Fed bank oversight rules expected this week - source

The U.S. Federal Reserve building is seen in Washington June 29, 2011.

WASHINGTON (Reuters) - The Federal Reserve is expected to release this week a highly anticipated proposal for how it will oversee the largest U.S. banks, a person familiar with the plan said on Monday.

The proposal, which includes a group of rules such as new capital and liquidity requirements, was mandated by the 2010 Dodd-Frank financial oversight law, enacted in response to the financial crisis.

The rules are intended to make large banks more stable by ensuring they have enough capital and liquidity to absorb market shocks. They will also require banks to act to strengthen themselves if it appears they are heading into trouble, such as being overexposed to risky assets.

Release of the proposal, which is expected to be more than 1,000 pages, could be delayed until January if it does not receive final approval this week from all members of the Fed's board.

Once the proposal is released, the banking industry and public will be allowed to give the Fed feedback before a final set of rules is implemented.

Under Dodd-Frank, the Fed is charged with providing more oversight of the largest U.S. financial firms. This includes all banks with more than $50 billion in assets, such as Goldman Sachs (GS.N), JPMorgan (JPM.N) and Citigroup (C.N), and any financial firm the government identifies as being important to the functioning of financial markets and the economy.

The government has yet to decide which non-banks, such as insurance companies and hedge funds, meet this standard.

The capital requirements the Fed will lay out are expected to closely mirror the standards agreed to earlier this year by regulators from around the world as part of the Basel III agreement. Implementation of the agreement is due to start in 2013.

The Basel agreement will require banks to maintain top-quality capital equal to 7 percent of their risk-bearing assets. In addition, global "systemic" banks may have to hold up to an additional 2.5 percent. A 1 percent surcharge would be imposed on banks that became significantly larger.

Fed Governor Daniel Tarullo said in November that the Basel agreement, blessed by the Federal Reserve, was consistent with the capital rules expected to be issued under Dodd-Frank.

Banks have complained that the Basel rules, which increase the amount they are funded by equity as opposed to debt, will cause them to lend less, thereby hurting economies.

Regulators and academics who support the rules contend that a more stable financial industry will better serve economies. Basel negotiators are still hammering out the final details on liquidity requirements.

If the Federal Reserve enacts new rules before a final international agreement is reached, it will give the United States the lead in implementing stiffer requirements for banks.

U.S. banks are anxiously awaiting the Fed's proposal to see what the central bank would have them do if their financial positions deteriorated. Dodd-Frank requires the Fed to lay out mandatory "early remediation".

The dilemma is to create requirements that would allow a bank to recover instead of putting it into a death spiral by raising concerns in markets that the institution was in peril.

Mark Van Der Weide, a senior staff member at the Fed's Division of Banking Supervision and Regulation, said at a conference in September that one of the biggest challenges was deciding the parameters that would force a bank or financial institution to shore up its capital position.

(Reporting By Dave Clarke)