By Dave Clarke
WASHINGTON (Reuters) - Federal Reserve Governor Daniel Tarullo said on Friday the Fed will soon issue guidance allowing some banks to increase dividend payments but warned they would have to meet strict standards.
Banks would have to submit plans "that demonstrate their ability to absorb losses over the next two years under an adverse economic scenario that we will specify, and still remain amply capitalized," Tarullo said in a speech prepared for delivery to the George Washington University law school.
He said banks also will have to show they can meet the new capital requirements laid out in the recent Basel III international agreement and they can "accommodate any business model changes" required by the new financial reform law.
Tarullo said the dividends guidance would go into effect the first quarter of next year.
Banks have been pushing to boost dividends. But regulators have balked at giving them the green light, citing uncertainty about the economic outlook and new capital rules.
With global capital rules and the U.S. financial regulatory system retooling, Tarullo said it is now easier for the Fed to measure whether strong banks should be allowed to increase dividends.
"While there continues to be a relatively high degree of uncertainty about near- to medium-term economic prospects, the basic questions surrounding capital and regulatory reform have now been answered," he said.
Tarullo also used his speech to advocate that banks pursue mortgage modifications rather than foreclosures, arguing in most cases it would be a better outcome for all involved.
"It just cannot be the case that foreclosure is preferable to modification -- including reductions of principal -- for a significant proportion of mortgages where the deadweight costs of foreclosure, including a distressed sale discount, are so high," he said.
State and federal officials, including the Fed, are investigating allegations that for years banks have not reviewed foreclosure documents properly or have submitted false statements to evict delinquent borrowers.
"I would hope that both servicers and ultimate holders of the mortgages will take this occasion not just to correct documentation flaws and to contest who should bear the losses of mortgages gone bad, but to invigorate the modification process," he said.
(Reporting by Dave Clarke, Editing by Neil Stempleman)