By Alexandra Alper
WASHINGTON (Reuters) - Consumer groups will try to convince the Federal Reserve this week that rubber stamping the Capital One Financial Corp <COF.N> takeover of ING Groep NV's <ING.AS> online banking unit would prove that "too big to fail" is alive and well.
The Fed is holding the first of three nationwide hearings on Tuesday on the $9 billion deal that observers are characterizing as a test case for how the U.S. government will view big-bank mergers after the 2007-2009 financial crisis.
During the crisis, U.S. taxpayers extended multibillion-dollar bailouts to large banks whose failure could have brought the financial system to its knees.
Last year's Dodd-Frank financial oversight law did not force regulators to break up big banks, but instructed them to closely scrutinize future mergers.
Capital One stands to become the 7th-largest U.S. bank with more than $320 billion in assets if it acquires ING and HSBC Holding Plc's <HSBA.L> U.S. credit card business, which it announced in August, according to SNL Financial.
"It is one thing for a $20 billion bank to fail. We'll feel a ripple, there will be hand-wringing," said John Taylor of the National Community Reinvestment Coalition, who has led the charge against the merger and will testify in Washington on Tuesday. "When a $300 billion bank fails, that is a threat to our system."
Tuesday will mark the Fed's first public hearings on a merger since Bank of America Corp <BAC.N> acquired Countrywide in 2008.
Representative Barney Frank, the top Democrat on the House Financial Services Committee, last month said the deal needed a tough review and asked the Fed to hold public hearings.
"An important subject like this ought to be dealt with with as much chance for public input and as transparently as possible," Frank said in an interview with Reuters.
Community groups are eager to weigh in.
"(The Fed has) signaled that 'too big to fail' is a very serious issue," said Bartlett Naylor, a financial policy advocate at Public Citizen's Congress Watch division. "I hope they are shaken by their failure to prevent the financial crash."
DOES SIZE EQUAL SYSTEMIC?
Dodd-Frank requires U.S. regulators to now take systemic risk into account when evaluating a merger, in addition to public benefit, concentration of resources, unfair competition and other factors.
McLean, Virginia-based Capital One gets over half of its revenue from credit cards and would access about $80 billion in deposits and 7 million new customers from ING.
Some industry experts say the deal could produce benefits.
Karen Petrou, managing partner of Federal Financial Analytics, said the merger would make Capital One less risky by diversifying the credit-card focused company and giving it more access to capital.
She also pointed out that the Dutch government -- which bailed out ING in 2008 -- told it to sell its U.S. portfolio.
"The only entities that can acquire so large a portfolio are big banks," she said. "Size is not a good criterion of systemic risk."
Some community groups will testify on Tuesday in support of the merger.
But Taylor says neither company has a good enough track record to be trusted with growing larger.
Capital One, "had to be bailed out, they are buying another bank that had to be bailed out even more and they have essentially a mono-line approach to banking, which means all their eggs are in one basket," he said.
Capital One received a federal bailout of about $3.5 billion during the financial crisis, while ING received about 10 billion euros from the Dutch government.
Capital One has vigorously defended the merger. Last week, chief executive Richard Fairbank said the deal does not create enough systemic risk to warrant scrapping it.
"If you look at the criteria for systemic risk, the answer is no, no, no, no, no on the long-list of items," Fairbank said at the Barclays Capital financial services conference in New York.
The Fed has signaled it will take a nuanced approach in its review.
In a speech on September 15, Federal Reserve Governor Daniel Tarullo said the Fed will not automatically block mergers if they increase risk to the financial system.
"While Congress instructed us to consider the extent to which a proposed acquisition would pose a greater risk to financial stability, it clearly did not instruct us to reject an acquisition simply because there would be any increase in such risks," he said at a conference hosted by the Federal Reserve.
(Editing by Andre Grenon)