The Senate's latest proposal to break up the big banks faces an uphill battle, but senior regulator Thomas Hoenig still says it could have a major impact on the movement to separate big banks' commercial and investment activities.

Hoenig, the vice chairman of the Federal Deposit Insurance Corp., has long argued that the nation's largest banks should become smaller, simpler and less risky. Last week he threw his support behind a new bipartisan bill that would reinstate the Glass-Steagall law that once barred commercial banks from trading and other capital markets activities. The so-called 21st Century Glass-Steagall Act was introduced this month by senators including Elizabeth Warren and John McCain.

 "I'm supportive of it," Hoenig said in an interview Wednesday. "It would be very healthy for the financial industry generally and very healthy for businesses, more generally. … It has merit and deserves a healthy debate."

Many industry members and observers say that a debate is all that is likely to result from the bill. Like related legislation introduced earlier this year by Sens. David Vitter and Sherrod Brown, which would restrict large banks' activities through sharply higher capital requirements, the Warren-McCain proposal stands little chance of becoming law in its current form.

Hoenig acknowledges the current long odds against the Warren-McCain bill, but argues that those who dismiss it are short-sighted.

"You never know what the possibilities of something are until you have the full story out, and the full debate. And if the debate is healthy and the facts come out and suggest that we would be better off with the separation clearly reintroduced, then it could in fact pass," he says. "I don't dismiss it — I don't give it high odds, but a year ago I would have given it less odds. Now I give it more odds; a year from now, even more odds."

Far from receding after the financial crisis and its era of government bailouts, the debate over big banks' size and complexity has picked up steam in the past year. Regulators have addressed it most directly through their work to increase banks' capital requirements, especially under the international Basel III capital standards.

Hoenig has frequently criticized Basel III as inadequate, because it relies on banks' own assessments of the riskiness of the assets they hold. This month he broke with the rest of the FDIC's board and voted against the interim final Basel III rule. But he supported a separate regulatory plan that would require many of the biggest banks to increase the overall percentage of their assets that they hold as capital; bank holding companies would have to maintain a 5% leverage ratio while their insured subsidiaries face a 6% ratio.

The plan would require the country's eight largest banks to add as much as $89 billion total to their capital levels in order to comply with the requirements, the FDIC estimated.

Relying on increased capital standards to slowly winnow down banks' operations and related risks is "not the preferred method" to breaking up the banks, "because it's not systematic and it's not statutorily driven," Hoenig said Wednesday. "So you get into who's got the right amount of capital and what capital is, which is in and of itself a debate. So I would prefer that we do it where it's equally applied and systematically applied. And I think the outcome will be better."

He also elaborated on his skepticism about Basel III, arguing that it "assumes knowledge we do not have. It assumes I know the future, it assumes that I know where risk will be."

Big banks including JPMorgan Chase (JPM), Citigroup (NYSE:C) and Bank of America (BAC) faced shareholder questions over the new capital rules this month, as they reported second-quarter earnings. JPMorgan Chase executives would not reveal the leverage ratio of the bank's deposit-gathering subsidiaries, despite repeated questions.

A few days later, Citigroup Chief Financial Officer John Gerspach voiced the industry's frequent refrain on capital levels, a worry that higher requirements in this country will hamper U.S. banks' ability to compete with international rivals.

"We would all be better if there was a level playing field around the world," Gerspach said during a conference call Monday.

On Wednesday, Hoenig argued that stronger institutions will ultimately find the best positions on any playing field.

"Strength always wins in the long run. So if you're competing with someone who has infinitesimal margin for error, they're going to suffer, as some of them are today, and you can compete. People want to be with strong institutions," he says. "They'll always go for price in the short run … but having a stronger capital level gives confidence to the market and gives you, in the long run, a very strong and competitive position."

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