Four top Federal Reserve officials urged Congress on Thursday not to strip the U.S. central bank of the authority to supervise small banks, saying they would lose an important finger on the pulse of the economy that helps them guide monetary policy.

A financial regulatory overhaul bill unveiled in the U.S. Senate this week would diminish the powers of most of the regional Fed districts and leave some with no banks to oversee.

It is a travesty, Thomas Hoenig, president of the Kansas City Federal Reserve Bank, told a bankers' group. It is absolutely disenfranchising our relationship with a very important, hugely important, sector outside of Wall Street across the United States.

It makes the central bank the central bank of Wall Street and not of the United States, he said.

Hoenig, along with president of the Cleveland Federal Reserve Bank, Sandra Pianalto, Richmond Fed chief Jeffrey Lacker, and Fed Governor Elizabeth Duke presented a united front against the proposal at a conference sponsored by the American Bankers Association.

The Senate proposal would shift oversight of banks with assets of less than $50 billion from the Fed to other regulators. By some estimates, that would reduce the number of banks under Fed supervision from around 5,800 to 50.

Fed Chairman Ben Bernanke had presented a similar argument to lawmakers on Wednesday.

Hoenig said the legislation introduced by Senator Christopher Dodd on Monday would remove all of the banks in his district from his bank's supervision. Other districts, such as St. Louis, would likely also have no more banks to supervise.

Duke said the U.S. central bank's broad supervisory authority gives it a better understanding of the economy's condition and it would be a mistake to narrow that focus to only larger banks.

Duke said broad-based knowledge of banks' condition was specially helpful to Fed policy makers during the financial crisis when they had to respond quickly to changing conditions.

So I would hate to see the Federal Reserve become focused too narrowly on the activities of just the largest institutions, she said in a separate speech.

Since Dodd announced his bill, shares of smaller banks have outperformed big bank stocks on the expectation that larger firms will face tougher requirements that will hurt profits.

Smaller banks, as measured by the S&P MidCap Financial Index <.4GSPF> have risen 2.6 percent this week, compared with a rise of 1.8 percent for the bigger companies in the S&P Financials <.GSPF> index.

The Fed system is composed of the board of governors in Washington and 12 regional banks around the country, including in New York. Regional Fed banks contribute to monetary policy decisions, supervise banks in their districts, and conduct economic research.

The bill unveiled by Dodd, chairman of the Senate Banking Committee, would expand the Fed's authority over larger banks and put some large non-bank financial firms under the Fed's watch. But it would give authority over smaller banks to the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency.

Hoenig told the bankers' group the vocal opposition from the Fed was not driven by the idea of simply protecting our 'turf,' but instead was driven by a desire to serve the best interests of the nation.

Speaking at the same conference, FDIC Chairman Sheila Bair said her agency was not taking a position on Dodd's proposal.

The bank regulatory provisions are part of a broader bill to rewrite financial rules that Dodd is trying to push through the Senate. The House of Representatives passed its own bill in December, which would not strip the Fed of small bank oversight.

If the Senate approves a bill, it would have to be reconciled with the House measure.

Regulatory reform is a top priority for the White House after the worst financial crash in generations pushed the economy through a punishing recession. The Fed has come under extensive criticism for regulatory lapses that are seen as laying the groundwork for the crisis.

(Additional reporting by Caroline Valetkevitch; Editing by Leslie Adler)

Ben Bernanke