WASHINGTON (By Dave Clarke) - America's big international banks should restructure their operations unless they can prove they can easily be broken up if they start toppling during a financial crisis, said U.S. regulator Sheila Bair.

Multinationals will need to set up more foreign subsidiaries and realign their legal structures to make it easier for regulators to liquidate them if necessary, Bair told the Reuters Future Face of Finance Summit.

"If they can't show they can be resolved in a bankruptcy-like process... then they should be downsized now," said Bair, chairman of the Federal Deposit Insurance Corp.

"There is no reason in the world why they should get some special treatment backstop that other businesses in this country don't have," Bair said.

She also said investors need to accept that they will get lower returns from banks that hold higher capital and run safer operations.

The aim of orderly liquidation is to avoid a repeat of 2008, when the Bush administration bailed out American International Group and other firms but not Lehman Brothers. Lehman's bankruptcy virtually froze capital markets.

The "living will" requirement mandated by last year's Dodd-Frank financial reform law is also designed to end the idea that some firms are too big to fail. It would put the greatest burden on banks with complex businesses and big international presences such as Citigroup, Bank of America, JPMorgan Chase, Goldman Sachs and Morgan Stanley.

By year's end, big banks are expected to file with regulators their plans that would show how they can be closed down if they face a liquidity crisis.

REGULATORS VS SHAREHOLDERS

Bair said traditional deposit-taking banks in the United States probably can produce plans for a shutdown, but large multinationals with complex legal structures need to simplify.

"The burden is on them initially to show us that they don't think they need subsidiarization," she said. "They need to give us a plan on how they can be resolved on an international basis without it."

A former general counsel at Bair's agency said there may a tension between banks trying to meet these new regulations and maximizing shareholder value.

"If you set up a business in a way to optimize ease of liquidation, that may not be the way to optimize running a successful business," said John Douglas, now a Davis Polk attorney.

Others said the changes may be more hassle than expensive and the changes would be legalistic. "This is just the latest in 'Can you jump through this hoop backwards?'," said Paul Miller, an analyst with FBR Capital Markets.

Bair made clear she was not advocating that some large banks be broken up now -- only that they need to make structural changes so that they could be broken up if they begin to fail.

"Far too many of them, they manage their businesses along business lines as opposed to legal entity," she said.

INTERNATIONAL CHALLENGES

Bair is now in the final months of her five-year term heading the FDIC, which she led during the tumult of the financial crisis. Her term ends in June.

Bair said she hopes to have major aspects of new capital requirements and the liquidation regime in place before she departs.

Among her concerns going forward is that new capital rules, known as Basel III, agreed to by leaders of the Group of 20 leading nations in November, will not be carried out with their intended strength.

Banks have argued they are too strict and will impede their ability to lend and aid economic growth, an argument that may have traction with politicians.

"I hope political leaders hold firm on this and understand that this is really something to protect their taxpayers and to protect their economies, this needs to occur," she said.

(Reporting by Dave Clarke in Washington; Additional reporting by Joe Rauch in Charlotte; Editing by Tim Dobbyn)

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