U.S. financial reform should include some form of the Volcker rule, which would limit large financial firms' ability to engage in speculative trading, Thomas Hoenig, president of the Kansas City Federal Reserve Bank said on Wednesday.

Hoenig, among a small minority of Fed officials to openly call for banks deemed too big to fail to be broken up, argued the country's mammoth investment conglomerates had not served the broader economy well.

Adopting a version of the proposed Volcker rule would be healthy for long-term stability, Hoenig told a conference sponsored by the U.S. Chamber of Commerce. We have seen the formation of a powerful group of financial firms.

Hoenig said some of the push toward deregulation during the 1990s had been detrimental to financial stability, and needed to be reversed.

In particular, he said big financial holding companies should not be allowed to trade for their own accounts, so-called proprietary trading. He said they should be forbidden from investing in or sponsoring their own hedge funds.

He also stressed the need for greater transparency in derivatives markets, which many blame for bringing the global financial system to the brink of collapse in late 2008.

Hoenig supported efforts to give regulators the authority to wind down big financial companies in an orderly fashion, but said current proposals left too much at the discretion of the political process. There is considerable room for exception in the hands of the Treasury, he said. This needs more attention.

He added that the implicit guarantee by government of the dominant banking interests gave them an unfair advantage in the market, including cheaper borrowing costs and higher credit ratings.


Hoenig also used the forum to make the Fed's case that, despite some failure in regulation in the run-up to the crisis, the central bank should retain its supervisory powers over both large and small financial institutions.

Some of the proposals from Washington aim to narrow the Fed's role to focus more exclusively on the bigger banks.

Such a measure would reconfigure the central bank of the United States into the central bank of Wall Street. I think that would be extremely harmful, Hoenig said.

The official said he would also like the Fed to play a big role in consumer protection. Analysts blame regulators, including the Fed, for poor oversight of credit card and mortgage sectors that aggravated the financial crisis.

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(Editing by Andrew Hay)