WASHINGTON (Reuters) - Republican lawmakers on Tuesday pressed a Federal Reserve official on how to tell if any banks pose a "grave threat" to the financial system, a finding that would allow regulators to take drastic steps such as forcing a bank to sell assets.
The 2010 Dodd-Frank financial oversight law gives the Federal Reserve authority to impose tough restrictions on individual firms it feels could shatter the financial system.
But this authority could create uncertainty in financial markets if regulators do not explain what types of threats could trigger the tougher oversight, Republican members of a House of Representatives subcommittee said on Tuesday.
"If we want to breed stability within the sector, certainty within the sector, does your standard of 'when I see it, I'll know it,' does that really breed that stability and certainty?" asked Representative Sean Duffy, a Wisconsin Republican.
Scott Alvarez, the Fed's general counsel, told the panel that the agency was not likely to spell out what would constitute a grave threat.
"This decision depends very much on the facts and circumstances, and so it is very hard in this area to set a uniform rule," Alvarez said.
Congress passed Dodd-Frank to prevent future meltdowns after the 2007-2009 financial crisis. But some lawmakers have said the law went too far and that regulators could use their new powers to try to break up the biggest banks.
The financial services committee's oversight panel held the hearing on Tuesday to consider regulators' efforts to end "too big to fail," the belief on Wall Street that some firms are so critical that the government would bail them out rather than see them fail.
Representative Patrick McHenry, a North Carolina Republican who leads the oversight subcommittee, said he was concerned that the Fed could legally use its power to crack down on individual banks that pose grave threats even when there is no financial crisis.
He asked whether regulators might use that power to set caps for groups of banks, effectively deciding the ideal size of banks.
Representative Al Green of Texas, a Democrat, said defining what counts as a grave threat could create problems if it led market participants to speculate on when banks might have to sell assets.
He pointed out that the Federal Deposit Insurance Corp, which regulates smaller national banks, does not alert markets before it takes over failed banks under its jurisdiction.
Alvarez also told the panel that Dodd-Frank sets out a number of hurdles that regulators must surpass before they could force banks to sell assets.
Two-thirds of a risk council made of the heads of financial regulatory agencies would have to agree that the firm posed a grave threat before the Fed could move forward with tougher regulation.
Regulators also must consider alternatives such as limiting mergers and acquisitions or requiring the termination of some activities before they could force a firm to sell off assets, Alvarez said.
(Reporting by Emily Stephenson; Editing by Lisa Shumaker)