Members of the Federal Advisory Council “continue to have concerns about the uncertainty and confusion generated by the significant differences between the analysis utilized by the Federal Reserve” in its stress-test models and those “utilized by the participating banks in their own models,” said the memo of the May 11 meeting released today by the Fed.

“Those disparities place bank boards in a highly vulnerable position,” the memo said. “Board members are literally compelled to ‘fly blind,’ in effect guessing about high-stakes capital distribution decisions that can tip the balance between the success of passing” the stress test and “the market punishment associated with failure.”

Tension between banks and regulators has grown as agencies begin to implement new rules under the Dodd-Frank Act requiring banks to raise capital, curtail risk and rein in compensation. The Fed in March completed its most recent stress test, which it calls the Comprehensive Capital Analysis and Review or “CCAR,” and published its own test results for the 19 largest U.S. financial institutions.

The KBW Bank Index, which tracks 24 large U.S. and regional banks, fell about 0.9 percent to 43.22 at 12:40 p.m. in New York. The Standard and Poor’s 500 Index fell about 0.2 percent to 1,322.84.

Bankers Complain

The bankers complained that Basel III liquidity requirements would result in banks selling holdings of government agency securities and reducing certain deposits by as much as $1 trillion. The bankers said the proposed liquidity ratios create an incentive to hold government securities even if other assets are more liquid and carry less risk.

The Fed on June 8 proposed capital rules under the terms of Basel III. The regulators didn’t include liquidity rules agreed to by Basel two years ago and are reworking them for a later release.

The bankers said some aspects of U.S. and global regulatory reform “could add to the risk of spillover and contagion effects.” They complained that a “consistent bias” against non-U.S. sovereign debt could disrupt “global efforts to mitigate systemic risk.”

Volcker Rule

Regulators have exempted U.S. government debt from regulations such as the Volcker Rule limit on proprietary trading and the single-counterparty credit limits while not extending such loopholes to non-U.S. sovereign debt.

The council meets four times a year and includes one banker from each of the Fed’s 12 districts. Members this year include Vikram Pandit, Citigroup Inc. chief executive officer; James Rohr, chairman and chief executive officer of PNC Financial Services Group; and Richard Fairbank, chairman and chief executive officer of Capital One Financial Corp.

Fed Chairman Ben S. Bernanke, Vice Chairman Janet Yellen, and Governor Daniel Tarullo, who is leading the Fed’s supervisory efforts, attended the meeting, according to the memo.