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WASHINGTON (Reuters) - A Federal Reserve official on Thursday downplayed the impact of regulators potentially missing a July deadline to finalize the Volcker rule's ban on proprietary trading, and said authorities will step in to provide clear guidance if needed in an effort to soothe any fears in the financial industry.
"There is obviously a real possibility that we don't meet the July 21st date," Fed Governor Daniel Tarullo told a Senate Banking Committee hearing.
"If we are not going to, I think it is incumbent on all the regulators to provide some guidance for firms to let them know exactly what the expectations will be and not let this hang out there as an unknown, and I think we should be able to do that if needed," he said.
Banks have raised concerns that if a final rule is not ready by July 21, when the trading restrictions take effect under law, there could be disruptions in markets because of a lack of clarity on how to comply with the new crackdown.
The proprietary trading ban is known as the Volcker rule, after former Federal Reserve chairman Paul Volcker who championed the crackdown. It was included in the 2010 Dodd-Frank financial oversight law.
The Volcker rule bans banks from trading with their own funds and greatly limits their ability to invest in hedge and private equity funds.
The idea is to limit excessive risk-taking by banks that enjoy government backstops such as deposit insurance and access to Fed loans.
The Volcker rule could significantly bite into the profit potential of Wall Street firms including Goldman Sachs Group Inc and Morgan Stanley.
Regulators issued a proposed Volcker rule in October - but it was roughly 300 pages, with hundreds of questions for public comment, indicating the final version could look significantly different.
The financial community complained that it was too complex and too vague, especially for a reform set to go live in July of this year.
Republican Senator Mike Crapo on Thursday told regulators that he has introduced legislation along with two other Republicans and three Democrats that would delay implementation of the Volcker rule until release of a final rule.
But Tarullo told Crapo he did not think legislation was needed.
Tarullo said the guidance should be enough and noted that there is a two-year transition period and that the Fed can provide more clarity on what regulators will expect during this time frame as well.
"I think we can deal with both issues here without legislation and we will try to go ahead and do so," Tarullo said.
Acting Comptroller of the Currency John Walsh told the committee that the current July deadline can be a positive because it is motivating regulators to work quickly.
The Volcker rule has been one of the most controversial aspects of Dodd-Frank.
Banks and other critics have argued it will reduce liquidity in trading markets which in turn will make the cost of borrowing go up.
Many foreign governments have also raised concerns about the fact that the October rule provides an exemption for proprietary trading with U.S. debt, but not debt issued by other countries, which they contend will make their borrowing costs rise.
Tarullo said the Fed is working to better understand the rule's impact on sovereign debt, but he downplayed the threat.
He said some of the foreign regulators did not understand when they first aired concerns that there is an exception for bank trading done on behalf of customers, or so-called market making, that would address some of the issues they have raised.
He added that banks are not the only institutions that trade in sovereign debt.
"There are other firms that are not subject to the Volcker rule who are out there who may well take up any slack that does exist," he said.
Tarullo also told the committee that the Fed will look at how foreign banks in the United States are regulated after Deutsche Bank AG changed the legal status of its main U.S. subsidiary in order to avoid injecting billions of dollars of capital into the unit.
When asked whether Deutsche's decision would have an impact on the health of the financial system, Tarullo said he thought the Fed will need to respond.
"The development to which you just alluded has certainly affected my thinking of how we do structured regulation of foreign bank organizations, and I think we will need to respond to that," Tarullo said.
Deutsche Bank declined to comment.
Reporting By Sarah N. Lynch, Dave Clarke, Rachelle Younglai in Washington and Edward Taylor in Frankfurt; Editing by Gerald E. McCormick and Matthew Lewis