaller firms from governmentbackstops, such as deposit guarantees and the Fed's discountwindow, during the 2007-09 financial crisis.
The six biggest banks participated in crisis-era emergencyprograms, although they later stopped relying on much of thatfederal support, the U.S. Government Accountability Officereport said.
U.S. regulators have been scrambling to write tough newrules for banks that were required by the 2010 Dodd-Frank law,which Congress passed to overhaul Wall Street oversight.
The law called for banks to rely less on debt, hold assetsthat could be sold quickly in a credit crunch and stop makingrisky trades with their own money. Regulators are stillwrestling with the details of some of these changes.
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Yellen said the Fed is considering additional rules thatwere not part of the Dodd-Frank requirements, and may writerequirements for Wall Street's activities in physical commoditymarkets once the Fed winds up a review of banks' raw materialstrading.
The Fed said in July it was reviewing a 2003 decision toallow regulated banks, including Citigroup and Barclays, to trade in oil, metals and other commodities.
That led to banks' ownership of assets like oil storagetanks and power plants, and accusations of price manipulation.
Thursday was the first time a Fed official had said newrules could come out of its review into raw materials trading byGoldman Sachs, JPMorgan and other banks, results of whichare expected early next year.
"We may be involved in additional rule-making as we completethis review," Yellen said.
Brown, the Ohio Democrat, will question the Fed next week ata sub-committee hearing about whether banks' commodity dealingsdistort prices in markets from electricity in California toaluminum.
Yellen also said the Fed expects to be able to addressconcerns about a rule that forces banks to isolate riskyderivatives trading into separate business units - the so-calledpush-out rule - without changing the law.
The rule is aimed at separating swaps from federalgovernment backstops such as deposit insurance. Banks saycomplying with the rule would be too costly and complex.
A total of 70 Democrats in the House of Representativesvoted along with Republicans last month to adopt a bill to undomost of the provision, a victory for bank lobbyists even if theproposal stands a slim chance of becoming law.
Yellen also said concerns about banks' overly-heavy relianceon short-term funding - a crucial cause of the collapse ofLehman Brothers in 2008 - could be fixed by asking them to putup higher safety buffers, or margin.
Governor Dan Tarullo, the Fed's main spokesperson onfinancial regulation, first said the central bank was working onthe rule in July, but did not provide details.
